The age of mega-threats

William Kentridge, History of Chief Complaint, 1996
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By NOURIEL ROUBINI*

There are many domestic and international obstacles in the way of policies that would allow for a less dystopian future.

For four decades after World War II, climate change and job-destroying artificial intelligence were on nobody's mind; terms like “deglobalization” and “trade war” had no hold. But now we are entering a new era that will more closely resemble the tumultuous and dark decades between 1914 and 1945.

Serious mega-threats are jeopardizing our future – not just our jobs, income, wealth and global economy, but also the relative peace, prosperity and progress achieved over the past 75 years. Many of these threats weren't even on our radar during the booming post-World War II era. I grew up in the Middle East and Europe in the late 1950s to early 1980s and was never worried that climate change might destroy the planet. Most of us had barely heard of the problem, as greenhouse gas emissions were still relatively low compared to what followed.

Furthermore, after the collaboration between the US and the Soviet Union and US President Richard Nixon's visit to China in the early 1970s, I never again worried about another great power war, let alone a nuclear one. The term “pandemic” was not registered in my conscience either, because the last big one had occurred in 1918. And I did not imagine that artificial intelligence could one day destroy most jobs and make the Homo sapiens obsolete, because those were the years of the long “artificial intelligence (AI) winter”.

Likewise, terms like “deglobalization” and “trade war” had no value during this period. Trade liberalization had been in full swing since the Great Depression and, soon to follow, would come the hyperglobalization that began in the 1990s. Debt crises posed no threat because the ratios of public debt and private debt to GDP were low in advanced economies and emerging markets. Growth was robust. Nobody needed to worry about the massive accumulation of implicit debt, in the form of unfunded liabilities from pay-as-you-go social security and health care systems. The supply of young workers was increasing, the proportion of older people was still low, and robust, mostly unrestricted, immigration from the Global South to the North would continue to support the labor market in advanced economies.

In this context, economic cycles were contained and recessions were short and superficial, except during the stagflation decade of the 1970s; but even so, there were no debt crises in advanced economies because debt ratios were low. The types of financial cycles that lead to crises were contained not only in advanced economies but also in emerging markets, due to the low leverage, low risk-taking, sound financial regulation, capital controls and various forms of financial repression that prevailed during this period. period. Advanced economies were strong liberal democracies, free of the extreme partisan polarization that has recently come to pass. Populism and authoritarianism were confined to an ignorant group of poorer countries.

 

goodbye to all this

Leave that relatively “golden” period between 1945 and 1985 and fast-forward to the end of 2022. Now it will be immediately noted that we are being gripped by extreme new mega-threats that were not on anyone's mind. The world has entered what I call a geopolitical depression, with (at least) four revisionist powers – China, Russia, Iran and North Korea – challenging the economic, financial, security and geopolitical order that the United States and its allies created after the Second World War.

There is an ever-increasing risk not only of war between the great powers, but also of nuclear conflict. Next year, Russia's war of aggression in Ukraine could turn into an unconventional conflict with direct NATO involvement. And Israel – and perhaps the US – may decide to launch strikes against Iran, which is on its way to building a nuclear bomb.

With Chinese President Xi Jinping further consolidating his authoritarian rule and the US tightening its trade restrictions against China, the new Sino-US cold war is getting colder by the day. Worse still, there could be a change of heart for Taiwan as Xi is committed to reuniting the island with the mainland; now, US President Joe Biden is apparently very committed to the defense of the Asian ally. Meanwhile, nuclear-armed North Korea once again draws attention by firing rockets at Japan and South Korea.

Cyber ​​warfare takes place daily between the West and these revisionist powers. Several other countries have taken a non-aligned stance towards Western-led sanctions regimes. From our contingent point of view in the midst of all these events, we still don't know if the Third World War has already started in Ukraine. That determination will be left to future historians – if they still exist.

Even discounting the threat of nuclear Armageddon, the risk of an environmental apocalypse is becoming increasingly serious, especially as most talk about zero-pollution investment, as well as about "environment and governance" is just "greenwashing” – or “green wishing”. The recent “green inflation” is already in full swing as accumulating the metals needed for the energy transition requires a lot of energy and it is very expensive.

