An Interview with Niall Ferguson

Q: You’ve used the phrase “the great repression” to describe the state of mind of the world’s leaders.  What do you mean by that?

The Great Repression is of course is a play on words. 

Repression is a psychological  term. We often talk about being in denial about a trauma. I think there are a great many people who are still in denial about the scale of this economic crisis. The Obama administration, for example, published a budget document not so very long ago which projects US economy will grow 3%  next year 4% the year after that and 4.6% the year after that. That’s a fairy story.  Anybody who bases their budget plans on a forecast like that is exhibiting all the symptoms of the great repression.

The denial is actually quite widespread. Even people who think that they are being realistic, still assume that by next year we’ll be back to normal and the economy will grow again. I think that’s because of the expectation that the future will be very like the recent past, when recessions don’t last more than a year and a half. Therefore it is inconceivable to them that this thing could be as protracted as a depression.  I think this is a depression. It’s not as serious a depression as ’29 to ’33 period, but certainly it will be as protracted as that.


Q: What numbers would you cite to explain why this economic setback is worse than the recessions we’ve seen in our lifetimes?

I would begin with debt burden under which US financial institutions and households and European financial institutions and households and western governments are laboring.  In the US if you add all the private and public debt together you get something like 355% of GDP. That’s a pretty big number historically. This is an economic crisis of excessive debt, or of leverage as we like to say these days. It’s quite different from the recessions that happened in the ’70s and ’80s, which were recessions caused in large measure my monetary tightening at a time of inflationary pressure. This thing is happening at a time when monetary policy has essentially been set to zero in terms of interest rates and in which fed has injected massive amount of stimulus into the monetary base.

The contraction of output and the increase in unemployment that has happened in the US is reminiscent of the early 80s and early 70s but the difference is that this isn’t going to stop the way it did then. Back then in both cases the Fed eased and the economy recovered. The Fed has done all the easing a central back can do and the economy is still in an extremely weak state. The unemployment numbers are going to carry on rising, and we have a whole range of things coming — defaults by corporations on a scale we have not seen since the time of the depression.

When it comes to equity markets, I am extremely skeptical when anyone tells me we’ve reached the bottom. There were 11 bear market rallies between 1929 and 1934 and it is terribly easy to be seduced by supposed green shoots.  The media in particular will respond to noise. They will turn a blip into a sign of recovery. You have to look at the fundamentals of excessive debt. You have to look at extreme difficulty of causing a recovery in consumer demand in highly leveraged societies and realize that for that very reason this is very different from anything we’ve lived through.

Q In historical terms, is there any period you would compare this to?

I don’t think it’s like the ’29 to ’33 period partly because the policy response has been so completely different.  In the depression of the early ’30s the monetary and fiscal authorities practically everywhere did the worst possible things: They tightened monetary policy and tried to balance the budget. We’re not making those mistakes. Full marks to be Ben Bernanke for learning the lessons of the great depression. At the same time another eminent economist, Larry Summers, is ensuring that Keynesian policies are applied so let’s assume that the combined effects avoid a great depression of the early ’30s style.

There is another possibility, which goes back to the 1870s. There was a great depression that began in 1873 with a financial panic: bank failures on both sides of the Atlantic.  It was a very protracted depression. Economic performance and prices declined for about five and quarter years right up until 1878. It wasn’t as catastrophic as the early ’30s. Output in the US only really declined for one of those years but prices and the equity market continued to decline gradually rather than precipitously.  That seems to me a possible scenario.

Q: That sounds like Japan in the 1990s.

Japan’s parallel is quite illuminating here. It’s not inconceivable that you have something very similar in the west. You end up with zero interest rate policy, quantitative easing, massive increase in the public debt, and oh dear, nothing much happens. You avoid a complete collapse but you end of with growth that averages an anemic 1% in Japan’s case over a period of ten years.  I suppose I could imagine that happening for five years in the western world. You end up with something that averages close to 1% rather than the 2 to three % that the administration forecasts for the medium term. That’s my expectation. Lets’ call it a slight depression.

Q What if deflation takes hold? Is there a spiral here that could get out of hand?

There is, which is why the 1870s example is not entirely reassuring. That was a period of deflation, and deflation is painful for debtors. In the 1870s there were not a huge number of people who were debtors.  The principal ones were farmers, which is why we associate that period after 1873 with the rise of populist movements in the US and Europe.   Today many, many more people are debtors.  In fact the overwhelming majority of American households are to some degree leveraged. This time deflation will be very painful for many more people because the real debt burden would increase even with lower interest rates. That’s a scenario Ben Bernanke is justifiably worried about.

If consumers’ expectations become deflationary, if they start to expect prices to drop, which they already do in the real estate market, you postpone decisions.  I’m doing this. I postponing any major purchase on the assumption prices will fall. We already are in a deflation. Most countries now have negative numbers of wholesale prices and some have consumer price indices that are in negative territory.

