The U.S economy is the largest economy in the world. This economy’s current account deficit is usually financed by the central banks of other countries in the world. As early as in 2003, central banks from other parts of the world including China, injected $440 billion of dollar reserves and another $465 billion in 2005 into the U.S economy. However the U.S economy is currently going through its worst recession in fifty years. This scenario has resulted in the collapse of the stock and financial markets in the U.S.
Nouriel Roubinis, a leading Professor of Economics as well as a credible authority on economic and financial matters in the U.S, predicted in 2008 that the current economic recession will have a snowballing downfall in GDP of approximately 4%. Most of Roubini’s predictions have been witnessed found to be true. This paper seeks to research on Nouriel Roubinis predictions made in 2006 on accounting or asset valuation.
Table of Contents
Background Information on Nouriel Roubinis and the Us Economy. 4
Nouriel Roubinis Predictions Made in 2006. 4
Accounting or Asset Valuation Issues That Contributed To the Predictions. 5
Differences in Predictions from Other Economists/Analysts. 7
Factors that Cause the Differences in Predictions. 8
Impacts of Roubini Predictions on the US Economy. 8
The increase in central banks’ assets of U.S Treasuries has been enough to fund approximately the entire structural decline in the U.S deficit since the year 2001 (Roubini & Setser, 2005. p. 2). It has been predicted that the scale of the funding required to uphold U.S current account deficits is rising faster than the enthusiasm of the world’s central banks to carry on building up their dollar reserves. This scenario is bound to be a source of instability in the U.S economy from the period of 2006 to date. (Roubini & Setser, 2005. p.3).
Background Information on Nouriel Roubinis and the Us Economy
Nouriel Roubinis is a leading Professor of Economics and a credible authority on economic and financial matters in the U.S. He predicted in 2008 that the current economic recession will have a snowballing downfall in GDP of approximately 4%. This would demand a fiscal incentive to moderately stimulate the fall in private aggregate demand. This economic crisis has been created by the greatest leveraged asset and credit bubble ever experienced (Roubini, 2008. p.2-3).
Nouriel Roubinis Predictions Made in 2006
Roubini predicted in 2006 that the U.S financial system would loose approximately $1 trillion and has later on predicted that the economy will actually loose approximately $3.6 trillion from the credit disaster. Roubini claims that the U.S banking system is effectively bankrupt since it operates with a capital of $1.4 trillion (Bornstein, 2009. p.1). Roubini had predicted mortgage-related lender losses in the excess of $1 trillion (Carrol, 2009. p.1). Roubini’s predicted that the GDP will fall resulting in a drop in housing prices by 15%. His projections in the drop in GDP and a resultant drop in assets prices have been confirmed. He also predicted that the U.S and global recession will carry on into the last quarter of 2009. The U.S and global equities prices had been predicted to be in the direction of a downfall. This was predicted to result in the sale of assets into liquid and anxious markets, thus resulting in a drop in prices and shutting down of bankrupt financial institutions (Roubini, 2009. p.1).
The forecasts given by Roubini argue that there will be dismal growth of the U.S economy in 2009. The forecast is as shown: quarter 1, 2009 will be a negative 5%; quarter 2, 2009 will be negative 4%; quarter 3, 2009 will be negative 2.5%; while the last quarter of 2009 the growth will be negative 1%. These figures give an annual GDP growth of -3.4% in the year 2009. According to Roubini’s forecasts, personal expenditure will drastically fall as a result of losses from housing and equity market losses (Roubini, 2009. p.1).
The housing starts are also headed to drop by 20% from the current levels. The housing prices will fall by 44% from the 2006 peak level. The labor market will also be impacted in that; there will be a resultant drop the demand for labor. Big as well as small companies will experience immense job cuts. This will result to a rise in unemployment rates by 9% by the end of 2009, and 10% by the second half of 2010. Investments are likely to fall drastically in 2009. The export market will drop sharply in 2009. The falling commodity prices will consequently fall in the average annual headline CPI inflation rate to around minus 2%. This is a technical deflation and will result into genuine deflation (Roubini, 2009. p.1).
Accounting or Asset Valuation Issues That Contributed To the Predictions
Roubini’s predictions were mainly based on the fact that the scale of the financing requisite to sustain U.S current account deficits was escalating faster than the world’s central banks’ keenness to continue building up their dollar reserves. Roubini established that the augmented dependence of the U.S economy on external financing of its current account deficit was not sustainable. As early as in 2003, central banks from other parts of the world including China, injected $440 billion of dollar reserves and another $465 billion in 2005 into the U.S economy (Roubini & Setser, 2005. p.2).
This scenario created a major source of volatility. This was mainly because the institutional infrastructure of the Bretton Woods 2 system was found to be deficient to maintain the pace of dollar reserve buildup required to uphold the system. This is mainly because the U.S is under no obligation to protect the world’s dollar reserves and normally pursues policies that increase its demand for reserve financing. The world economies are likewise under no obligation to build up on their dollar reserves. This creates vulnerability in that the imbalances can only be sustained by recurrent financing. The U.S economy does not have policy measures to check its need for external financing; neither do the world economies have policy measures to control their dependence on the weak expansion in the U.S domestic demand (Roubini & Setser, 2005. pp.3-5).
