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  1. 1. 20 Cover story: Nouriel roubiNi n tio The bigger picture encompassing global economics is a must- have for hedge fund managers, discovers Margie Lindsay. Ticking economic timebomb uc Nouriel Roubini is an economist to global forces, it’s critical to have to them and predict them is Rou- be reckoned with. His outspoken that global view. Bottom-up stock- bini’s forte. “It’s absolutely critical and acerbic comments on the picking becomes much harder.” for proper asset management and od world’s economic woes may have Roubini believes his expertise is also risk management,” he declares. earned him the nickname Doctor what hedge funds need. “Anybody He believes the “more sophis- Doom, but his pronouncements and who does any asset management ticated” hedge funds think this forecasts are uncannily accurate. needs to know and understand the way. “Everybody thinks about Through Roubini Global Eco- macro and top-down – the link- tail risk but the question is do nomics (RGE), an independent ages across countries and not just you have the internal exper- global macroeconomic and market individual countries. You need to tise to do so?” he questions. strategy research company he co- know what happens in Greece can There are multiple kinds of tail pr founded, he has come into the orbit affect the global economy and finan- risk. “It’s critical to identify which of hedge funds, advising some of cial market. I think a macro global kind of tail risk you are worrying the biggest names in the business. view is critical [for hedge funds].” about. Is it tail risks of high or low It is no wonder hedge fund man- inflation, of deflation? Are you wor- agers are eager for his opinions in The real deal rying about tail risk of a double-dip order to understand the bigger eco- Leaving aside the self-promotion, recession? Of another global financial nomic picture. Roubini has advised Roubini is the real deal. His analysis crisis?” Roubini believes managers re US presidents, joining the Clinton is exactly what hedge funds need first need to identify what those administration in 1998 as a senior in these uncertain and challenging tail risks actually are and where economist in the White House times. Roubini’s take on tail risk, for they are most likely to occur and council of economic advisers and example, is fundamentally different over what time horizon. Only then then later moving to the Treasury as from that of most economists. can a manager select the best tools a senior adviser to Timothy Geithner, The first chapter of Roubini’s and strategy to hedge the risks. then undersecretary for international Crisis Economics starts off with a But what perhaps Roubini is or affairs and now Treasury secretary new take on tail risk. Where most most known for is his pronounce- in the Obama administration. see black swans, Roubini sees white. ments on the general global eco- RGE, stresses Roubini, is not just “A black swan event is something nomic picture. As a self-confessed him. The company provides global like a random tornado or earth- ‘global nomad’ he can travel, liter- economic analysis on all the major quake. It’s unpredictable,” he says. ally, around the world several times economies of the world including White swans are what everyone a year. His peripatetic lifestyle is advanced economies, emerging should be worried about. “Tail events his way of “connecting the dots”. tf markets and some of the more are always the result of a build-up The interrelatedness of events, exotic frontier ones. A strategy team over time of macro, fiscal, financial situations, actions and reactions is essentially provides market ideas, policies. The mistakes reach a tipping what makes it possible to forecast the asset implications and global asset point. Therefore, they are, to some future with a degree of accurateness. allocation throughout all the major measure, predictable, even if the Ever since Roubini’s identificationNo asset classes – equity, credit, foreign timing of them is sometimes hard. of the US housing crisis, including exchange and commodities – derived “Our entire approach is based on the demise of international banks, from the overall macroeconomic trying to identify those build-ups, long before the event, few dismiss analysis. “It is a top-down approach those vulnerabilities that will lead his approach. This ability to take a to asset allocation,” says Roubini. to these white swan events or tail disparate set of seemingly uncon- From this is derived the fundamental risk or whatever you want to call nected events and facts and come up economic macroeconomic analysis. them. The world is not one of normal with a coherent story and prognosis Within that framework, Rou- distribution of events but is one in is what Roubini is startlingly good at bini expands on his own view which there are big fat tails. There- – and why people consult with him. of the world. This is what people fore, those fat tails have a massive Looking at 2012 he has formulated are clamouring to hear. “Because effect on asset performance.” Being some “baseline views”. Although the headwinds are coming from able to recognise the forces that lead many may think a presidential elec- Hedge Funds review    February 2012
  2. 2. 21 Cover story: Nouriel roubiNi n tio Alex Towle uc od pr re or tfNo “Deleveraging has barely started for households, for governments, for banks, for financial institutions and even for the corporate sector. We see a hard slog of well below-trend dynamic growth for many more years and with the risk of an outright downturn.” Nouriel Roubini Hedge Funds review    February 2012
