Nouriel Roubini, an economist famed anticipating the global financial crisis, spoke with LatinFinance about his take on the global economy, reflecting on how China’s economic challenges could affect Latin America. The chairman and CEO of Roubini Macro Associates, widely known in the capital markets as Dr. Doom, is not totally gloomy on Latin America’s outlook. The interview was edited for length and clarity.
LatinFinance: First of all, let me ask you about the global economy. Are there any signs that it is turning the corner?
Nouriel Roubini: The global economy is a mixed bag. There was a surge in inflation in most advanced economies and most emerging markets, the exceptions being Japan and China. And in the last couple of years, central banks had to exit unconventional policy and normalize policy rates. The debate over the last year has been on whether this is going to be a soft landing, with a return to a 2% rate or whatever the target is without a recession, or whether it’s going to be bumpier with a shorter and shallower recession, or whether it will be a too hard landing with a severe recession and financial instability.
I would say the good news is that the risk of a real hard landing with a severe recession and financial instability looks like a tail risk. And whether there is a soft landing as opposed to a bumpy, short and shallow recession depends on the regions of the world. In the eurozone, you get two or three quarters of zero or slightly negative growth. Inflation is still above targets, and that’s why they had to hike again. There are these stagflation problems. On one side, inflation is high, and on the other growth is weak. The UK is in the same predicament, but inflation is actually even worse in the UK and growth is weakening as they’re showing a contraction, based on the latest number. So, I would say the eurozone and the UK are headed towards a bumpy landing.
China is in a structural, not just a cyclical, slowdown of growth. So, I don’t think they’ll achieve their 5% target. The potential may not be any better than 3% or 4% for the medium term.
“The good news is that the risk of a real hard landing with a severe recession and financial instability looks like a tail risk.”
The more benign story is the US, where so far in spite of the significant tightening by the Fed, the economy actually has slowed down a little bit, but not severely. The forecasts for growth in the third quarter [of this year] are above potential, and growth was slightly above potential both in the first and second quarters. So, you could make a case that the US is more likely than other regions to have a soft landing. But there are some uncertainties. There is now a further spike in energy prices. The Fed paused its rate hikes again in September. So, whether there’s going to be a sort of soft landing as opposed to a sharp and shallow recession, I think that’s an open question for the US even if the US looks a little bit better than other regions of the world. And luckily some of the financial stresses have been contained. The contagion from some of the regional banks on the financial system has been limited, in part because of quick action or the bailouts, and some of credit stresses in US and Europe are under control. There’s a bit of a credit crunch, but not a severe one for now.
LF: Do you think the Fed will need to raise rates further? When will we have interest rates that will allow companies access to more affordable financing?
NR: I would say that at most we will have another hike. You cannot rule out two hikes if inflation really surges again. But as of now, I would say at most another hike in November at the earliest. And then even if they stop hiking, the question is how long they’re going to stay on hold. For a while, the markets were expecting they would have cut rates already this year. They were expecting a recession. That did not occur. And I would say that given that inflation is still uncomfortably high, even if the Fed stops in November after another hike, maybe the Fed will keep rates at those levels through the middle of next year. Whether they’re ready to start cutting rates in the second quarter as opposed to the third quarter is going to depend on the data, but they’re going to reduce them only gradually. And the equilibrium Fed funds rate probably is not 2.5% anymore. It might be 3% or 3%-plus.
The European Central Bank may or may not be done. The signals are mixed. Inflation is high and their forecast for inflation is still meaningfully above target. They’ll stay on hold for another nine months, so it will be the middle of next year before they start cutting. But you never know. If inflation is persistent in the eurozone, they may need to hike once more. It’s unlikely, but it’s possible. In the UK, they may need at least another two or three hikes, even if now the signals from the Bank of England are dovish. Japan has not yet started policy normalization. China is the only one where there is significant additional easing because the economy is weak and they are in deflation or near deflation, so the monetary policy is easing. And, of course, those emerging markets that hiked sooner and faster when they saw a surge in inflation, they can maybe start now to afford to cut rates, and you have already seen a couple of examples in Latin America. But again, they have to do it slowly and gradually.
