The Fiscal Cliff and How We Got Here - Public Choice Theory

The article below is a very good explanation of how "we got to where we are".  It is a discussion  about Public Choice Theory, why it is rational, and the consequences of a series of poor decisions.  The discussions continues into how this ultimately led to the issue of the Fiscal Cliff, the consequences of going or not-going over the cliff, and possible solutions.  

By the way, I found this article at a website that I recently discovered called the Global Economic Intersection.  This site publishes a number of new posts every day and many of them are very interesting.  I encourage to visit the site.

The article is in italics and most of the bold is the authors.  From the Global Economic Intersection:

As the fiscal cliff approaches on January 1, 2013, when automatic spending cuts, tax rate hikes and elimination of certain deductions goes into effect, we must consider how we got to this point – and how to get out of it, if we can. The effects are economic, but the causes are psychological, sociological and political. Let’s explore the causes of why we are here, with a mountain of federal government debt that rivals our economic output. While it may seem strange to consider, perhaps entirely logical decisions led to a rather illogical state of affairs.

Follow up:

First, politicians do not simply appear in office. We elect them. We should hopefully know what policies they support beforehand, and we might reelect them based on what they did while in office. If we had any objections, we could have made a different choice. Our obligation – and certainly that of all elected officials – is to vote for what is in the best interest our nation. As we will see, however, people acting entirely rationally can act in a way that is in the best interest of the fewest people at the expense of that of the most.

Politicians make all sorts of promises, and at least some of us seem to believe them. A car in every garage – with lower taxes at the same time to boot! Who wouldn’t vote for such things? But remember, if it sounds too good to be true, it probably is. No matter how clever at legislating, politicians haven’t been able to outlaw the rules of simple math. To balance a budget, income must be greater than or equal to expenses. It’s just that simple.

Public Choice Theory

But really, it’s quite complicated. At this point, we must introduce a concept known as public choice theory. Public choice theory uses modern economic tools to study problems that are generally in the realm of political science. From the perspective of political science, it explains how voters, politicians and bureaucrats all act in rational self-interest, but which results in political decision-making outcomes that conflict with the preferences of the general public. Several public choice scholars have been awarded the Nobel Prize in Economics, notably James Buchanan (1986), along with others, including George Stigler (1982) and Gary Becker (1992).

Delving into how this theory works in practice, consider the example of special interest groups – those lobbying efforts by corporations or other agents who want spending for a particular project. Even though the public might oppose this type of spending on pork barrel projects in principal, few members of the public have the time or energy to combat the intensive lobbying efforts for the many individual projects that go before lawmakers.

Proponents invest much more in the outcome than those who might oppose the measures, simply because those few people stand to gain quite a bit, compared to individual members of the public, whose costs, individually, are quite small.

After all, one project by itself might not seem like a large sum to the government, but it is a very big deal to the special interest group in question. Not to mention, of course, voters in a district that benefits from these projects will certainly not complain. Instead, they might be more, not less, likely to vote for a politician who proposes these spending projects, even if it might be considered by others to be “wasteful.”

As such, the cost/benefit relationship is distorted. Proponents invest much more in the outcome than those who might oppose the measures, simply because those few people stand to gain quite a bit, compared to individual members of the public, whose costs, individually, are quite small. Suppose a new, hypothetical “bridge to nowhere” cost $30 million to build. Is it worth me fighting about it when its costs average out to be ten cents to me (and every other American)? Am I even a voter in that representative’s district, where the legislator will heed my complaints?

It’s in my own, individual best interests not to fight this one hypothetical project. This is not the most productive use of my time and energy, especially given my poor chances of succeeding in a one-man effort against a lobbying firm. Hence, even if I am angered by excessive spending, I am acting in an entirely rational fashion to ignore this particular project, preserving my own resources of time and energy, but acting against the nation’s long term best interest.

… many small bad decisions get multiplied into a much bigger problem.

Then there are other reasons beside the money involved. Politicians might feel a bit more powerful and might feel like they have a bit more clout on Capitol Hill, if they can get the project in question passed. More importantly, politicians might want a new career as a lobbyist themselves at one of those firms after leaving government. It always helps to play nice with someone who might be your new boss.