  3. 3. 22 Cover story: Nouriel roubiNi Read more online For similar articles go to: n tio Alex Towle “A world where there is weak economic growth in advanced economies and economic challenges for some emerging markets is a world that is also politically and geopolitically more uncertain and more unstable.” uc Nouriel Roubini tion in the US could change policy, Roubini is not so sure. He expects the painful process of deleveraging od to continue with less spending and more saving across the board. He expects five to 10 years of below- trend economic growth for the US. “The story is the same, but it’s only going to be worse,” he notes. In 2010 US economic growth was 2.7%. In 2011 growth will also be below trend, pr not reaching 2%. For 2012 his base- line, 50/50 prediction is 1.4% growth if the US is to avoid recession. But he cautions that internal and external shocks (like a eurozone meltdown) In short it is not a question of the petitiveness with larger external would lead to “an outright double- leadership of President Obama or current account deficits. Restruc- re dip recession in the case of the US”. a new Republican presidency. “It’s turing has to be an option for the six He does not believe the US can not an issue about anything else. We problem countries: Greece, Ireland, avoid a recession. “It’s never black have a gridlock political system,” he Portugal, Italy, Spain and Cyprus. and white. Our baseline is 50% prob- says. He admits the relative power The contagion, he says, has spread ability of a recession and a really and economic performance of the US beyond the periphery to the core, low probability on the upside of is also declining relatively because including France and Belgium and having growth at potential or above there are rising powers in the world he believes it is only a matter of or potential. There are some external such as China, India and others. time before it engulfs Germany. shocks that are not under the control “It’s not just a relative decline If one of the larger countries like of the US. If the eurozone develop- but an absolute decline if we’re Spain or Italy were forced to exit the ments were to become disorderly, not going to start soon enough eurozone, that for Roubini is effec- then the US could have a double- with a wide range of policies tively a break-up of the monetary dip recession even if the domestic to restore the competitiveness union. “But that’s going to take at fundamentals were to be better.” and the productivity growth of least two or three years to mate- tf One big question mark hanging the US. That’s what is at risk.” rialise, if it’s going to materialise. over the US has to do with policy It is complex. Analysis starts It’s not going to happen in 2012.” responses. “There is a big question on with macro fundamentals and However, “at least a couple of how large the fiscal drag in the US will balance sheets that lead to them, or the smaller ones, are going be. This depends on policies and Con- macro developments, to indig- for sure to exit the eurozone. ThereNo gressmen. Fiscal drag could be signifi- enous policy responses. He admits: is a 40% plus probability that even cant and could bring the economy “Our view is certainly still more Italy or Spain eventually will leave. close to stall speed if not a recession. bearish than consensus.” I’m speaking about two or three “Then there is what might years from now, not in the next happen to the labour market, to Eurozone frustrations 12 months if they don’t succeed housing, to consumers. What’s For the eurozone, Roubini seems in doing what they need to do.” going to happen to China? What is to be as frustrated as the rest of the The probability that the Germans the impact a slowdown in Asia as world. “It’s a slow-motion train- will accept massive monetary easing, an external factor will have? How wreck,” he says. There is too much a fiscal stimulus in the core, a 30% fast can the policy response by the private and public debt. There is a weaker euro and either debt neutrali- Fed be? How effective will it be?” lack of growth and a loss of com- sation and/or the European Centre Hedge Funds review    February 2012
  4. 4. 23 Read more online For similar articles go to: Cover story: Nouriel roubiNi nn tio Bank providing support to the sover- that need to be taken into account. ties. “There is a correlation between eigns, says Roubini, is “close to zero”. “A variety of macro, financial and economic, fiscal and financial Germany, he notes, wants the rest structural reforms are needed. Even uncertainty and security, social and of Europe to have several years of the high growth of [the Brics] cannot political instability,” he warns. sacrifices until it becomes like Ger- be taken for granted. China could uc many. “My worry is that strategy, have a hard landing. India may not Social dynamics without a more systematic adjust- do the structural reforms that imply Just as complex as the economic ment and restoration of growth in the high economic growth. Russia is not dynamic is the social side of the next few months, implies a recession diversifying and its potential growth equation. “In the Arab world you becomes a near depression. Then now looks like 4% rather than the have the Arab Spring, in the US you politically it’s unsustainable because 7% to 8% it had for a decade.” had Occupy Wall Street, in