'I am not Dr Doom'

The economist who predicted the crippling meltdown supports Obama's stimulus packages and believes banks in trouble should be nationalised

Lally Weymouth of Newsweek and The Post sat down last week with economist Nouriel Roubini. Excerpts:

QUESTION: You are the economist known for predicting the economic downturn in 2008. What do you believe is happening to the economy today?

Nouriel Roubini: The consensus among economists is that they see the economy that was contracting for the last two quarters at six per cent going into positive economic growth by the second half of this year... I believe that the rate of economic contraction is going to slow from negative six per cent in the last two quarters to negative two per cent by the fourth quarter.

Next year, I believe that the growth rate is going to be low - 0.5 per cent for the United States, compared to the consensus view of (plus) two per cent.

I believe the unemployment rate this year is going to go well above 10 per cent and will be well above 11 per cent next year, so even if we are technically out of a recession, we are going to feel like we are in a recession.

I do agree that there is an improvement in the sense that the rate of contraction is not going to be as much as it has been in the last couple of quarters, but I still believe that the bottom of the economy (will be seen) toward the beginning or middle of next year. So my views are more bearish than the consensus.

I believe things are going to be very mediocre throughout the world; in particular, in Europe and in Japan. They will only get out of their recession toward the end of next year.

So you are still Dr Doom?

No, I am not Dr Doom. I am Dr Realist. I don't believe we are going to end up in a near-depression. Six months ago I was more worried about an L-shaped near-depression. Today, after the very aggressive policy actions taken by the United States and other countries... we are, instead, in the middle of a U [shaped recession].

You think the Obama administration is on the right track with the stimulus packages and chairman of the Federal Reserve Ben Bernacke pumping money into the system?

Yes, I have to give credit to the administration. Within 30 days of coming to power, they did an $800 billion (Dh2.9 trillion) stimulus package, a new programme to deal with mortgages and foreclosures, and also a bank plan that, when Treasury Secretary Tim Geithner came with details, made the markets rally sharply.

Again, the glass is only half full because in order to do things with speed, they did not do them perfectly. Each one of these three programmes has some flaws. The fiscal stimulus could have been more front-loaded. For the mortgages, eventually you are going to need the reduction of the face-value principal of the mortgages. And on the banks, I believe the PPIP (Public-Private Investment Programme) plan can work for banks that are solvent.

But... after the stress tests, it is going to be obvious that even some of the largest banks are so fundamentally in trouble that you cannot buy their toxic assets. You need to take over these banks on a temporary basis, clean them up and then sell them back to the private sector.

You have to nationalise these banks?

Yes, if you do not like the dirty N-word, you can call it a temporary takeover. Nobody is in favour of permanent government ownership of the financial system. But we might need to do it on a temporary basis.

How do you feel about the deficit that the Obama administration is building up?

In the short term I am supportive of it, because if we didn't have these fiscal deficits, the recession would become a depression. I think we need to stimulate demand in a situation in which every component of aggregate demand is sharply falling - consumption, residential, inventory, exports. On the other side, I do agree that this is not a free lunch.

What is going to fuel the next growth cycle?

That is a difficult question because the periods of high growth in the United States in the last 25 years have been characterised by an asset and credit bubble. The real estate bubble of the '80s ended up with pain in the (savings-and-loan) crisis. Then came the tech bubble, which ended up in another crash and led to a recession. And now we have this more generalised housing and credit bubble, which ended up in a big disaster...

We have to switch our capital into things that are more productive and more stable in terms of social growth. That is going to be a challenge. And the potential growth rate might fall to a much lower rate.

Do you believe this is a bear-market rally or do you think it is the market anticipating an economic recovery?

I do believe it is a bear-market rally... We have seen this cycle of bear-market rallies. It is true that as time goes by, it is possible that the latest low is going to be the true low... As we reach newer lows we may be closer to a level of the market that is fundamentally right. A year ago we were not as close to a true bottom. Today we are closer to it.

Do you worry about China getting tired of holding our bonds?

In the short run, China has no option but to accumulate dollar reserves. Why? Because if they stop doing that, their currency would appreciate sharply while their exports are plunging. China cannot afford to let its currency appreciate any further, and to prevent the appreciation given their current and capital accounts they have to buy another $300 (billion) or $400 billion of reserves this year alone.

But I have seen a huge number of new initiatives in the last month after China expressed its worries that suggest they are pushing for the yuan to become an international currency and a reserve currency...

They want to create a yuan zone in Asia. They are pushing for inter-Asian trade to be conducted in yuan. They are taking several steps that will lead their own currency to become an international currency.

Over time, they are moving away from the dollar?

Yes, slowly they will. In order to move away from the dollar, first they have to establish their own currency as an international currency. That will take years, but already in a month they have done more than in the last 10 years.