I think this will continue because and the shock to the global economy is much greater than the shock to the US economy. This is one of the great asymmetries of this crisis that many Americans do not fully appreciate. The shock in east Asia is far greater because the export models of east Asian economies have essentially broken down for Taiwan, for South Korea, above all for Japan. This already is a depression. Exports have already declined by 49% year on year for Japan. The east Asian economies and to a lesser extent the European economies are really plummeting. Capacity is simply not being using fully. That kind of drastic reduction in economic activity is really the driver of deflation.

Q You don’t see an inflation scenario?

Many people say “We’re worried about inflation because we see this massive expansion of the monetary base and it’s only a matter of time before we are the Weimar republic.”  This is just completely wrong. The monetary base can be expanded as the Fed buys or lends against all kinds of toxic assets.  Bernanke has already doubled the monetary base. You could treble it. Probably he could quadruple it.  But that’s not the key to inflation. They key is what banks do and how consumers behave.

The only possible upticks in prices that I foresee in commodity markets where there is some kind of supply constraint. That may be true of oil; it’s certainly true of copper. And that in turn is simply a factor of China’s stimulus because China almost uniquely in the world is in a position to stimulate economic activity and that can feed straight into commodity markets.

Q Is China in a position to implement a meaningful Keynesian growth policy?

If any economy is able to be Keynesian, it is China’s. They have the capital controls. They have the spare capacity, in abundance, as far as the labor market is concerned.  There’s plenty of public works they can do because the hinterland is still quasi-African. So there’s no shortage of worthwhile things to do, and it’s already happening. It’s pretty impressive, even in this fairly early stage in the process. Chinese consumer demand seems to be bouncing back. Yes, China has suffered in  its exports but when you look at retail sales, they’re up. Industrial output is up. I think China has become more domestically driven.  And that ‘s the right thing for them to do. If anything, they could do more to boost consumer demand, more to encourage Chinese households to save less and spend more. China desperately needs more financial intermediation. But the first steps have been taken with this plan for a proper system of universal health insurance could make a big difference.

Q: That marks pretty fundamental shifts for China’s economy.

If China can establish a model of state-stimulated, consumer-led growth, and wean itself off exports to the West, then what I call Chimerica, the magical marriage between China and America, can end in divorce. It will no longer be necessary for China’s growth to be dependent on a profligate U.S. consumer. That’s a really important part of the story. So, while the Chinese can be successful Keynesians, I’m not so sure the Americans can be.  The Chinese look at the prospects for a bounce back of American consumption, I think they conclude, quite rightly, that it’s not going to happen. This is a big change.

Q In that divorce, who suffers the most?

For China. the transition can’t happen overnight. The pain of restructuring will be very acute in those eastern zones, where they’ve sunk an enormous amount into manufacturing export industries. producing for export.  But that’s a challenge their system is pretty well prepared to meet. It helps to have a communist party monopolizing power and a tradition of central planning. It seems to me they’ve been pursuing a traditional approach, almost Stalinist at core.

What drives China’s growth after all is state-led infrastructure investment. It’s been the case all along. The free market elements are parasitical on that. This is a model that can cope with the transition from exports to domestic demand.

The pain is going to be felt by China’s neighbors.  That is the important point to grasp. The economies in the world that are suffering the most at the moment are the other east Asian economies. If China becomes more self sufficient, then the whole system looks quite different. The breakdown of globalization hurts smaller economies much more than bigger economies. That was true in the 1930s too. It’s really quite a troubled time to be Taiwan or South Korea, or for that matter Thailand of Vietnam.

Those are the people who will actually suffer. It’s a little bit like divorce is painful for the parents, but most traumatic for the children.  But if you think of that analogy it works quite well. It’s not so much that the US will be devastated by the breakdown of Chimerica. It won’t be because the US ultimately is a pretty self-sufficient economy. It doesn’t rely on exports as much as these other economies we’re talking about.

Q: But couldn’t the consequences on the financial side still be pretty grave for the US?

I think that’s the divorce manifests itself for the US.  Last year I think it’s true the Chinese bought around 400 billion dollars worth of dollar denominated bonds. Deutsche Bank estimates it will be a quarter of that this year and I think it will be even less. I don’t think China has any desire to increase holding of US government bonds if it can think of a better strategy, and a better strategy is obviously to go and buy copper mines in Africa.

Q: To what extent do you think the China’s leadership sees an opportunity on the world stage now that the US is on its knees economically and China’s coffers are full?