All of this means that many small bad decisions get multiplied into a much bigger problem. There are 535 members of the US Congress, with plenty of opportunity for special interest spending to be introduced.

Public choice theory - individuals acting in a rational fashion, focused on their own self-interests, can lead to a very poor outcome for the nation as a whole.

Meanwhile, voters in each district are focused only on the policies proposed – and the results delivered – by only their representative when casting a vote, reducing the accountability of the institution as a whole. Costs are diffused, while benefits are concentrated, and all of it is someone else’s money, anyway.

Thus, public choice theory shows that individuals are acting in a rational fashion, focused on their own self-interests, leading to a very poor outcome for the nation as a whole. When it comes to public policy, not free market enterprises, perhaps Ayn Rand might not be entirely correct in her views that there is a virtue to selfishness, or rational self-interest, as she describes in her writing, including her book, “The Virtue of Selfishness.”

Our Current Situation

That leads us to our current dilemma. We’ve seen debts grow and grow after many, many years of deficit spending. All those little sums of individual projects have added up in a very, very big way. What were we thinking?

Perhaps we were just hoping it would all go away. For decades now, we’ve engaged in mass delusion; that somehow, growth would subsume the need for restraint. We’ve believed that the magical powers of some yet-to-be-determined force would create powerful economic growth that would obviate our need for maintaining smaller deficits that won’t grow faster than the economy as a whole. But one must never build a budget or economic models based on just hopes and wishes; yet that is what we, as a country, have done.

We’ve had ample opportunity to see that this hasn’t worked, over decades, if not entire generations. We’ve spent more than we’ve earned in the difficult 1970’s and in the prosperous 1980’s. We did it again in the booming 1990’s, except maybe for a year or two, and then again in the austere 2000’s. We’ve had ample opportunity to see that there is no economic genie that will grant our wishes for the problem to simply go away.

But one must never build a budget or economic models based on just hopes and wishes; yet that is what we, as a country, have done.

We could have voted for politicians that were realistic, but people don’t like to hear Debbie Downer giving a political speech. A salesman always sells more cars than does the engineer who actually knows how they work.

Now, things have come to a head. We’ve seen the disaster that excessive debt has wreaked in Europe, and we’re eager to avoid those problems now. We do recognize the European model of generous spending has failed. But perhaps Europe’s attempt of a solution of immediate austerity does not work, either. Indeed, a starvation diet to wean us off gorging on debt spending can lead to problems with our economic health. Like a rubber band stretched too far and snapping back in the opposite direction, is our current fixation with rapid deficit reduction going too far in the other extreme?

Indeed, a starvation diet to wean us off gorging on debt spending can lead to problems with our economic health.

After all, deficits, like many things in life, can be beneficial in smaller, more moderate amounts, but can become problematic in excess. We should point out that our trade deficit and budget deficit are intertwined: the capital account must equal the current account. If we are going to tackle our budget deficit – remembering that foreigners buy many of our Treasury instruments – the corollary must be that our economy would slow from reduced government spending to the point that our imports would be reduced, unless our exports somehow increase.

So, we might ask, can we have a better solution, perhaps a more moderate approach to cutting the deficit rather than try to do most of it all at once? What businesses (and consumers) want mostly is to know what is going to happen with taxes and spending; they aren’t necessarily asking that all of these things happen right this second, as long as they know that there is a credible plan. And a more gradual implementation of this fiscal restraint can give both businesses and consumers more time to plan and adjust, rather than going off the fiscal cliff.

The Problem: The “Fiscal Cliff”

By now, many of you have heard about the federal belt tightening that is scheduled to begin January 1, 2013. This is because our two primary political parties are unable to compromise, the same factor that Standard & Poors cited when downgrading our federal government debt. The Congressional Budget Office (CBO) reports that fiscal tightening will lead to a recession in 2013. They detailed their findings with a number of economic projections, comparing if we go off the fiscal cliff (meaning lawmakers do nothing), or if politicians change the current law to reduce the impact of the fiscal restraint.