These imbalances if unchecked were forecasted to result in a drastic plummet in the value of the U.S dollar, a rapid increase in U.S long-term interest rates and a sharp plunge in the price of risk assets housing and equities included. The asset price regulation would lead to a serious slowdown in the U.S economy. The plunge in U.S imports linked to the U.S slowdown and the dollar plunge would lead to a harsh global economic slowdown or an absolute recession (Roubini & Setser, 2005. p.5).
In 2004, there was a trade deficit of $620 billion and a current account deficit of $660-670 billion. Less that $45 billion of the overall 4120 billion increase was as a result of the surge in oil prices. The world’s central banks financed a large part of this deficit. The Central bank reserve accumulation in 2004 was approximately $700 billion (Roubini & Setser, 2005. p.5). Changes in valuation could only account for approximately $80 billion of the dollar reserve increase globally. At the same time the world’s central banks increased to approximately 75% of their dollar reserves (Roubini & Setser, 2005. pp.5-6).
The distortion that was caused by continued low interest rates depressed personal savings. The low interest rates pressed up housing prices and thus increased borrowing against the increasing value of housing to sustain current consumption. The distortion is demonstrated by the low interest rates being a consequence of intervention by the central bank to sustain undervalued currencies. This intervention can barely persuade investment in the trade able goods segment of the economy while it enhances over investment in sectors like housing (Roubini & Setser, 2005. p.15).
Differences in Predictions from Other Economists/Analysts
There is a difference in the models used in the prediction of asset value between Roubini and Butter. According to Butter, price is independent of starts, foreclosures or sales. Price, being driven by nominal GDP and long-term interest rates should influence the variables. Butter advocates for the use of international standards in the valuation of assets which he claims that Roubini did not apply in his predictions (Roubini, 2009. p.1).
According to Bornstein, the predicament in the financial and housing sectors has been brought about by low levels of financial management skills among the borrowers. He argues that if the borrower is effectively guided to avoid default in payments, the financial and housing markets will react positively. The effect will be a turnaround of the downward inclination in the valuation of the distressed assets (Bornstein, 2009.p.1).
According to Harrison, unstable banking systems, compromised and incompetent write-downs which are not compliant with the traditional financial policy tools, have been the major cause of the global economic crisis (Bornstein, 2009. p.1).
According to Lucy and Herlitz, the troubles of the large banks and AIG arose largely from borrowing short-range to purchase long-range derivatives and from the sale of credit default exchange, insuring derivatives supported by mortgage payments but not from losses on foreclosed residential mortgages (Carrol, 2009. p.1).
Factors that Cause the Differences in Predictions
Roubini had established that the U.S economy increased dependence on external financing of its current account deficit was not sustainable (Roubini & Setser, 2005. p.2). This means that Roubini’s predictions had a broader perspective of the forces at play. Roubini’s predictions were based on data that had been gathered from as early as 2000 (Roubini & Setser, 2005. p.6). In regard to foreclosures, Roubini predicted a 15% fall in the price of housing by the year 2010, given the excess supply of homes in the market. This excess supply according to Roubini has been as a result of cause and effect mechanisms of the recession (Roubini, 2009. p.1). While according to Butter, the price of housing is independent of foreclosures and is only driven by the GDP and long-term interest rates. Butter also supports the use of international standards in the valuation of assets. Banks and other lenders have claimed losses in excess of the actual reduction in value of the houses on which mortgages have been foreclosed (Carrol, 2009. p.1).
Impacts of Roubini Predictions on the US Economy
A collapse in the stock and financial markets has made policy makers more aware of the jeopardy of a systematic financial meltdown. This has resulted in interventions such as the unrestrained access of liquidity to the banking system and to several division of the shadow banking system to refurbish inter-bank lending and lending to the authentic economy (Roubini, 2008. p.5). There have been policy changes in regard to using fiscal policy to enhance aggregate demand.
The U.S congress should pass a budget that would limit unrestricted expenditure, through a range of sustained development in the deficit by minimizing non-defense discretionary expenditure (Roubini & Setser, 2005. p. 43).
In the light of the collapse of the private aggregate demand, it is imperative to provide a enhancing to aggregate demand to guarantee that the slump does carry on indefinitely. The U.S government requires implementing a clear strategy to bring down the face value of the mortgages (p.7). A new Home Owners Loan Corporation (HOLC) should be put in place to address the issue of bringing down the face value of mortgages as well as facilitating the home owners from defaulting on the newly financed mortgages (Roubini, 2008. p.8).
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Roubini, N. (2008). Joint Economic Committee October 30th 2008 Hearing on Faltering Economic Growth and the Need for Economic Stimulus. Retrieved 23 March 2009, from
Roubini, N. & Setser, B. (2005). Will The Bretton Woods 2 Regime Unravel Soon? The Risk of a Hard Landing in 2005-2006. Retrieved 23 March 2009, from
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