Eurozone at risk of entering Japan-type spiral: Lord Turner

But Turner is best known for his stint as chairman of the Financial Services Authority (FSA) from 2008 to 2013, where he defended actions of the regulator during the global financial crisis, and said other regulatory bodies throughout the world too failed to predict the economic collapse.

In April 2013, he joined George Soros’ economic think tank as a Senior Research Fellow.

Also read: World recovery increasingly dependent on US growth engine

Below is the transcript of Lord Adair Turner’s interview on CNBC-TV18.

Q: Let me start with the economy at your doorstep, closest to you, the Eurozone. It has been marked by recession for the better part of 2014. Does it recover to see some growth in 2015?

A: I don't know exactly what the pattern of growth will be in 2015 but the overall picture for the Eurozone is: I have to say, not an optimistic one. We are caught in a deep deflationary, recessionary cycle with a very low inflation and the dangers that it could actually turn into absolute deflation and we have imperfect policy levers within the Eurozone institutional structure to deal with it.

So, without getting involved in the business of predicting a particular year’s growth rate, my worry for the Eurozone is that unless we are very careful, the next five or next ten years the Eurozone will look rather like Japan in the 1990s and 2000s.

In other words, a very slow growth and very slow rate of inflation and that is a major risk for the Eurozone whatever the precise level of growth we see next year.

Q: That sounds very dire, 5-10 years like Japan. Won't political dynamics within the Eurozone work to resolve it? Won't you expect a full blown quantitative easing (QE) in the first quarter of 2015 from the European Central Bank (ECB)?

A: We probably will see now something of the form of QE in the first quarter of 2015. The difficulty is that unless it is accompanied by some fiscal relaxation either in the major country which doesn't have a debt problem which is Germany but also in some of the other countries, I am not sure that QE in itself will necessarily be transformative.

I mean QE works through the indirect impact of higher asset prices or it works through reducing long-term yields as well as the short term interest rates, which have already been reduced to a very low level. But the fact is that the Eurozone already has very low interest rates.

Businesses already borrow at very low rates of interest and I think pushing them even further lower and longer along the yield curve through a QE operation although it is bound to have some beneficial effect, I am not sure that in and of itself it is going to be transformative of performance.

From the point of view of financial market investors, it's highly relevant. It probably underpins the price of bonds and to a degree is equated but what we know from the pattern of ultra-loose monetary policy over the last five or five years in the western economies and in Japan in the 1990s and 2000s is that very low interest rates alone can take a long period of time to stimulate the economy.

So yes, I do think the ECB will take action. I think it might be quite significant action. I think it's a majority on the board to do that and the minority who are voting against will accept the will of the majority. My concern is not about whether they will do QE or not but how effective that will be alone in stimulating the Eurozone economy.

Q: There are some critics who think that there could be some kind of political crisis and maybe there is already one developing in Greece. Jim O'Neill on one episode of this show pointed out that there are unusual parties that have come up, political parties that didn't even exist a year ago in countries like Spain. You spoke of a possibility of long recession. Would that lead to social tension and therefore even to (Euro) exit-like situations in some countries like we saw in Greece a couple of years ago?

A: Well, what we are seeing increasingly is a number of populist parties which are either talking about exit from the Eurozone or effectively repudiation of debts. So, we have the Greek left wing party and we'll have to see how they do in the forthcoming elections that we're going to have in Greece. In Italy what we have seen is the Northern league which was previously positioned as essentially a secessionist party within Italy is repositioning itself as essentially a party saying that Italy should leave the Eurozone and then of course we have Podemos in Spain who are arguing for repudiation of debt and then only two and a half years down the line of course we have the French presidential election where an increasing number of observers are beginning to assume that Marine Le Pen, head of the National Front will get through to the second round though most people assume at the moment that she would lose at that point.

So, we do have a set of forces around Europe who are basically arguing that they're not going to put up with a slow growth low inflation path and are arguing for more radical policies. I cannot predict how well they will do and how that plays out. It is possible that each of them will do relatively well but never quite well enough to capture a hold of the political power and put their beliefs into action but the longer that we have a period of slow growth, rising unemployment and low inflation, the greater the dangers that they get that reaction and I would say here that I draw the analogy with Japan in the 1990 and 2000s but it is much more worrying in Europe.

