Lord Turner analyses state of US, Europe & Indian economies

Lord Adair Turner, the last chairman of the US Financial Services Authority, the chairman of the International Financial Stability Board, says the US economy is now recovering for sure but it is a very weak recovery. He says the Fed funds rate may end up being lower for longer than most people realise.

Lord Turner has also been on the boards of Standard Chartered Bank and Merrill Lynch.

As far as Europe goes, he feels extreme events such as uncontrolled default or exit from the euro has been very significantly taken off the table. However, he is quick to caution that the problems of the Eurozone are far from over. He feels the crucial thing for Europe is the danger of deflation.

He says Abenomics is the best thing that could have happened to Japan at the moment. “I wish it was done ten years ago because I think it was absolutely right to set a positive inflation target at 2 percent and to commit to meeting it and to use QE to try and get there,” he adds. He gives further inputs on the state of the Japanese economy and the way ahead.

Lord Adair Turner goes on to analyse India and says the crucial thing is to look at the degree of reliance on short-term debt and that is something that RBI governor Raghuram Rajan has commented on within the nature of financing of current account deficit (CAD).

Below is the verbatim transcript of Lord Adair Turner's interview on CNBC-TV18

Q: How would you assess the three major developed regions in the world - US, Europe and Japan and how emerging markets may negotiate the world in 2014.

A: I think the recovery of the US economy is now reasonably assured but we still have to say this is a very weak recovery. After a real plunge of gross domestic product (GDP) in 2009, we have not seen the sort of bounce back that the US economy used to have after its recessions of the early 80s or earlier 90s. So there was no sign that the US economy is returning to the previous trend of GDP growth and in particular, the US economy is not creating jobs on anything like the scale it used to. The way to measure that is not through the unemployment rate but the employment rate. The employment rate in the US is very low and unemployment to degree is only coming down because there will be a lot of people discouraged and completely out of the work force.

My own belief is that this may imply that rates in the sense of the Fed funds rate may end up being lower for longer than most people realise. A lot of people don’t make adequate distinction between the tapering of QE, reduction of the pace of increase of extra bonds earned by the Fed and the Fed funds decision, policy interest rates. Quite possible for the Fed to complete this year in line with the stated programme - the whole of the tapering and stop buying more long-term bonds for Fed funds rate to stay at the present level for several more years.

Q: In fact, both Ben Bernanke and maybe Janet Yellen have been trying to emphasize that.

A: It was something that the Federal Reserve was very keen in the autumn to point out that these things were not linked and indeed there was quite an important paper by Fed. Economists in November said we have the option of doing the tapering in 2014 and if we want not taking the Fed funds rate up to 2017 and people need to realize that is at least within the range of possibility.

Q: Let me come to what you make of Europe before we discuss more of tapering and the global economy. Do you think Europe definitely has put its secessionist problems behind, there were fears of debt default and therefore the possibility of one-two states even quitting the European Union, would you say that the last 15 months have put those fears behind?

A: I think that tail risk as we call it of extreme events such as uncontrolled default or exit from the euro has been very significantly taken off the table but I think we have to be clear. The problems in the euro zone are not solved.

First of all, I don’t think there will be a Greek government default because I think there is going to be a negotiated official sector involvement but I think the chances of Greece paying back in full at the currently stated interest rates, the totality of its government debt is close to nil and I think that is one of the sort of truths that dare not speak its name. Everybody knows this just by looking at the figures, there will be an official sector involvement (OSI) following the private sector involvement (PSI) two years ago.

But even more importantly I think the crucial thing for Europe is the danger of deflation. The latest inflation figures are now running significantly below 1 percent both from the headline and on core inflation measures. Mario Draghi has on several occasions said that we are absolutely clear, we are likely to be keeping interest rates as low as they are or lower for an extended period of time and I think the crucial issue will be whether the deflationary pressures take grip and whether ECB then has to think about radical measures whether it has to think about either negative interest rates or some category of QE. But the problem is that the QE is very complicated within the structure of the ECB whose bonds do you buy? If you are the US Fed and you said which bonds do I buy, the obvious stuff is United States Treasury (UST) bond but if you do it in Europe, you have to do some formula basis to buy everybody’s bonds simultaneously and of course is somewhat restricted by the constitutional and legal structure of the ECB.

Q: Before I discuss the implications for emerging markets of Europe and US with very weak recovery, one word on Japan. Do you think Abenomics has worked and do you think those two lost decades are all that Japan has lost?

A: I think Abenomics is the right thing to do and I wish it was done ten years ago because I think it was absolutely right to set a positive inflation target at 2 percent and to commit to meeting it and to use QE to try and get there. So that statement is clear I think governor Haruhiko Kuroda is absolutely determined and he has made it absolutely clear that if there are headwinds this year from the increase of the sales tax, he will just do even more through the monetary lever.

I think that the difficult years - when you live that sort of determination to hit a positive inflation target, when you live it for a couple of decades, you are dealing with such an enormous accumulation of government debt that there are risks. There are risks that people will suddenly take fright and say oh my god, what happens if this real inflation and interest rates will go up at that stage, this government debt burden becomes unsustainable because some of these are relatively short-term - it rolls over a reasonable pace and therefore a higher rate of interest would get reflected in debt servicing cost. Or you just cannot repay the debt. I think there is almost no scenario in which Japanese government debt is repaid in the normal sense of the word repay. The Japanese government which has been running deficits switches through to a surplus and pays it back.

I think what may end up happening is that the purchase of this government debt by the Central Bank of Japan will turn out to be permanent. This will be a permanent monetization of this debt. I don’t think we should be terrified of that. I think there are some circumstances where that is the right thing to do and that will be my prediction that Japanese government debt is not going to get repaid in the normal sense of the world repay. This increase in the Japanese Central Bank balance sheet will probably turn out to be permanent.

Q: Where does this leave countries like India, Indonesia, the fragile five? At least for 2014 from what you are saying it appears that the global financial system will remain deflated with everyone providing the currency but something like May 22 could happen yet again? So how do economies like India prepare for it?

A: The crucial thing is to look at the degree of reliance on short-term debt and I know that is something that Raghuram Rajan has commented on within the nature of financing of current account deficit (CAD). As long as CAD is funding a high level of investment building productive capabilities of future and is funded with long-term debt or CAD can be a sustainable part of the growth model if you look at the US in the 19th century it pretty much continually ran CAD and grew very well. The problem is that if your CADs are being financed by a set of short-term debt flows and of course once those have occurred and they have occurred, it is very difficult to do policies about them. If you are going to use anything like capital controls or macro-prudential tools, you want to apply those on the way in not the way out.

I don’t think in the modern world, outflow capital controls are too effective but you cannot play some limitations in a different set of tax forms or macro-prudential forms, requirements on the banking system that just pushed back from those flows of short-term debt which can de-stable us.

To the extent of those are in the system already, there is a vulnerability and that vulnerability was revealed by May-June last year after Ben Bernanke’s comments which at one level it was quite extraordinary that reaction. All of that Ben Bernanke said was the most oblivious thing in the world which is this isn’t going to go on forever and we are beginning to think maybe we should think about perhaps beginning the taper and all hell breaks loose. I think at one level that may be in the point of maximum risk because that was the point where people crystalise - no, no this thing does end. Now that we know that it does end that tapering has begun, I don’t think it is the same point of a crystallisation of a sudden shock but it certainly is incredibly important for the RBI and other Central Banks in their role as regulators of the banking system trying to understand what are the currency mismatches, what are the vulnerabilities to short-term funding in the way CADs have been financed over the last few years.