The mood is discernibly changing. The tone of official pronouncements is changing. Wen Jiabao’s speech at Davos struck me as being as saying the world has changed and there will no longer be a world centered around the profligate US and there has to be a new international financial architecture. 
They do think more historically than Western leaders do and they are acutely aware that great shifts in power happen. Empires rise and empires fall over the very long run and this is China emerging from the deep historical trough of the 19th and early 20th century. And they must sense that this does accelerate the process whereby power is transferred from west to east. They know they are nowhere close militarily. One should not read too much into naval skirmishes in the south China sea. They don’t want to go there yet. They are nowhere near ready for an explicit showdown with the American military hyper-power. In terms of finance and economics I think they know they can be more assertive, that they really are in a powerful position.

Q Western responses to the crisis seems to be divided between free spending Keynesians and fiscal tightwads. Where do you stand on this divide? 

I’ve spent much of my life battle the ghost of John Maynard Keynes, and I am critical of the shadow of Keynes once because I don’t think you can solve a crisis of excessive debt with more debt. We have a deficit this year in the US on the order of 12.3% of GDP. Now there has not been a deficit that large in relative terms since World War II.  The effects have yet to be felt, but they are coming soon. 
To me the critical issue that no one wants to talk about is an obvious contradiction between the monetary policy being pursued by the fed and the fiscal policy being pursued by the treasury. The fed’s objective is to keep long term rates down in order to keep mortgage rates low. Thus far he has been relatively successful in doing that.

The problem is that if the treasury issues 1.75 trillion dollars of new bonds this year, you are going to have upward pressure on yields and downward pressure on bond prices. It’s extremely hard for Bernanke  to make his policy work in the face of this huge glut of new bonds. And it’s not just the US that’s doing this. The International bond market is going to be hit by a tsunami this year. I estimate that there will be somewhere in the region of 4.2 trillion dollars of new bond issues by the major developed economies, and I don’t really see how you can do that at a time when international capital is being depleted by the contraction of trade without having some kind of upward pressure on bond yields.

Q You’ve written that the US is beginning to look like Argentina circa 2004, when that country defaulted on its international debt.  Is it really that bad?

I think the comparison is a good one. Argentina is the poster child for improvident governance .  The Argentine default of 2004, when bondholders took a massive 65% haircut, sent a great shock wave through markets.  Of course there is one big difference:  the US can borrow in its own currency. That gives the US more leeway. The US doesn’t come to borrow and repay in a hard currency. So that’s one important difference.

The other difference is households, which are the little Argentinas of this story. American households are in a rather complex relationship to their creditors because mortgages were taken after the point of origin and then bundled together and then sliced and diced to produce mortgage-backed securities and those complex collateralized debt obligations. Until one can identify the creditor it is very hard to achieve any restructuring of mortgage debt. The biggest problem in addressing mortgages lies there. It’s hard to do that because of the complexity of the financial superstructure built on top of these mortgages.

Q: Your prescription, I believe, is mortgage relief and bank restructuring.

This is a really major problem that I think can only be dealt with only by pretty high-handed action on the part of the federal government. Nothing is impossible. This is where you get into Argentine territory. If the US were to take action simply to write down the mortgage debt of the US in order that 13.5 million Americans in negative equity could sigh with relief that would make everyone feel better except creditors. They would be facing the kind of default that Argentina creditors faced just five years ago. That’s the kind of thing that may have to be done in the end. What’s being attempted right now isn’t going to work.

There is the TALF and P-PIP.  I am very dubious these measures will address the fundamental problem that there are some major financial institutions – big banks in particular – that by any meaningful measure are very close to insolvency. Secondly no matter how much money is drip fed into these institutions their assets just keep deteriorating. Let’s face it: real estate prices are falling at an annual rate of 18 or 19 percent and that’s residential real estate. The commercial real estate crisis is in its early stages and it will cause much more pain to the banks than the residential crisis. So there is a fundamental problem of excessively leveraged financial institutions that have basically had their capital base wiped out.  We are in denial about that. TALF and P-PIP are not really sufficient to address the problem.  They are basically screwed and at some point probably have to be taken into public ownership and restructured. Again, the bondholders are going to have haircut.

Early on in this crisis someone was foolish enough to say that the bondholders would not be wiped out; in fact, they would be made whole. I never understood why that should be. I don’t understand why someone who bought a bond should be sacrosanct, even at the expense of vast sums of taxpayers money. But that idea crept into the system and at some point we are going to have to be disabused of this idea just as Argentine  bondholders had to take a haircut. It’s coming.

Q: Let’s turn to global finance. Is the US dollar going to get hammered?

The pessimists have been painting this scenario for a while. The assumption is that if the US current account deficit got to be this large sooner or later there will be a run on the dollar. But paradoxically the dollar has appreciated in this crisis. The worse the crisis got the stronger it became. So where would you out your money? The Chinese have asked themselves this. What else can we hold? Euros? Well clearly the problem with the Euro is Europe. Europe’s financial problems are worse than those of the US. The European banks are in a worst place than the US banks – a lot more leveraged, far fewer write downs, and much more exposed to eastern Europe and east Asia. The European bank crisis is coming and when it comes, it will be hard to see a good future for the European Union and the Euro. I don’t really buy the idea that the dollar yields to some other currency.