There is also a growing risk of new pandemics, which would be worse than the biblical plagues, due to the link between environmental destruction and zoonotic disease. Wildlife, carriers of dangerous pathogens, are coming into closer and more frequent contact with humans and the livestock humans raise. This is why we have experienced more frequent and virulent pandemics and epidemics (HIV, SARS, MERS, swine flu, avian flu, Zika, Ebola, COVID-19) since the early 80s. worse in the future. In fact, due to the melting of the permafrost Siberian, we may soon be facing dangerous viruses and bacteria that have been locked away for millennia.

Furthermore, geopolitical conflicts and national security concerns are fueling trade, financial, and technology wars and accelerating the process of deglobalization. The return of protectionism and Sino-US decoupling will leave the global economy, supply chains and markets more balkanized and fragmented. The keywords "friend shoring"and "secure and fair trade"replaced the terms"offshoring"and "free trade” employed widely in the recent past.

But on the home front, advances in artificial intelligence, robotics and automation will destroy more and more jobs. And this will happen even as policymakers build higher protectionist walls for domestic employment. By restricting immigration and requiring more domestic production, aging advanced economies will create a stronger incentive for companies to adopt labor-saving technologies.

While routine jobs are obviously at risk, so are any cognitive jobs that can be broken down into discrete tasks and even many creative jobs. Artificial Intelligence language models like GPT-3 can already write better than most humans; they will almost certainly replace many jobs and sources of income. Already some scientists believe that homo sapiens will become completely obsolete due to the emergence of artificial general intelligence or machine superintelligence – although this is a highly controversial subject of debate.

So, over time, the economic malaise will deepen, inequality will increase further, and more blue and white collar workers will be left behind.

 

Tough choices, tough groundings

The macroeconomic situation is no better. For the first time since the 1970s, we are facing high inflation along with the prospect of recession – that is, stagflation. The rise in inflation in advanced economies was not “transient”. It is persistent as it is being driven by a combination of bad policy – ​​excessively loose monetary, fiscal and credit policies that have been held in place for too long – and bad luck. No one could have predicted how much the initial shock of COVID-19 would reduce the supply of goods and labor and create bottlenecks in global supply chains. The same goes for the brutal Russian invasion of Ukraine, which caused a sharp rise in the prices of energy, food, fertilizers, industrial metals and other commodities. Meanwhile, China has continued its “zero-COVID” policy, which is creating additional supply bottlenecks.

Although demand and supply factors combined to trigger the inflationary process, it is now widely recognized that supply factors have played an increasingly decisive role. This is important for the economic outlook, because supply-driven inflation is stagflationary and therefore increases the risk that monetary policy tightening will produce a hard landing (rising unemployment and potentially a recession).

What will follow from the current tightening of the Federal Reserve US and other major central banks? Until recently, most central banks and most Wall Street traders belonged to the “soft landing” camp. But the consensus quickly changed; now, even Fed Chairman Jerome Powell acknowledges that a recession is possible, that a soft landing will be “very challenging” and that everyone should prepare for some “pain” ahead. The model used by Federal Reserve Bank from New York indicates that there is a high probability of a crash landing. Furthermore, the Bank of England expressed similar views on the UK economy. Several prominent institutions of Wall Street also made recession their baseline scenario (the most likely outcome if all other variables are held constant).

The story also points to deeper problems ahead. In the US, over the past 60 years, whenever inflation has been above 5% (currently above 8%) and unemployment has been below 5% (now at 3,5%), all attempts to reduce inflation to its 2% target caused a recession. Thus, a hard landing is much more likely than a soft landing, both in the US and most other advanced economies.

 

sticky stagflation

In addition to short-term factors, negative supply shocks and medium-term demand factors will cause inflation to persist. On the supply side, I count eleven negative supply shocks that will reduce potential growth and increase production costs. Among them is the backlash against hyperglobalization, which is gaining momentum and creating opportunities for populist, nativist, and protectionist politicians; there is growing public anger at income and wealth inequalities, which is leading to more policies in support of workers and those “left behind”. Well-intentioned as they are, such measures could contribute to a dangerous wage-price spiral.

Other sources of persistent inflation include rising protectionism (both left and right), which has restricted trade, impeded the movement of capital, and increased political resistance to immigration, which in turn has put further pressure on wages. Strategic and national security considerations have further constrained flows of technology, data and talent. And new labor and environmental standards, as important as they are, are hampering commerce and new construction.