Specifically, here’s what the economy might look like without going off the cliff, that is, if current law is changed, but current policies remain the same. (Remember that the way the law is currently written, we will go off the fiscal cliff. Lawmakers must change the current law to retain taxes and spending as they are now to avoid the cliff.)

§  In 2013, the deficit would total $1.0 trillion, almost $400 billion (or 2.5% of GDP) more than the deficit projected to occur under current law (but it is still $91 billion less than in 2012).

§  Real GDP would grow by 1.7% between the fourth quarter of 2012 and the fourth quarter of 2013, and the unemployment rate would be about 8% by the end of 2013 (basically, right near where it is now), the CBO projects.

Now, here is what happens if we do go over the cliff (remember, this happens if lawmakers simply do nothing).

§  The deficit will shrink to an estimated $641 billion in fiscal year 2013 (or 4.0% of GDP), almost $500 billion less than the shortfall in 2012.

§  Such fiscal tightening will lead to a recession, with real GDP declining by 0.5% between the fourth quarter of 2012 and the fourth quarter of 2013, and the unemployment rate rising to about 9% in the second half of calendar year 2013.

§  Because of resource slack, the rate of inflation, as well as Treasury yields, will remain low in 2013, in the CBO forecast.

Pick your poison: a recession now or more debt. The CBO notes, though, long term, our economy will be in much better shape with the deficit reduced significantly – though it does not need to be eliminated entirely. We now must pay the price for decades of voters who seem to always want politicians to give us more spending with lower taxes. If we didn’t want to accumulate that debt in the 1970s, the 1980s, the 1990s and the 2000s, we sure had ample opportunity to break out of this debt snare long before it hit a crisis.

… people acting in a rational fashion can, ultimately, act against their own best interests when viewed as citizens, members of the nation as a whole, not individuals. That is the paradox.

But as we learned, in our nation’s journey on the way to the fiscal cliff, perhaps we weren’t as irrational, as individuals, as an outside observer might think. Yes, who would vote against the best interests of the country? But, as public choice theory demonstrates, people acting in a rational fashion can, ultimately, act against their own best interests when viewed as citizens, members of the nation as a whole, not individuals. That is the paradox.

Possible Solutions and their Impediments

No matter how we got to this point, or what theories explain it, we are in a difficult bind. Competing paradigms now battle each other. With gridlock in place, current law will undo decades of overspending relative to our revenues in just one short year. Yes, we need to move closer towards reasonable deficits over a reasonably short period of time, but a compromise solution certainly could allow for, well, compromise, from lawmakers on both sides of the aisle.

The only way that we can gradually descend from our mountain of debt, instead of tumbling headlong off the edge, is for the leadership of both parties to work together. Unfortunately, that is less likely than not.

Maybe deliberately jumping off the cliff could still be avoided. However, the problem is, economic troubles may start sooner if businesses and consumers start cutting back before the fiscal cliff arrives. By then, it may be too late, as a recession may start, based on worry and doubt. But relying on hopes and wishes rarely leads to prosperity, either. Can there be a middle ground, a rational decision process that leads to our mutual best interest, for all of us and our nation as a whole?

Finding a middle ground is vital. But few politicians seem to advocate for the solution that is most necessary: a combination of both spending cuts and revenue increases. Entitlements need to be addressed for younger generations, and we may need to cut defense spending.

But some good news is that we don’t need to eliminate deficit spending entirely…. additions to our debt would be no greater, proportionally, than additions to our aggregate economic output.

Otherwise, if we were to try to balance the budget through spending cuts alone, without addressing entitlements or defense spending, we would need to close every single government agency and department. (See table S-4 in the attached budget http://www.whitehouse.gov/sites/default/files/omb/budget/fy2013/assets/tables.pdfif you’re curious.)That’s everything from the FBI to the IRS and everything in between, whether it’s NASA, national parks, federal courts or Amtrak. Our nation would suffer enormously if we tried a rigid, partisan approach to balancing the budget, without compromise or consideration of realistic economic models.