London you’ve already had three years of On top of all this economic you had riots, in Germany they were od recession in the eurozone. There gloom come the social uncertain- smashing the cars of the fat cats. In will be another recession in 2012. Another three or five years is not going to be politically acceptable.” The outlook for the rest of the Roubini’s wisdom developed world brings little relief. What advice would you give … Although he believes advanced economies, compared with Angela Merkel, German Chancellor kind of technologies that increase productivity growth over If the objective is to maintain the eurozone rather than a the long run. Those have to be the priorities in the long run pr emerging markets, have better fun- break-up, you need a massive monetary stimulus by the ECB of any administration. damentals, getting back to ‘normal’ [European Central Bank], zero interest rates, quantitative The average American is probably centrist on most issues will be a multi-year process. easing and then credit easing. You need the ECB to become but the two parties are becoming more radicalised and more “It may take another five years a lender of last resort. You need the value of the euro to fall divided. There’s gridlock and either one can veto [initiatives] or more. Deleveraging has barely another 30% to parity with the US dollar. because nobody has 60 votes in the Senate. started for households, for gov- You need fiscal stimulus in Germany and in the core… Republicans can veto tax increases, Democrats can veto Germany will have to accept maybe a few years of inflation entitlement reforms and on all the other issues the two ernments, for banks, for financial re being 3%-4% rather than only 2%. Germany has to accept parties are so radically polarised that the problem is that if institutions and even for the cor- an asymmetric adjustment in the eurozone so you cannot Obama’s elected or a Republican, whoever is president… is porate sector. We see a hard slog of just impose austerity on the periphery and have an internal not going to have 60 votes in the Senate and unless you have well below-trend dynamic growth devaluation with inflation in the periphery. That’s a recipe 60 votes in the Senate, you’re not going to be able to pass for many more years and with the for disaster: from recession comes depression. legislation on infrastructure, on energy, on climate change, risk of an outright downturn.” If you want to have balanced return to growth, your deficits on fiscal measures, on investing in infrastructure – on all the on the periphery on the trade side have to shrink but they things we need. Looking at emerging markets, have to shrink because the surpluses of Germany and the Unfortunately, it’s not the question of the leadership of an Roubini is only slightly more upbeat. core shrink as well. Obama or a Republican. We have a gridlock political system. or He believes emerging markets have Everybody is talking about financing and providing only partially decoupled. Although money to the periphery for growth. The flow problems are Chinese politburo they have robust growth, the “tail- as important, more important. You have to reduce the trade It’s clear that the growth model of China is not sustainable… winds coming from the eurozone deficit and you have to restore growth. Because if you don’t It’s a model of growth where consumption’s only one third get growth going in the eurozone, soon enough there’ll of GDP, savings are more than 50% of the GDP. For a more and US” will force a slowdown and be a political backlash against the austerity. Second, more balanced, sustainable growth rate, exports have to fall, fixed lower growth in 2012. “The decou- importantly, you’re trying to stabilise deficits and debts both investment has to fall, the savings have to fall and consump- pling is only partial… when the US tf private and public, domestic and foreign as a share of GDP. If tion has to rise and so will GDP. That’s the biggest challenge sneezes, the whole world catches a GDP keeps on falling, your debt ratios are going to explode, for China. If they don’t do it fast enough, then by 2013 or cold, including emerging markets.” even if you’re trying to deal with the flow deficit. 2014 you could have a hard landing in China. He sets growth rates for emerging So it cannot be just fiscal austerity. Because no country in the world can be so productive every year, you take half of your GDP and invest it into new markets at anything between 4% US President Barack Obama  capital stock whether it’s commercial, residential real estate to 8% with “maybe an average of There is short-term advice and there’s long-term advice. I or infrastructure or in an industrial manufacturing capacity.No 6%”. The deleveraging in advanced think that on the fiscal side the US needs a massive short- You’re now going to have three underlying problems. One economics could be another five term fiscal stimulus because the economy’s weak. We need a is a huge number of NPLs [non-performing loans] in your years at least before there is anything trillion-dollar infrastructure spending programme to restore banking system. We estimate that public debt in China is resembling potential growth, he our crumbling infrastructure. We need to invest in educa- already 80% of GDP. tion, human capital, skills. The official number is 17% but that’s only the central predicts. “The secular higher growth We don’t need an industrial policy but a growth policy government. You have to add all