Japan is one country with a debt which is pretty much owed to itself by itself. It is an ethnically and culturally homogenous society and it does not have large immigration flows. The Eurozone is a country of many nations where you can then get blame games and national politics. It has a significant degree of ethnic and religious and cultural diversity with imperfect degrees of integration which then has potential for people to blame each other and for minorities to react against majorities etc and various forms of right wing populism can exploit that and it has a very significant and I fear somewhat uncontrollable immigration flow from our somewhat chaotic neighbourhood in bits of North Africa and to the Middle East and all of that I think makes it far more important that the Eurozone avoids a long period of stagnation.

If we put a long period of stagnation in the Eurozone, the social and political consequences are much more potentially severe than they were in Japan but unfortunately it's not only more important to have radical actions that avoid a long period of stagnation it's also more difficult to get those radical actions because of the particular complex structure of the Eurozone as a country of one central bank but many nations and with the fiscal debt residing at the national level. So it’s very important to have as good a leadership, as thoughtful a leadership as possible through this and I'm hopeful that we will manage without severe crisis but this is a worrying outlook I think for the Eurozone.

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Q: The euro has fallen enough. Do you see further falls in that currency in 2015? Does it trade on par with the dollar?

A: I am very wary of forecasting of foreign exchange rate movement. If I was able to do that I would be a much richer man than I am. Most people assume and I would assume that with the possibility next year the probability that sometime next year there will be the first stages of monetary tightening in the US, my own gut feel is more towards the end of the year than the beginning of the year, but at some stage that will occur but no chance whatsoever of monetary tightening in the Eurozone or indeed in Japan or China that the direction of change in currency markets is highly likely to be a gradual appreciation of the dollar.

My own expectation is that is more likely to happen in a gradual fashion rather than with some sudden huge overshooting. One of the interesting things after all of the last six year of continual initially financial crisis, the Eurozone problems and then a recession and low recovery from recession is that as the dog that hasn’t barked is foreign exchange volatility. We haven’t seen that as one of the problems that hasn’t occurred and apart from for instance some smaller emerging markets as between the big blocks of the world I wouldn’t expect it to be dramatic. And even if it is dramatic it is not all that destabilising.

You can take significant movements in euro versus dollar without that necessarily having big financial stability effects. The disadvantage though is that even a significant depreciation of the Eurozone doesn’t transform Eurozone economic prospects.

You have to remember that the Eurozone is a big continental scale economy, therefore its exports of the whole zone as a percent of Gross Domestic Product (GDP), I forgot what the figure is, they are more like 10 percent other than 30 percent and in that environment it is very difficult to pull yourself out of a recessionary cycle simply by export demand driven by lower currency. You have to have forms of domestic demand as well.

So, the thing that I wouldn’t anticipate because I may be completely wrong is that by middle of next year we are talking about a financial crisis produced by a sudden and dramatic overshooting of the euro exchange rates and my anticipation is a gradual depreciation against the dollar but with that not sufficient in itself to pull the Eurozone out of it’s slow growth pattern.

Q: Finally do you see any crisis because of debt repudiation by any country, say, a country like Greece?

A: Debt repudiation it is almost certainly the case that there are debts around Europe that cannot be repaid. There is a political movement for debt repudiation in Spain now. In Spain there is probably a part of getting the debt under control. In Greece the Greek government debt is still unsustainable. I have always believed it is highly likely that at some stage what was called the private sector involvement which was the write down of the private sector holdings of debt which was introduced, I have forgotten when it was in 2011 or 2012, I have always believed that that would be followed at some stage by an Official Sector Involvement (OSI) and now that Greece is running a primary surplus there must be people in Greece who are beginning to think that that is a good idea.