But some good news is that we don’t need to eliminate deficit spending entirely. In the same general vein that a consumer may undertake some debt, such as to buy a house or car, or a business may borrow to expand, the federal government may find it beneficial to borrow a bit. The general thesis, though, is that the debt should not grow faster than the economy. This means that deficits should be in the general range of long-term, potential economic growth, say, perhaps 3% or so. Thus, additions to our debt would be no greater, proportionally, than additions to our aggregate economic output, and debt as a percentage of GDP will remain more-or-less stable over time.

Why would we want to have some deficit spending? One is our current environment. As consumers deleverage, and pay back debt, their consumption tends to fall, all things equal. That debt isn’t going to be replaced by more bank lending, and those funds basically get taken out of the economy. This can cause economic growth to be sluggish, or in some cases, even contract.

When the government steps in to be the “consumer of last resort,” government borrowing replaces consumer borrowing to goose the economy. Paradoxically, this is the exact opposite of “crowding out theory,” where government borrowing displaces borrowing by businesses and consumers. In normal times, this could limit economic growth. But now, in the “Great Stagnation,” to borrow a term from Boston Federal Reserve Bank President Eric Rosengren, we are not in a normal environment, when such theories tend to hold.

Perhaps the government could raise taxes when inflation rises and cut them when inflation falls below desired levels.

Instead, government borrowing, in moderation, can steady the economy, adjusting upwards or downwards to right the ship if more extreme behavior in the private economy takes place. This is the best use of deficit spending, when fiscal policy can expand during lean times and contract during strong expansions.

Such flexible approaches to deficits can help keep inflation from moving too far above or below the target, 2% or just a bit less, as well as keep economic growth from contracting too much in recessions. Perhaps the government could raise taxes when inflation rises and cut them when inflation falls below desired levels.

The trick is getting politicians to consider deficits through the lens of economics theory.

Coincidentally, this may tend to stimulate the economy when it needs to be juiced and recoup tax revenues to lower the deficit when the economy is more amped. This would help keep inflation and growth steady and our deficits under control.

Conclusion

The problem is that we haven’t been able to use deficit spending either appropriately or in moderation. Politicians don’t seem able to choose judiciously when to spend and when to use restraint. But as we have seen, public choice theory explains why our addiction to excessive debts can make logical sense when viewed as such, even if the result of our behavior does not.  The trick is getting politicians to consider deficits through the lens of economics theory, not economists viewing deficits through the lens of political science. For our economic well-being, one might come to trust an economist over a politician, even if their promises fail to excite.

Gold and Silver Basics 

I saw this at Infographics and was fascinated by the graphics.  It is the basics of gold and silver in a picture.

Lakshman Achuthan Reaffirms His Call That the US is in Recession

From  Bloomberg:

The Real Value of QE1 Through QE3?

As a result of the collapse of the housing market that started in 2006, households in the US lost just over $7 T (yes, that is $7 trillion dollars) in home owner's equity (Q4 2005 through Q3 2011).  In recent quarters this loss is not quite so severe at $ 6.2 T.  See the first chart below:  

However, during a similar period of time household net worth declined initially $16.2 T (Q2 2007 to Q4 2008), however, all but $4.7 T has been regained as of the end of Q2 2012.  Clearly the difference in the household net worth and owner's equity has been the value of the stock market and the net repayment of debt (not quite $1 T).  See the chart below.

Just in case you are curious about the value of QE1 through QE3, these programs put excess reserves into the banking system and have the added feature of maintaining the level of the "wealth effect" for the US consumer by propping up the value of the stock market.  

In the Fed data used above household net worth and home owner's equity data includes non-profit organizations.  Although it is not specifically broken out by the Fed, the non-profit sector is assumed to be about 6% of the total.  Other authors.  

Raising Taxes Cannot Solve the Problem of the Rising Federal Budget Deficit.

Once again the people at AIER (American Institute of Economic Research have put together an article that is easy to read, about economics, addresses a very important current issue, and is thought provoking.  Basically, tax increases above 20% of GDP are counter-productive.  The article is in italics.  From AIER:

Federal tax revenues have averaged 19.6 percent of GDP since World War II. As the chart above shows, federal receipts broke the 20 percent ceiling only once, reaching 20.6 percent during the tech boom of 2000.