LF: A big concern for Latin America is China’s economic problems. Why should China’s struggles be a red flag for the region – and the world?
NR: This slowdown of growth in China is not cyclical, it is more structural. The potential growth may be as high as 4% or as little as 3%, depending on their policies. You have an aging population, you have a real estate overhang, you have significant amounts of debt and leverage both in the private sector that is real estate-related, but also in state-owned enterprises and in the financing vehicles of local governments. You have a bit of a backlash against a private sector with a whole bunch of controls and a return to state capitalism that is bashing technology and other sectors. So, there is a weakness in business and consumer confidence. Export growth is slowing down for both cyclical and structural reasons.
China needs to increase domestic demand, but government spending is limited by what the government is willing to do fiscally at the central level. This is limited because they don’t want to have an excessive fiscal expansion. Private investment is weak, confidence is weak. Attacks by the public sector have led to too much debt and leverage that has become excessive.
In order to increase consumption as a share of GDP, you need to reduce savings as a share of GDP. Savings are high for two reasons. The first is that there is the bashing of the private sector, and so people are cautious, and they want to save. And second, there are structural reasons why consumption rates are low and have been low in China for a long time, including a weak social safety net, which means that people have to save for old age for when they get sick, and for education or if they become unemployed. If you’re a migrant, you don’t have benefits in the cities where you work. So, for these reasons the share of labor income in GDP has been low, and that’s why consumption as a share of GDP is low. All of these factors together imply that potential growth is much lower.
LF: What spillover effects could this have on the global economy?
NR: China does a lot of trade. So, in the supply chains for goods, China is growing less and exporting less, and that affects countries like Japan and South Korea and others with strong consumer or even tech industries. In metals, a softening of growth will reduce that demand. China is an important part of global growth, so a slowdown in China affects a lot of global growth. European firms – more than Americans – export to China, and if China slows down, then some of their exports may suffer. And you have many foreign firms with investments in China, and so if Chinese growth slows then those investment opportunities, leaving aside all the political and geopolitical noise, might become less profitable.
LF: And how long can this structural slowdown last in China?
NR: If it’s structural, the potential growth of China is not in 5% anymore. It used to be 10%, then 5%, and now they will be lucky if it is 4%. And some people make the argument that China’s potential growth may be closer to 3%, depending on which of the policy actions they are going to take. They talk sometimes about opening up, but there seems to be more concern about security and control, especially by [President] Xi Jinping. There doesn’t seem to be an urgency to change economic policy so that it is more private-sector and market-friendly oriented, at least for now. So, I would expect that growth is potentially 3% to 4%, so for the next decade China may be growing only on average 3.5%, at best 4%. This is not something cyclical, it is structural for the long term.
“Some people make the argument that China’s potential growth may be closer to 3%”
LF: US-Chinese relations are tense and have been for a while. How could this affect the global economy, especially if tensions worsen?
NR: Of course, given a geopolitical rivalry, there is some degree of de-risking. People say it’s not decoupling, but de-risking. But that leads to potential for fragmentation. Both the US and China are going to have friends, allies, and both countries will be saying, “Either you’re with me or against me.” That puts Europe and others in an awkward situation. There are some sectors that are more critical, like tech and related stuff that is not of national security concern. It’s going to lead to a re-shoring or friend-shoring, and that friend-shoring can actually benefit those countries that can be part of a new supply chain that is less reliant on China and more on the friends and allies of the United States.
LF: Which markets stand to benefit from this friend-shoring?
