New York University Professor Emeritus of Economics Nouriel Roubini joins Yahoo Finance Live to discuss the U.S. banking crisis, economic growth, the possibility of a recession, rate hikes, oil, and the labor market.

Video Transcript

RACHELLE AKUFFO: All right, well, turning now to our top story, cooling inflation raising hopes the Fed could hold or even bring down rates. That optimism shared by Gary Cohn, former NEC director, who says the worst of the trouble with the banks may already be behind us. Take a listen.

GARY COHN: We're more acutely aware of what's going on now because we've seen larger banks, much larger banks, run into financial trouble, and we've seen larger banks go out of business. I don't think we have seen the end of this banking situation. I won't call it a crisis because I don't feel like we're in a crisis.

RACHELLE AKUFFO: Our next guest, however, says increased spending, the fallout from recent bank collapses, and yes, still high inflation are creating storm clouds on the horizon. Joining us now, Nouriel Roubini, Stern School of Business New York University Professor Emeritus. Thank you for joining me this morning. So I first want to get your reaction to where we are in this banking crisis and the repercussions.

NOURIEL ROUBINI: I think the worst is still ahead of us. The business model of many regional banks is broken. They have a narrow deposit base. They have a large amount of uninsured deposits. They have massive losses on their securities. Even the value of their loans is falling. They have exposure to commercial real estate. And many of them, if you measure it correctly given the change in interest rates, are now insolvent.

If they have to raise money another 50 basis points on their deposits because people can get 4% or 5% on safe money market T-bills, then you have a problem in terms of cost of funding and value of their assets. So I think that the worst in terms of severe banking stress is still ahead of us. And of course, this credit crunch is going to reduce significantly economic growth. They lend to SMEs. They lend to households. They lend to commercial and residential real estate. Their credit crunch is going to tip the US economy into recession later this year.

RACHELLE AKUFFO: I mean, we still don't know exactly how long these repercussions will last, but some not quite as pessimistic. In Jamie Dimon's annual shareholder letter, he noted that there would still be repercussions from the banking crisis for years to come. It does raise recession risks. But he said nothing like what we saw in 2008 because it involves far fewer financial players and fewer issues that need to be resolved. Is there something missing there from this picture?

NOURIEL ROUBINI: Well, compared to 2008, now we have inflation. At that time, we didn't have inflation. We've had a number of negative aggregate supply shocks that reduced economic growth and increased the cost of production. So at that time, with a demand shock, a credit crunch, deflation could do massive monetary, fiscal, and credit easing. Now enter an economic contraction when inflation is too high and the Fed has to keep on hiking.

Even before these banking stresses, the Fed was facing a dilemma because either you raise rates to fight inflation and you cause a recession, or if you care about job growth and you don't raise rates enough, then you have a [AUDIO OUT] expectation. Now the dilemma has become a trilemma because in addition to price stability, maintaining growth, we also need financial stability. And as you raise rates, you create more stresses for both creditors and for borrowers. And therefore, you have only one policy instrument. In this case, the Fed funds rate to hit three target-- price stability, growth, and financial stability. To me, that looks like mission impossible.

RACHELLE AKUFFO: And you mentioned there's trilemma there. So you have the looming insolvency crisis, recession risks, inflation as well. But you also do have a much stronger consumer now than you did in 2008. But you say that a doom loop is coming. Is it not avoidable then?

NOURIEL ROUBINI: Well, among the households, there are those who are doing better off. But the bottom 50% of the household sector lives from paycheck to paycheck. The average household has only a few dollars of liquid cash spare. They had savings during COVID, but they spent a lot of it. Real wages have been falling because wages were growing less than inflation.

And the-- there is some meaningful amount of financial fragility. Anybody who has a consumer loan, a credit card, an auto loan, student loan, or mortgages at variable rate now is facing much higher debt servicing costs. So we're starting to see the buildup of fragilities for at least half of the household sector as well.

RACHELLE AKUFFO: So what can central banks do at this point? I mean, we saw the IMF raising risks as well about even the vulnerabilities of non-bank financial institutions as well and talking about how much the global financial stability hinges on that as well. What can central banks do?