This has led many economists to argue that it is irresponsible for the U.S. to make long-term commitments to expenditure levels above about 20 percent of GDP. Nonetheless, government expenditure was 25.5 percent of GDP in 2011 and is projected to be more than 24 percent this year.

The 20 percent ceiling for government revenue holds despite a wide variation in tax rates. In the postwar period, the highest personal income tax rates have been as high as 92 percent and as low as 28 percent, while corporate tax rates have ranged from 35 to 53 percent.

This means that raising taxes to address mounting U.S. debt is not an option. While it may seem fair politically, it is unrealistic and counterproductive in practice.

At some point, apparently around 20 percent of GDP, increased tax rates are offset by shrinkage in the tax base.

Individuals and businesses postpone income, find tax shelters, move assets offshore, and hire armies of accountants and lawyers to protect their income. Some even move to lower-tax countries. Higher taxes can also slow economic activity by reducing the personal rewards for working, innovating, and investing.  If a 25 percent increase in the tax rate is met by a 25 percent decrease in whatever the government is taxing, the country does not gain tax dollars.

Higher taxes have succeeded in increasing government revenue in small, homogeneous countries such as Sweden and Finland. With the large, diverse, and often fractious population of the U.S., it just doesn’t work. The history of U.S. taxes and spending shows that once expenditures rise above 20 percent GDP, no level of taxing will pay for it.

Housing Market Suffering From Contract Cancellations

The housing market for existing homes is suffering from a relatively large number of contract cancellations.  The specific reasons are not known but it is some type of problem in the purchase process such as a problem with the home or the inability to secure financing.  I have read, but cannot confirm, that only 1 out of 32 mortgage applications are approved.  That is not a very high approval rate.  In spite of all the optimistic talk and excitement about the housing market, I find it interesting that the lowest mortgage rates since the Eisenhower Administration still cannot clear the housing market.

The article is in italics and the bold is my emphasis.  From Market Watch:

A housing recovery may be under way, but there’s an obstacle that appears to be slowing down the rebound: the unusually high number of buyers who walk away from their contracts.

An average of nearly 18% of signed contracts on existing home sales were canceled during the three months ending July, according to data released this month by Capital Economics, an independent research firm. That’s the highest all year and the most since May 2010, when that figure reached 23%; in the five years before the housing slump started, the average never went higher than 10%. Separately, 36% of Realtors are reporting some kind of problem with a contract, including cancellations, delays and renegotiations of the sales terms, according to August data by the National Association of Realtors. That’s up from 30% earlier this year.

The latest setback comes as home sales are rising. Existing-home sales increased 7.8% in August from a month earlier and rose 9.3% from a year prior, according to data released this morning by the NAR.

Ironically, the recent pickup in home sales is contributing to rising contract cancellations. As more buyers compete over a limited inventory of for-sale homes, some are bidding aggressively to get the seller’s attention, but not assessing whether they truly want the house until they’re in contract, says Bryan Sweeley, a real estate agent in Santa Clara, Calif., with ZipRealty. This strategy could make it more likely that buyers will walk away from homes if red flags are raised in an inspection or the appraisal, he says. As we previously reported, appraisals have been derailing home sales in cases when the appraised value of the home comes in lower than the purchase price the buyer and seller had agreed to.

Tight lending requirements are also contributing to contract cancellations, says Paul Diggle, property economist at Capital Economics. As more buyers move off the sidelines to purchase a home, they’re finding they can’t qualify for a mortgage, he says. (Data from the Mortgage Bankers Association shows that mortgage applications for home purchases have been relatively flat most of the year with some increases posted in recent months.) While buyers are encouraged to get preapproved for a mortgage before making an offer on a home, it’s not a requirement. But skipping this step opens them up to the possibility of being denied a mortgage on a property that they’ve already entered into contract on.

To be sure, contract cancellations don’t necessarily mean those buyers are leaving the market, experts say. In some cases they’re making offers on other homes or working on a new contract with new terms on the same property in question. 