This balkanization of the global economy is profoundly stagflationary and coincides with demographic aging, not only in developed countries, but also in large emerging economies such as China. As young people tend to produce and save more, while older people spend their savings and demand many more expensive services in healthcare and other sectors, this trend will also lead to higher prices and slower growth.

Today's geopolitical turmoil further complicates matters. The disruptions to trade and the rise in commodity prices following the invasion of Russia were not just a one-off phenomenon. The same threats to food crops and shipments that emerged in 2022 could persist in 2023. Furthermore, if China finally ends its zero COVID policy and starts to restart its economy, a surge in demand for many commodities will increase inflationary pressures globally. . There is also no end in sight to the Sino-Western decoupling, which is accelerating in all dimensions of trade, be it goods, services, capital, labor, technology, data and information. And, of course, Iran, North Korea and other strategic rivals to the West could soon contribute in their own way to global chaos.

Now that the US dollar has been fully used for strategic and national security purposes, its position as the main global reserve currency could eventually start to decline. And a weaker dollar would, of course, increase inflationary pressures in the US. More broadly, a frictionless world trading system requires a frictionless financial system. But broad primary and secondary sanctions have thrown sand into what was once a well-oiled machine, vastly increasing the transaction costs of commerce.

On top of all this, climate change will also create persistent stagflationary pressures. Droughts, heat waves, hurricanes and other disasters are increasingly disrupting economic activity and threatening harvests (thus raising food prices). At the same time, demands for decarbonization led to underinvestment in fossil fuel capacity before investment in renewables reached the point where it could make up the difference. Today's big spikes in energy prices were inevitable.

The increased likelihood of future pandemics is also a persistent source of stagflation, especially given how little has been done to prevent or prepare for the next one. The next contagious outbreak will give further impetus to protectionist policies as countries race to close borders and hoard essential supplies of food, medicine and other essentials.

Finally, cyber warfare remains an underestimated threat to the health of economic activity and even public safety. Businesses and governments will face more stagflationary disruptions in production or have to spend a fortune on cybersecurity. In any case, costs will increase.

 

The worst of all possible economies

When the recession comes, it will not be short and shallow, but long and severe. Not only are we facing persistent negative supply shocks in the short and medium term, but we are also heading towards the mother of all debt crises, due to the rising levels of public and private debt that have occurred in recent decades. Low debt ratios spared us that outcome in the 1970s. And while we certainly had debt crises after the 2008 crash – the result of excessive debt by households, banks and governments – we also had deflation. It was a demand shock and a credit crisis that could be met with massive monetary, fiscal and credit easing.

Today, we are experiencing the sum of the worst elements of the 1970s and the 2008 crisis. Multiple and persistent negative supply shocks have coincided with even higher debt ratios than during the global financial crisis. These inflationary pressures are forcing central banks to tighten monetary policy even though we are heading towards a recession. This makes the current situation fundamentally different from the global financial crisis and the COVID-19 crisis. Everyone should be preparing for what may come to be remembered as the “great stagflationary debt crisis.

While central banks have made an effort to appear more aggressive, we should be skeptical of their declared willingness to fight inflation at any cost. Once they find themselves in a debt trap, they will have to blink. With debt levels so high, fighting inflation will cause an economic and financial meltdown that will be deemed politically unacceptable. Major central banks will feel they have no choice but to back off. Inflation, the degradation of fiat currencies, boom-bust cycles and financial crises will become even more severe and frequent.

The inevitability of central bank failures was recently discussed in the UK. Given the market reaction to the reckless fiscal stimulus of the Truss government, the BOE had to launch an emergency quantitative easing program to buy government bonds. This sad episode confirmed that in the UK, as in many other countries, monetary policy is increasingly subject to fiscal policy capture.

Recall that a similar turn of events took place in 2019, when the Fed, after previously signaling continued rate hikes and quantitative tightening, discontinued its “currency easing” program and began pursuing a mix of “closed-door liberalization” and interest rate cuts at the first sign of mild financial pressures and a slowdown in the economy. growth. Central banks will talk tough; but in a world of excessive debt and risks of economic and financial collapse, there is good reason to doubt their willingness to do “whatever it takes” to return inflation to its target.

