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Index Universe (IU.com): You’ve said that you’re worried we’re already sowing the seeds of the next crisis. Where do you see that most directly?
Dr. Nouriel Roubini (Roubini): Well in commodities, I look at oil prices. They fell from $145 last summer, came down to $30 earlier this year and now they’re back close to $80. But if I look at the fundamentals of demand and supply, demand is down to 2005 levels, supply and inventories are at all-time highs.
In my view, the movement in oil prices is not fully justified by the fundamentals.
There are improving fundamentals. There is a global recovery. But that justifies oil going from $30 to maybe $50. I think the other $30 is all speculative demand feeding on it—speculators and herding behavior. Last year, when oil was at $145, that killed the global economy. I worry that oil is going to go up above $100 for reasons that have nothing to do with the fundamentals of supply and demand. Oil at $100 would have the same negative effects on the global economy as oil did at $145 last year.
Last year, when oil was at $145, the global economy was still growing. Right now it has collapsed, and is recovering. Oil pushing above $100 would have nasty, negative real trade effects and real disposable-income effects on all importing countries: U.S., Europe, Japan, China, India; all the countries that were hit by the oil shock last year. So that’s an element that is in my view totally speculative, and dangerous to the global economy.
IU.com: Is that true elsewhere?
Roubini: I could make a similar argument for other commodity prices. In my view, rising commodity prices are not justified by the fundamentals.
There’s a huge bubble, because we have zero rates in the U.S., zero rates around the world and a huge carry trade. Everyone is borrowing at zero interest rates in dollars and getting a capital gain because the dollar is weakening, so they are borrowing at negative rates. And then they invest in risky assets: commodities, equities, credit. We’re creating a bigger bubble than before.
It’s going to go crashing down, in an ugly way. That’s the basics of the argument.
IU.com: You recently co-authored a report in which you and your colleagues ranked the U.S. third in world financial markets, after London and Australia. Was regulation a big component of that?
Roubini: The U.S. might have been No. 3 overall, but it was ranked No. 38 out of 55 in financial stability, because we’ve had a disastrous banking and financial crisis. That was in part due to poor regulation and supervision of financial institutions. That’s one of many factors and reasons why the U.S. was ranked so low on that particular pillar. Certainly there has been a massive failure of regulation and supervision of the financial system. But the regulatory failure was more in the direction of unwillingness by regulators to apply regulations. The Fed had all the powers to regulate toxic underwriting of mortgages, but they believed in laissez faire markets, and they created a disaster.
IU.com: How does this get fixed?
Roubini: I don’t believe in market discipline. It doesn’t work. That was the ideology of the last 10 years; self-regulation means no regulation. Market discipline doesn’t exist with irrational exuberance and reliance on internal risk management models that don’t work. Nobody listens to risk managers, because it’s risk takers that make the profits. The reliance on ratings agencies that have their own conflicts of interest, the reliance on soft-touch regulation, the focus on principles instead of rules—that particular regulatory philosophy has been a disaster, and we’ve learned it the hard way. We have to go to simpler rules, tougher rules and more binding rules. That’s the right approach.