Q: In your book, “The Ascent of Money,” you suggest that we could be facing the global disorder of the sort that could reverse globalization and even set the stage for wars.

Globalization takes a while to start and get established. It took decades to get from the highly regulated economies of the 1970s seventies, to the free-wheeling, highly globalized economies of  2007. It takes a lot less time to destroy globalization. We found that out before. Globalization from the 1870s to 1914 was a pretty spectacular achievement with few reversals. When it reversed, it reversed at a far faster speed.  And that’s what worries me.

We are already moving very rapidly away from globalization. The collapse of trade is the thing that most impresses me at the moment. We will also see it in migration.  There will be dramatic declines in migration, and migrants will be forced economically, or in the case of Japan, by other means, to return to their countries.

The issue is to me is whether this year, on top of the macro-economic shock, we end up with a geopolitical shock. That would really finish things off.

Q: What kind of shock?

I can think of two immediately. One is the possibility that Israel will simply lose patience with Iran’s nuclear program and decide to take unilateral action.  Many people say the United States can restrain  or prevent it from doing this. I really struggle to see how. There have been very few occasions in the last twenty or thirty years when the U.S. effectively restrained Israel from doing anything. That’s one scenario that’s easy to imagine.

The other issue, of course, is Pakistan, which is an extraordinarily volatile and unstable place, a failed state in the making. And a source not only for nuclear proliferation, but for extreme Islamic fundamentalism and terrorism.  Which poses a real threat to the stability of India.

Then there is Russia’s stated policy of expanding its influence in the former Soviet Union.  From Russia’s point of view, anything that increases the political risk in the world is helpful, because it will push energy prices up and that helps them. The Russians certainly would not shed a tear if  Israel attacked Iran. It would suit them very well indeed-which is why they helped the Iranians with their nuclear program. They want Iran to be attacked and oil to go back up to 80 dollars a barrel. So if you just build a scenario of geopolitical crisis on top of a very frail global economy, it’s easy to see how this could get a lot worse.

Q: You’ve argued that US should be a great force for good in the world, as it has been at different junctures. Is the potential still there?

I have become more pessimistic about what the US can do. The analysis always was that if the US was going to have a problem of overstretch, it would be domestic and would have to do with excessive debt. The moment in (my books) “Empire” and “Colossus” when I argued for a more confident American empire was a relatively short lived as it turned out because all the things I worried about turned out to be right. The US is not likely to be as successful a liberal empire as Britain because it is so heavily reliant on foreign capital, because it has a manpower deficit — Americans don’t want to go to hot, poor countries — and above all because of its attention deficit disorder. It is very, very hard to turn Iraq into a stable state in four years, and that was always the time frame the American had in mind. When I would stand up in 2003 and say, “Do realize that you will have to be there for 40 years, like Britain was?” People would just gasp in horror.

Q: Are we looking at the start of an American decline?

Not quite, in the sense that this crisis affects others worse than the US. It certainly affects Europe worse. Power is relative. In that sense it’s all very unfair because it looks like the crisis was made in America but it hurts more or less everybody else, except China, more than the US. 
Meanwhile what’s unquestionably likely to happen, is that China, provided it doesn’t succumb to some unexpected bout of instability, becomes something more like an equal partner, or rival. So you end up with a world with two major powers, one of which is the US, and the other of which is China. 
We’re not in that world yet, because China’s GDP won’t catch up with that of the US for another decade or more, but that seems to be the trajectory that the world is on.

Q: President Obama. What kind of a leader is he shaping up to be?

I should come clean. I was an advisor to John McCain who lost faith in his campaign with the nomination of Sarah Palin and with the obvious difficulty McCain had with understanding and responding to the economic crisis.

The world wants Obama to be a Woodrow Wilson or a black John F. Kennedy. I worry he could turn out to be a black Jimmy Carter. The worrying thing at this point is that so focused is the administration on the economic crisis that it’s making some mistakes in foreign policy. That was always the area that he was the most inexperienced.

Though I find many things in Barack Obama to admire, I worry a little bit that in the hard-ass game of power politics all the training of Chicago is of relatively limited use. Whether it’s with Iran or with Russia, to say nothing of Venezuela, the US president has to be very careful not to look weak, not to look soft, not to look naive. And I’m afraid that right now to many people in the rest of the world that is how the president looks.

Wanting to be liked is the biggest mistake Americans make in foreign policy. The US will never be liked as long as it is the worlds’ preeminent military and economic power.  Britain’s one great advantage big advantage a century ago was that they did not expect to be liked. They did not care if they were not liked. The US has ultimately to learn that lesson, and Mr. Obama in particular.


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