Roubini: US, Global Recession Ahead

By Nouriel Roubini

In recent weeks, the global liquidity and credit crunch that started last August has become more severe. This is easy to show: in the United States, the euro zone, and the United Kingdom, spreads between Libor interest rates (at which banks lend to each other) and central bank interest rates – as well as government bonds – are extremely high, and have grown since the crisis began. This signals risk aversion and mistrust of counter-parties.

To be sure, major central banks have injected dozens of billions of dollars of liquidity into the commercial banking sector, and the US Federal Reserve, the Bank of England, and the Bank of Canada have lowered their interest rates. But worsening financial conditions prove that this policy response has failed miserably.

So it is no surprise that central banks have become increasingly desperate in the face of the most severe crisis since the advent of financial globalization. The recent announcement of coordinated liquidity injections by the Fed and four other major central banks is, to be blunt, too little too late.

These measures will fail to reduce interbank spreads significantly, because monetary policy cannot address the core problems underlying the crisis. The issue is not just illiquidity – financial institutions with short-term liabilities and longer-term illiquid assets. Many more economic agents face serious credit and solvency problems, including millions of households in the US, UK, and the Eurozone with excessive mortgages, hundreds of bankrupt sub-prime mortgage lenders, a growing number of distressed home builders, many highly leveraged and distressed financial institutions, and, increasingly, corporate-sector firms.

At the same time, monetary injections cannot resolve the generalized uncertainty of a financial system in which globalization and securitization have led to a lack of transparency that has undermined trust and confidence. When you mistrust your financial counter-parties, you won’t want to lend to them, no matter how much money you have.

The US is now headed towards recession, regardless of what the Fed does. The build-up of real and financial problems – the worst US housing recession ever, oil at $90 a barrel or above, a severe credit crunch, falling investment by the corporate sector, and savings-less and debt-burdened consumers buffeted by multiple negative shocks – make a recession unavoidable. Other economies will also be pulled down as the US contagion spreads.

To mitigate the effects of a US recession and global economic slump, the Fed and other central banks should be cutting rates much more aggressively, rather than relying on modest liquidity injections that are bound to fail.

Complete article via Project Syndicate

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