the provincial debt, the of the emerging markets is more that re-emphasises the importance of manufacturing not debt of the thousands of SPVs [special purpose vehicles] that like a 10 to 20-year phenomenon.” just services. finance the local infrastructure, the railway ministry debt, Even that, he cautions, cannot be We have to invest. In the last 30 years, we’ve over- the policies of development, bank debt and the corporate taken for granted. It is not just about invested in the less productive forms of capital for housing. bonds. If you add it all up today, it’s already 80%. the Brics (Brazil, Russia, India and Maybe, too, an excessive amount of talent has been going Every single episode in the last 50 years of an investment into the financial sector. We’ve under-invested in infrastruc- boom has ended up in a hard landing. There is not a single China), he says, pointing out that ture, in human capital, in productive business and into the episode of a soft landing. there are 50-60 emerging markets Hedge Funds review    February 2012
  5. 5. 24 Cover story: Nouriel roubiNi Read more online For similar articles go to: n Israel, it’s the middle class saying ‘I Alex Towle tio can’t afford a home’. In Italy it’s the students saying ‘I cannot afford a good education’. In India it’s the anti- corruption drive. In Russia it’s the resentment against the Putin regime.” Even where the streets are off-limit for protests, people have computers and are able to demonstrate vocally uc and publicly their dissatisfac- tion. This, he believes, will mean governments will not be able to ignore the opinions of the masses. The common factors binding rich and poor countries are many and varied: economic and finan- od cial insecurity, people unsure about their jobs and futures. “They’re not sure if their chil- dren are going to be better off than they are. There’s a lot of poverty, lots of unemployment. At the same time there’s been a massive pr increase in income and wealth and inequality within advanced economies, within emerging run we’re dead’ is the expression. But strategy that preserves capital. markets – across all countries. maybe it’s the opposite: in the long Although he believes hedge funds “These factors are a source of run, actually, if we survive, we can be attract a lot of the best and brightest, social and political instability that doing very well. The problem is we’re when times are volatile it is hard to manifests in different forms in dif- going to be alive in the short term.” manage money. “People like volatility re ferent countries. A world where The trick is to avoid being dead when it goes all in one direction. there is weak economic growth in in the short term and for Rou- When it’s just a zigzag or a yo-yo, advanced economies and economic bini that means avoiding another it’s much harder to make money. challenges for some emerging financial/economic crisis. If the That’s the kind of volatilities we’re markets is a world that is also world can do that, the benefits of facing right now. There are more politically and geopolitically more the long term may materialise. challenging events out there.” uncertain and more unstable.” Just as one senses a glimmer of While the various scenarios he puts or While Roubini believes globalisa- a silver lining, however, Roubini forward give little comfort, Roubini tion can be a force for greater eco- extinguishes the light. There are also seems to relish the challenge of living nomic performance, this will only be long-term issues: demographic aging through challenging times. Times the case “as long as the side effects of in advanced economies, fiscal chal- are a bit too interesting and too vola- inequality are addressed”, he worries. lenges coming from that, pressure tile, he admits. “That’s why I wake If emerging economies can rely on resources and other factors that up these days at five in the morning more on domestic demand rather in the long term “can go both ways”. to see what’s going on in Europe. I tf than just exporting to advance While he admits it is a world of start tweeting at six in the morning economies for growth, the future uncertainty, “we could be right about it because you cannot have may not be so dark. There would and the world is going to turn out the luxury of waiting until eight or not be a backlash against globalisa- to be as bleak as we expect or the nine. Today it’s a 24/7 clock of news. tion and free trade if it is beneficial. world could actually improve.” Even over the weekends becauseNo More trade in goods and services, in But Roubini has little faith in of policy crisis and meetings.” migration of labour and capital, in that scenario. “We’re going to have For Roubini the crisis will continue. technology and information – these higher returns on risky assets for His definition of a crisis is “when are the elements Roubini believes the next five to 10 years. And then policymakers have to huddle together will sell the concept of globalisation. you’ll have plenty of time to jump over the weekend and make a deci- “So there are some negatives and on the bandwagon. Today we’re at sion before the opening of markets in there are some positives. Many of the peak of that fog of uncertainty.” Asia. And by that definition we’re still the positives are about the medium So for investors (and hedge funds) deep into crisis. Many more of those and long term,” he says. “’In the long he advocates a defensive plan, a weekends are going to happen.” ■ Hedge Funds review    February 2012