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Nouriel Roubini's Global EconoMonitor

A deadly cocktail mix: the 1973 & 1979 "Stagflation" meets the 1990 and 2001 "Asset/Credit Bust" with the result being an ugly U.S. recession and sharp global slowdown  Nouriel Roubini | Jun 30, 2008 It now appears that the U.S. and global economy is facing the worst of the shocks that led to the U.S./Global recessions of 1974-75 and 1980-82 (stagflationary shocks from oil prices) together with the shocks (asset/credit bubbles gone bust) that led to the recessions of 1990-91 and 2001. The combined mix of the worst shocks that led to the last four U.S. and global recessions (1974-75, 1980-82, 1990-91, 2001) is thus quite deadly and therefore one of the reasons why this will not be a short and shallow recession (V-shaped and lasting only 6 months) in the U.S. but rather a longer, uglier and deeper one (U-shaped and lasting 12 to 18 months). Let us detail how the current U.S. and global economic outlook shares the worst of the shocks of the last four U.S. and global recessions… The 1974-75 U.S. and global recession and the 1980-82 (double dip) recession were preceded by two massive staflationary negative supply side shocks triggered by two oil shocks: the Yom Kippur war that started in October 1973 that led to an oil embargo by Arab states and a sharp spike in oil prices; the Iranian revolution in 1979 that led to another massive spike in oil prices. Those shocks were massive supply side negative shocks – that are equivalent to a fall in output and a rise in prices/inflation – for oil importing economies (U.S., Europe, Japan and others) that tipped the U.S. and global economy into a severe recession. Conversely the 1990-91 recession and the 2001 recession were rather the result of asset and credit bubbles gone bust: the 1980s real estate bubble in the U.S. led to a housing bubbles and to the S&L crisis by 1990 and triggered the 1990-91 recession; the 1990s internet and tech bubble went into a bust by 2000 and led to a collapse of real investment – in the tech sector and corporate sector – by early 2001. Those asset and credit bubbles gone bust, the follow-up credit crunches and the ensuing fall in real capex spending (housing and/or corporate) were the triggers of those recessions. Of course in each one of the last four U.S. and global recessions things were a little more complex than a simple stagflation shock or an asset bubble gone bust shock. The rise in inflation in the early 1970s started earlier than the supply side shock of 1973 as goods inflation and commodity inflation started in 1970; in that episode the breakdown of the Bretton Woods 1 regime was also behind the rise in global inflation before the oil shock of 1973. Similarly in 1990 and in 2000 oil shocks played also a role – if secondary – in the economic downturn: the 1990 recession started in June because of the housing bust, the S&L crisis and the ensuing credit crunch; but the August invasion of Kuwait by Iraq also led to a temporary stagflationary increase in oil prices that lasted through the spring of 1991 when the war against Iraq was won and the recession ended. Similarly while the bust of the tech bubble was the main driver of the 2001 recession even in that period there was a modest oil shock as the second Palestinian intifada led – among other factors to a doubling of oil prices – from low levels – between 1999 and 2000. So today the 2008 U.S recession and sharp global economic slowdown is combining the worst of the oil shocks of the 1970s with the worst of the asset/credit bust shocks (and ensuing credit crunch and investment busts) of 1990-91 and 2001: like in 1973 and 1979 we are facing a stagflationary shock to oil, energy and other commodity prices that by itself may tip many oil importing countries into a sharp slowdown or an outright recession. Also, like 1990-91 and 2001 we are now facing another asset bubble and credit bubble gone bust big time: the housing and overall household credit boom of the last seven years has now gone bust in the same way as the 1980s housing bubble and 1990s tech bubble went bust in 1990 and in 2000 triggering recessions. And a similar housing/asset/credit bubble is going bust in other countries – U.K., Spain, Ireland, Italy, Portugal, etc. – leading to a risk of a hard landing in these economies. A massive asset and credit bubble gone bust and the ensuing ugly liquidity and credit crunch were enough to tip the U.S. economy (and soon other economies) into a recession by the beginning of 2008. But last fall oil was closer to $80 a barrel while today it is above $140 a barrel. Thus, on top of the asset/credit bust and deleveraging forces that are leading to a U.S. and other countries' recessions on their own the U.S. and the global economy are now hit in the head by an additional massive stagflationary shock that has led real oil prices to be higher than their 1974 and 1980 peaks. That is why the potential effect of this double whammy on the U.S. and global economy is severe: worst of stagflationary shocks on top of worst of asset bubbles bust. In other terms we are getting the worst of the shocks that led to the two recessions of the 1970s on top of the worst of the shocks that led to the recessions of 1990-91 and 2001. Thus, the outlook for the U.S. and global economy is pretty dim. Finally, as I will argue in a forthcoming analysis, the same factors – U.S twin deficit, U.S. loose monetary policies and fixed pegs to the U.S. in the dollar standard regime of Bretton Woods - that lead to the commodity inflation and goods inflation in the early 1970s and thus to the demise of the Bretton Woods 1 regime are also the factors are also partially the factors that are leading now to the rise in commodity and goods inflation in emerging markets pegging to the U.S. dollar and/or heavily managing their exchange rates. Thus, as the rise of commodity and goods inflation led to the demise of BW1 the current rise in commodity and goods inflation in emerging markets may be the trigger that will lead – as argued in my 2005 work with Brad Setser – to the demise of BW2. BW2 is still alive as the massive reserve accumulation by BRICs, GCC and other emerging markets suggests. But the ensuing rise in inflation that these exchange rate policies are causing may soon lead to its demise abandoning pegs and/or letting currencies appreciate will be the necessary step to control inflation in such emerging market economies. But what will be the consequences for growth and inflation in the U.S. and abroad of the now likely demise of BW2? That, by itself, is a question that merits a separate analysis. So stay tuned for a comparison between the demise of BW1 and the likely demise of BW2 and for the consequence of this major breakdown of the international currency system.