NOURIEL ROUBINI: Well, right now, they are in a trap because either they raise rates even more-- and even today's inflation report suggests that core inflation is still at 5.6%, well above 2%. If you raise more in order to fight inflation, you cause an economic downturn. It's going to lead to more non-performing loans and more financial stresses. And more financial stresses in financial markets, banks and non-banks are going to imply a more severe economic downturn. So economic and financial crash.

Or if you care about growth and about maintaining financial stability, you stop raising rates when inflation is still too high. And then over time, you get the de-anchoring of inflation and inflation expectation, and you get the wage price spiral. And then you end up like the '70s, with inflation remaining high, eventually recession. But in the '70s, we had stagflationary shock. But that ratio went low, 100% of GDP traded in public. Today, they are 420% of GDP.

After the GFC, we had the debt problem-- household, housing, mortgages, banks. But we had a negative demand shock that was deflationary. Today, we have the worst of the '70s in terms of negative supply shocks and debt ratio that are significantly higher than they were even during the global financial crisis. That's why I do worry there's going to be a great stagflationary debt and financial instability. We have the-- the worst of the '70s and the worst of the post-GFC periods.

RACHELLE AKUFFO: And some of these other mega threats that you mentioned, what we're seeing in terms of countries engaged in what you call various wars, some real, some metaphorical. And talk about the domino effects on that and what that might mean for investors.

NOURIEL ROUBINI: Well, we are in a geopolitical depression. There is already a hot war with the brutal Russian invasion of Ukraine. This spring, this war is going to get worse, potentially further shocking commodity markets. I was recently in Israel, where it's clear that Iran has become a threshold nuclear state. If Israel were to attack Iran, you'll have a spike in oil prices worse than '73 or '79.

And I just visited China, where, unfortunately, the Cold War between US and China is getting colder by the day. And this geopolitical [AUDIO OUT] is leading to a fragmentation of the global economy, decoupling protectionist de-globalization, balkanization of global supply chain. We've gone from free trade to secure trade, from offshoring to friendshoring, from just in time global supply chains to just in case, and from caring about economic efficiency to talk about economic and geopolitical security. These things are costly. They reduce global growth and increase cost of production. And there are forces that, among others, are stagflationary for the real economy.

RACHELLE AKUFFO: And, I mean, we're seeing countries having to take sides as both China and the US trying to push forward with technological advancements. But obviously, the US dollar is still the predominant global currency, reserve currency. But as people do sort of take sides in this dynamic, what lies ahead then for the dollar and the multinational companies that are essentially stuck in the middle here?

NOURIEL ROUBINI: Well, we had, until now, a unipolar global reserve currency where the dollar was dominant. But it's clear that China and its allies, revisionist powers like Russia, like North Korea, Iran, Pakistan, and others, want to build an alternative global monetary and reserve currency system because they worry that the kind of sanctions imposed on Russia, if there was a conflict or escalation over, say, Taiwan, could be imposed on China.

And China is over [INAUDIBLE] of reserves that are in dollar. So they need to have a unit of account, a means of payment, a store of value that is alternative to the US dollar. And they're going to start to build it. And they're already talking not only to their own allies, but also other friends that do business like those in the Persian Gulf, about pricing oil in RNB, paying it in RNB, and building reserves in RNB. That's going to take time.

But I think that gradually over time, we're going to have a process of a movement of a unipolar global reserve currency system to a bipolar, where you're going to have US, Europe, the West based still on the dollar but then the Chinese are going to build the RNB as an alternative to the US dollar. That means less financing of our own twin fiscal and current account deficits when we still have very large stocks of private and public debt. That can push higher the cost of financing for the United States when we have very high private and public debt ratios.

RACHELLE AKUFFO: Certainly a lot of dynamics and nuances at play in this relationship investors should be aware of. Nouriel Roubini there, Stern School of Business New York University Professor Emeritus. Thank you for joining us on Yahoo Finance today.

NOURIEL ROUBINI: Great being with you today.