NR: Some markets that will benefit are in Asia and some of them may also be in Latin America. Mexico and even some other parts of Latin America can benefit. So, it’s not all negative for the rest of the world, but of course, it means that we are emphasizing security over efficiency. We’re emphasizing just-in-case supply chains rather than just-in-time, and this is going to imply a higher cost of production. Of course, that fragmentation, depending on how severe it is, has an impact on global growth. Overall, this reduces potential global growth and increases the cost of production over time, but it also makes trade safer and more secure, even if not fully free.
LF: In Latin America, Brazil, Chile and a few other countries have started to cut interest rates. Could this increase the flow of capital into those countries as a result?
NR: There are portfolio flows, and there are foreign direct investment flows. I saw a recent media report that actually said that this year, FDI for Latin America was very large from all over the world. This was in spite of the fact that there was a slowdown of growth compared to last year as they were tightening rates, in spite of somehow higher interest rates and slower growth, including in Latin America. A lot of that FDI is not coming from China, it is coming from the US or Europe. A lot of it is going into commodities, into energy and into fossil fuels, not just renewable energy.
But there’s also interest in developing some of the green metals that are important in the green transition and electric vehicles and batteries, copper and lithium. There are meaningful reserves in the region. So, in spite of that tightness of financial conditions and in spite of some of the political noises in the region, there’s been a significant amount of inward investment, even in unstable countries like Argentina. From a macro point of view, FDI in energy and mining has been meaningful in Latin America. These are sectors that produce commodities that are priced in dollars, and you export them regardless of the domestic conditions.
If the global cycle of tightening in advanced economies and emerging markets is over, if nominal and real rates were to be falling, I would say that that would increase the economic growth of these countries. Higher rates slow down growth, but you need that to fight inflation. Inflation is coming under control, but it is still higher than target. Early action was taken by some of the central banks, but there’s still a question mark on whether they’re acting too soon in cutting rates. There are a few exceptions. Argentina is always problematic in terms of fiscal policy and inflation, and there is even a risk of a debt restructuring, if not default. Overall, I would say that eventually, probably by next year, by the middle of next year, the European Central Bank, the Fed and other major central banks are going to start to cut rates and that may allow these countries in Latin America to cut rates further, and therefore there will be inflation without the downward pressure on the currency, without the widening of the sovereign spreads, and stuff that will be negative if they do it by themselves when it’s too soon.
LF: Do you think that the rise in commodity prices will help the region? Can it last?
NR: It seems there is now a little bit of a commodity boom. Demand for even some traditional fossil fuels is higher, demand for renewable energies is higher, demand for green metals is higher, demand for food and other things like fertilizer is higher. Those prices doubled after COVID. Of course, there was a correction last year and there is the expectation of a slowdown of global growth. But still, oil is now above $90 per barrel. The demand for many of these green metals is going to increase. The question is how fast you can ramp up supply of these things. But overall, there is a little bit of a still semi-circular commodity boom that may last for a while given the demand is going to be robust and supply is going to grow only moderately. And that’s an opportunity for some parts of Latin America to benefit if they are intelligent enough to ride the commodity cycle to attract investment: private, public, domestic, foreign.
LF: If China could be on track to buy less in commodities, where will the new demand come from going forward?
NR: It’s almost like there’s been a shift, in particular when we look at the IRA [Inflation Reduction Act] in the US. There’s been a shift in commodity demand. Whereas China was a big buyer, now we have Europe and the US buying more commodities. So, it’s almost like this mini commodity boom or the start of it will be beneficial regardless of China’s problems. If China has a very sharp slowdown, you might have some additional correction in commodity prices. But I would say demand for renewable energy is going to continue as there is a transition from fossil fuel to the new normal of clean energy. Even the demand for fossil fuels is still strong in spite of all the talk about reducing the reliance on fossil fuels.
The goal of a lot of Latin America is to try to maximize how much they can produce and ride that wave up until eventually there is peak demand and a reduction. Demand for stuff related to the green transition, like green metals, is going to be high. Food prices will probably be high because of climate change, as there will be some supply shocks, let alone the geopolitics, like Russia and Ukraine.
