Roubini Warns of New Financial Crisis

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Nouriel Roubini, the New York University economist who called the 2007 banking crisis with scary precision, thinks another financial bubble is forming.

This one is being fueled by investors borrowing U.S. dollars to stock up on emerging market equities and commodities. That amounts to “the mother of all carry trades,” he said today at a conference in South Africa, alluding to the practice of borrowing at lower interest rates to buy currencies or other assets at a higher rate.

Trouble is, the value of the greenback is dropping, amid a sharp rise in the currencies of developing nations. That trend is likely to continue as the Federal Reserve starts to raise interest rates and eventually weans the financial sector off government aid. In turn, investors could be forced to bail out of the dollar.

Everybody’s playing the same game and this game is becoming dangerous. . . . The risk is that we are planting the seeds of the next financial crisis. This asset bubble is totally inconsistent with a weaker recovery of economic and financial fundamentals.

Roubini said this latest bubble may inflate for another couple years before popping, as dollars continue to flood into emerging markets.

Anyone up for some bullion?

Alain Sherter is an award-winning business journalist who has written for The Deal and Thomson Financial Media.

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1

Daniel M. Harrison

10/27/09 | Report as spam

RE: Roubini Warns of New Financial Crisis

Nice piece, Alain.

You know, the biggest problem with these kinds of "star analysts/economists" is that most of them have no idea when to shut their mouths. Roubini has next to no knowledge of how emerging markets function, the drivers behind their performance, or these countries' Schizophrenic relationships to the dollar, gold etc.

Roubini said "things could get much worse" back in March this year. While I'm not entirely in disagreement, the wider berth of his recent comments do smack of defensiveness a little. What's your take here?
2

Alain Sherter

10/27/09 | Report as spam

RE: Roubini Warns of New Financial Crisis

Thanks, Daniel. What makes you say Roubini
doesn't understand emerging markets? While he
certainly wasn't alone in warning about threats to
the U.S. economy, there's little questioning his
acuity on domestic economic affairs.

Roubini's generally bullish about prospects for
developing countries. Here he's making what seems
to me a commonsensical argument about the risks
of carry-trading. I think he's right. Investors
leveraging up on dollars to buy into, say, Kazakh oil,
risk taking a beating if the greenback goes south in
a hurry.

You don't have be to prophetic to predict that, but it
bears mentioning. You disagree?
3

Daniel M. Harrison

10/28/09 | Report as spam

RE: Roubini Warns of New Financial Crisis

FX equations are always a part of macro-investing, and are best left unsimplified a lot of the time (unfortunately). What Roubini is trying to do is over-simplify a very complex and rapidly-changing supply/demand equation which is affected by a lot more than the relative weakness of the dollar right now.

Roubini is being irresponsible rather than commonsensical (as you suggest) here, in my opinion. Statements such as "we're planting the seeds of the next financial crisis" are so historically unverifiable in terms of carry-trade activity, they show little understanding of the way in which equity, commodity and FX cycles interact in the EM space.
4

Alain Sherter

10/28/09 | Report as spam

RE: Roubini Warns of New Financial Crisis

Except that there's ample precedent for
understanding how carry trade activity creates the
conditions for crisis.

For instance, huge yen purchases earlier this
decade were plowed back into subprime mortgages
and other risky assets. When credit tightened in '07,
investors got caught with their pants down. They
were dumping their yen-denominated investments
and loans at whatever knockdown price they could
get, pushing asset valuations down even further.

That said, I think you're right that Noubini is
simplifying a complex financial phenomenon,
especially as it affects emerging countries. But the
broader pattern is relatively straightforward. Carry
trades are fine so long as interest rates are low,
exchange rates are stable and there's ample
demand for the asset of choice. But when conditions
turn bad in a hurry, those trades raise the risk of
currency crashes.

I don't worship at the altar of Roubini, unlike some
folks. But I think he's generally been proved correct
in recent years.
5

ericmeyerson

10/28/09 | Report as spam

RE: Roubini Warns of New Financial Crisis

"Anyone up for some bullion?"

Correct me if I'm wrong, but couldn't one consider gold to be an emerging market commodity by this point? It is up ~40% in the last 12 months.
6

Daniel M. Harrison

10/28/09 | Report as spam

RE: Roubini Warns of New Financial Crisis

"For instance, huge yen purchases earlier this
decade were plowed back into subprime mortgages
and other risky assets."

Alain -- In my opinion, much of this is just financial media myth-making. I've never seen any hard evidence to back it up, and I have never met a debt trader who borrowed in Japan and carried the debt over to the U.S. to buy credit derivatives. Rather, cheap Japanese debt was used to prop up the prices of emerging market bonds, and that trade certainly didn't cause the financial crisis. If what you are suggesting is true then surely Japanese retail investors and banks would have been much more wounded than they were by the uptick in subprime loan defaults (instead they were busy buying U.S. banks this time last year)?

ericmeyerson -- I think yours is an interesting point, and certainly true to a large extent. Physical gold speculation is rampant in parts of South Asia such as Thailand and Indonesia (which don't have paper contracts), and a lot easier for investors there to get their heads around than is stock investing. (I have actually witnessed this physical trading before; there is just piles of the metal sitting in entrepreneur's studies!) In this sense, gold became an emerging market commodity more than a developed market one back as far as 2003/4. Gold also has a much higher relevance as an inflation hedge for faster-growing Asia than it does for the U.S. and Europe right now, and it's become a sensible currency hedge for the Chinese since the introduction of paper contracts in Shanghai back in 2007.
7

connoblehill

11/06/09 | Report as spam

RE: Roubini Warns of New Financial Crisis

They should only listen to forecasters who flagged the financial crisis before it happened. I do not want to listen to the 20/20 hindsight 'prophets'.