'I Am Dr. Realist'

How about the deficit the banks are building up?
In the short term I am supportive of it, because if we didn't have these fiscal deficits, the recession would become a depression. On the other side, I do agree that this is not a free lunch. We are going to add trillions of dollars to our public debt, which is going to go from 40 to 80 percent of the GDP. There are only a few ways in which you can finance that extra public debt. If you rule out default and a capital levy on wealth, you either have the "inflation tax" or you have to painfully cut spending or raise taxes, and either one is not going to be politically palatable.

What is going to fuel the next growth cycle?
That is a difficult question. The periods of high growth in the United States in the last 25 years have been characterized by an asset and credit bubble. Whatever the future growth is going to be, this time around it needs to be sustainable and not bubble-prone because we are running out of bubbles to create. We had the real-estate [bubble], tech bubble, housing bubble, hedge-fund bubble, private-equity bubble, commodities bubble, even the art bubble—and they are all bursting.

What makes you different from the other economists?
We think usually that crowds—on average—can be wiser than individuals. In this case, most people got it wrong because whenever we are in an irrational, exuberant bubble, people fail to think correctly.

Do you believe this is a bear-market rally or do you think it is the market anticipating an economic recovery?
As we reach newer lows, we may be closer to a level of the market that is fundamentally right. A year ago we were not as close to a true bottom. Today we are closer to it. As we become closer to the bottom of the economy, the stock market looks ahead and sees the light at the end of the tunnel and rallies. In spite of these caveats, I would argue that even the latest market rally is a bear-market rally.

Do you worry about China getting tired of holding our bonds?
In the short run, China has no option but to accumulate more reserves and dollar reserves. Why? Because if they stop doing that, their currency would appreciate sharply while their exports are plunging. So in the short run, they are going to keep on accumulating. But I have seen a huge number of new initiatives in the last month that suggest [the Chinese] are pushing for the yuan to become an international currency and a reserve currency. They are doing bilateral deals with countries like Argentina and half a dozen others in yuan, not in dollars.

They are moving away from the dollar?
Yes, slowly they will. First they have to establish their own currency as an international currency. That will take years, but already in a month they have done more than in the last 10 years.

© 2009