“Latin America has a comparative advantage in a wide range of commodities.”
Overall, with some caveats, demand for commodities will outstrip supply, and therefore the prices may be higher and that may be a positive in terms of the trade impact for those countries that are overall commodity producers and exporters. And Latin America has a comparative advantage in a wide range of commodities.
LF: You mentioned that one of the keys for Latin America, especially those that are exporting commodities, is to make sure they run their economies intelligently and their policies intelligently. What does that entail?
NR: It’s a combination of macro stability and policies that increase growth while being sustainable and inclusive. So, on the macro side, if you can maintain credibility on inflation and low inflation, all in all you will do well. If you have a fiscal policy that is reasonable in terms of limiting excessive spending or having the right access to finance that spending so that debt and deficits don’t rise too much, that is good. If debt and deficits rise too much, they can crowd out economic growth, they can lead to monetary expansion and cause inflation, and they can become unsustainable and lead to debt crises. The macro policy framework in terms of monetary policy, fiscal policy, and having a sustainable private and public, avoiding large twin current account and fiscal deficits and misaligned currencies, all those things are relevant. But in order to increase potential growth, that type of stability is necessary, but it’s not sufficient. You need a whole spectrum of structural reform to invest in your comparative advantages and you need greater openness to trade, greater diversification away from just natural resources, you need to invest in human capital, reduce some of the excessive regulations, attract FDI, reduce corruption if there is corruption, and have the right infrastructure. These are all the usual things that imply that gradually with time you will have higher potential growth and avoid excessive swings of policies.
Latin America sometimes goes from a populism of the left to a populism of the right, or swings of policies that are a bit too radical. More stability would be important. You want to do stuff that is opening up with reforms while making sure that your tax spending and other policies are progressive, and you reduce inequality while not hurting growth. And given the global climate change, every country around the world has to try to reduce emissions and invest in renewables. This is not easy and simple, but it is necessary to be able to have more sustainable growth. These are not easy tradeoffs. The traditional Washington consensus of the pure laissez-faire of opening up had its limits, but while you want to have inclusive and sustainable growth overall, stuff that is more market oriented with the right public policies to support equality, inclusiveness and so on, those things are still important for achieving stronger potential growth. The Chinese model of state capitalism is not working any longer, not even for China. I don’t think that model could be applied across Latin America.
LF: Do you think there are any standout economies in Latin America that are getting things right even despite all these challenges?
NR: Many of the Latin American countries in the last few years brought to power some more left-of-center rulers. There was a concern that maybe some of them would become excessively populist on the left. I would say that with some exceptions, again, Argentina as an exception, things have not proved to be so severe, in part because once you are in power, you have to moderate yourself. Two, there is market discipline and if you do things that are stupid, your exchange rate and your interest rate, your spread will widen in a way that forces you to have more discipline. Three, some of these people don’t have full control over their legislatures. They’re constrained in terms of how much they can do in terms of radical policies. So, you’ve had a bunch of populists on the left. On the other side, the policies have been, with some exceptions, reasonably moderate or there have been corrections. In Brazil, there was a concern that [President Luiz Inácio Lula da Silva] three would be more like Lula two or Dilma as opposed to Lula one.
It’s been a mixed bag overall. But this year, growth is somewhat improving. There’s more FDI into Brazil and so on. So, if they don’t screw up fiscal policy and they keep the central bank independent, Brazil will do well. Brazil is always the country of the future. You never get very strong growth. And it’s the same thing throughout Latin America. There are some countries that are really bad outliers, like Argentina, and there are others that are a mixed bag, and they all have been trying to blend in with populism until they realize that it doesn’t work. Whether it was in Brazil, in Chile, Colombia, in Peru, in Mexico, they have some tendencies along those lines. But then, market discipline and political factors control how much they can go in the wrong direction. So, things have not been so bad after all. But I don’t know if there is really a star economy in the region, frankly, that is a shining star the way Chile used to be for a while.
LF: Thank you.