With governments unable to reduce high debts and deficits through lower spending and/or higher revenues, those who can borrow in their own currency will increasingly resort to the “inflation tax”: relying on unexpected price increases to eliminate long-term nominal liabilities while keeping interest rates fixed.

How will financial markets and stock and bond prices behave in the face of rising inflation and the return of stagflation? It is likely that, as in the stagflation of the 1970s, both components of any traditional asset portfolio may suffer, potentially incurring massive losses. Inflation is bad for bond portfolios as they will suffer losses as yields rise and prices fall, as well as for stocks, whose valuations are hurt by rising interest rates.

For the first time in decades, a 60/40 portfolio of stocks and bonds suffered massive losses in 2022 as bond yields rose as equities entered a bear market. In 1982, at the height of the stagflation decade, the average price-to-earnings ratio for companies in the S&P 500 dropped to eight; today, it is closer to 20, which suggests that the bear market may turn out to be even more prolonged and severe. Investors will need to find assets to hedge against inflation, political and geopolitical risks, and environmental damage: these include short-term government bonds and inflation-indexed bonds, gold and other precious metals, and real estate resistant to environmental damage.

 

the moment of truth

Either way, these mega-threats will further contribute to rising income and wealth inequality, something that is already putting severe pressure on liberal democracies as those left behind revolt against the elites. And this fuels the rise of radical and aggressive populist regimes. One can find right-wing manifestations of this trend in Russia, Turkey, Hungary, Italy, Sweden, the US (Donald Trump and in the Republican party), post-Brexit Britain and many other countries. Look at the left-wing demonstrations in Argentina, Venezuela, Peru, Mexico, Colombia, Chile and now Brazil (which has just replaced a right-wing populist with a left-wing leader who wants to spend).

And, of course, Xi's authoritarian stranglehold gave the lie to the old idea that Western engagement with a rapidly growing China would inevitably lead that country to open itself up even more to markets and, eventually, to democratic processes. Under Xi, China shows every sign of becoming more closed and more aggressive on geopolitical, security and economic issues.

How did it come to this? Part of the problem is that we've had our heads in the sand for too long. Now, we need to make up for lost time. Without decisive action, we will be moving into a period that is less like the four decades after World War II than the three decades between 1914 and 1945. That period gave us World War I; the Spanish flu pandemic; the Wall Street crash of 1929; the great Depression; massive trade and currency wars; inflation, hyperinflation and deflation; financial and debt crises, leading to mass collapses and defaults; and the rise of authoritarian militaristic regimes in Italy, Germany, Japan, Spain, and elsewhere, culminating in World War II and the Holocaust.

In this new world, the relative peace, prosperity and increasing global well-being that had been achieved – and taken for granted – will disappear. If we don't stop the slow-motion ocean liner sinking, which is threatening the global economy and our planet in general, we'll be lucky to have just a repeat of the stagflationary 1970s. Much more likely is an echo of the 1930s and 1940s, only now with all the major disruptions of climate change added to the explosive mix.

Avoiding a dystopian scenario won't be easy. While there are potential solutions to every mega-threat out there, most are costly in the short term and will yield only long-term benefits. Many of them also call for technological innovations that are not yet available or implemented, starting with those needed to halt or reverse climate change. To complicate matters further, today's mega-threats are interconnected and therefore best addressed in a systematic and coherent way. Domestic leadership, both in the private and public sectors, and international cooperation among great powers are needed to avert the coming Apocalypse.

However, there are many domestic and international hurdles in the way of policies that would allow for a less dystopian future (though it will still be a very conflicted one). So while a less bleak scenario is obviously desirable, lucid analysis indicates that dystopia is far more likely than a happier outcome. The coming years and decades will be marked by a stagflationary debt crisis and related mega-threats – war, pandemics, climate change, disruptive artificial intelligence and deglobalization – that will be bad for jobs, economies, markets, peace and prosperity.

*Nouriel Roubini, professor of economics at the Stern School of Business at New York University, he is chief economist for the Atlas Capital Team. Author, among other books, of MegaThreats: Ten Dangerous Trends That Imperil Our Future, and How to Survive Them (Little, Brown and Company).

Translation: Eleutério FS Prado.

Originally published in Project Syndicate.

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