I cannot see how Greek government debt at something like 170 percent debt to GDP will prove sustainable. I don’t think it will be sustainable for them to simply generate enough primary surpluses gradually to bring that down overtime. The big issue to debate going forward is what we think about Italian government that is sustainability. At the level where they are, sort of 134-135 percent debt to GDP they are literally on the knife’s edge: between is this really a debt level which can be sustained without some time the debt level going up and then the bond markets reacting to it and then high yields becoming reinforcing. So I don’t know there is a chance that will be no restructure of Italian government there but I would not exclude that possibility sometime over the next decade.

Q: You expect the Fed to hike rates perhaps later in 2015. Why later? The economy number seem fairly good, US GDP has grown, last heard by 5 percent in Q3. You do not see this growth continuing in the US in 2015?

A: The US economy is now growing at a robust pace. We know that from the latest job market, figures and whole series of other indicators but it is still the case that there is large amount of long-term unemployment. Short-term unemployment has come down but the employment rate is well below the level that it was at before the crises and inflation is very low and inflation in the labour market is very low.

These things are always data dependent and what people are debating and they are trying to understand is where is the Phillips Curve inflexion, where is the point at which a fold in unemployment feeds into a labour market, tightening which feeds into real wages sufficiently high to track the inflation target. I think it is quite possible that we could see considerably more months of job creation but without translating into tightening of the labour market, sufficient to produce forward indicators of inflation in the labour market.

Obviously also with the oil price fall, the headline levels of inflation, if anything are going to trend down and of course if as most of us now expect we are more likely than not to see an appreciation of the dollar although again since America is a big continental scale economy that has dramatic effect, it does tend to reduce inflationary pressure.

So put all those together and my guess would be more of second half of the year than the first half of the year but it is data dependent and if we are surprised on the upside by set of strong labour market figure though the crucial thing that the Fed will be looking for is not just the pace of job creation but when does that job creation begin to change wage setting behaviour and at the moment in terms of wage setting behaviour, wage increase is high enough, there are forward indicator of inflation going above target in future. We are really not seeing that yet and the majority of the Fed board will be cautious of raising interest rates until they see that indication.

Q: What about China. We have seen a bit of growth scare in the latest GDP number as well as other industrial data out of China. Do you think in China the story in 2015 is going to be one of continued slowdown?

A: The China story is very dependent on what the authorities do but we could see a significant slowdown and it is staying at a slower rate. What the Chinese authorities have been struggling with for the last year is the dilemma that you face in late stages of credit and property and infrastructure boom. They unleashed an enormous increase in credit back in 2009 very successfully to prevent the economy going into recession after the global financial crises but the inevitable effect of that was a dramatic increase in Chinese debt to GDP.

There are various different ways of measuring it but from something like 140 percent to 240 percent debt to GDP. What has been happening this year is a set of signs that that is reaching a crisis point. We had a downturn in the property market; we know that there are some local governments who are under stress; there was unwillingness on the part of the People's Bank of China (PBoC) earlier in the year to offset that by and across the broad monetary loosening.

Q: Given that you see this slowdown in China and in Europe and in Japan, what is your take on the commodity markets, do you think they will remain bearish in 2015?

A: I think the most likelihood is that it continues to be bad year for commodities. I think the Chinese credit driven, investment driven model has been hugely important driver of demand for iron ore, copper, oil, coal. It therefore been very big driver of the Australian economy and we are now seeing a significant slowdown in the Australian economy with a dramatic turn in the Australian economy in terms of trade as the iron ore price falls very significantly.

The difficulty to know is to know whether what is occurring is fully in the market already and I am not great though say there is precise predictions; you have to be closer to the market – that specific market to know the extent to which they have already anticipated it but the broad direction of change over the last half of this year and looking forward to next year is bearish for commodities and that of course is driving a big slowdown in the Brazilian economy, in the Australian economy and in the oil price.

I am not going to predict whether the oil prices has now found a floor or not but we understand why it has been such a fall in the oil price although I would not like to know whether it’s precisely hit a floor or not, I would not anticipate a big bounce back because I cannot see a return across the world to the levels of growth which would drive tightening of the oil markets. So the broad picture which we are in at the moment yes, it’s indeed bearish for commodities.