Still, for sellers, canceled contracts can range from a slight nuisance to a major setback. In most cases, they extend the time sellers spend trying to unload their home. It may also set them back financially if the seller has moved out of the property in anticipation of the buyer moving in.

But it’s buyers who can incur the biggest financial setback when walking away from a contract—which can include losing the deposit they’ve paid on the home. Upon signing the contract, buyers typically put a small percentage of the purchase price down to be held in escrow. Paul Howard, a buyer’s broker in Cherry Hill, N.J., says buyers should ask their agents to include contingency clauses in the contract that state the buyer can walk away from the home if financing falls through or if the inspection or appraisal of the home isn’t satisfactory. (Some transactions might require additional contingencies.) In most cases if they abandon the deal based on a contingency clause in the contract, buyers should be able to get their deposit back. 

The Global "Perfect Storm" in Finance and Economics

Interesting article on the gathering of a perfect storm of continuing problems with the Euro, the fiscal cliff in the US, declining economic growth in the emerging markets, and the potential for a war with Iran.  No one is saying these thing will happen, these issues are not remote possibilities.

The article is in italics and the bold is my emphasis.  From the Huffington Post:

Experts and leaders gathered in Italy may disagree on the cure, but the malady seems clear: the world economy faces a "perfect storm" of risks that include prolonged crisis in a structurally flawed Europe, political paralysis pushing America off a "fiscal cliff," a slowdown in the emerging economies drying up the last of global growth, and the spectacularly destabilizing prospect of war over Iran's nuclear program.

A world of such unpredictable peril is also one in which jitters suppress the appetite for private and corporate risk, yielding meager investment and low consumption and prolonging the woes that snuck up on a booming world in the summer of 2007 as a "credit crunch", mushrooming a year later into the Great Recession.

Many attendees at the annual Ambrosetti Forum at Lake Como on Friday fretted about mounting U.S. debt and the Europe's inability to balance electorates' apparent insistence on national sovereignty with the need for regional coherence to salvage the teetering euro.

But economist Nouriel Roubini predicted years of gloom almost regardless of what is decided.

That analysis is rooted in the specific nature of this crisis, a downward spiral in which a financial meltdown largely caused by excess credit was defused by a blast of public spending; that 2009 stimulus, widely credited with avoiding a global depression, pushed some governments too far into the red for the markets' liking – a "sovereign debt crisis"; and this is turn was attacked through severe austerity measures that suppressed spending to the point that countries cannot grow their way back to prosperity.

"History suggests that whenever (there is) a crisis with too much private debt first and public debt second you have a painful process of deleveraging," said the famously apocalyptic New York University professor, a glowering fixture at such international talk-shops.

"That would imply many years, up to a decade, of low economic growth. And guess what? Economic recovery in the U.S. has been unending and in the eurozone and U.K. there's outright economic contraction right now, and that's not going to change unfortunately in the next few years."

The grim prognosis was consistent with new figures released a day earlier by the OECD, a club of the world's richest nations. Its report found that the global economy is slowing and that the G7 economies would grow at an annualized rate of just 0.3 percent in the third quarter of 2012. Furthermore, the OECD found, the continuing eurozone crisis "is dampening global confidence, weakening trade and employment and slowing economic growth" worldwide.

How to fix the eurozone, then? The different views are familiar.

Ali Babican, Turkey's deputy prime minister for economic and financial affairs, bemoaned the lack of a sense of common European interest – alluding to the lack of sympathy in places like Germany for the woes of an economically hammered eurozone colleague like Greece.

Other speakers focused on structural problems such as the "Balkanization" of Europe's banking system, which lacks a central guarantor like America's FDIC.

Increasingly popular is the argument that it is fundamentally illogical to allow a country to blunder into massive debt if it doesn't have the monetary tools to diminish its debt – lacking a currency to devalue.

Roubini said that the only solution was to extend the euro's monetary union in the direction of a banking, fiscal or even political union, at least to the point of having a single eurozone finance minister empowered to veto individual countries' budgets for exceeding a given deficit limit. "Today the eurozone is disintegrating. ... either move forward or you're going to fall off a cliff."

That rankled former Spanish Prime Minister Jose Maria Aznar, who declaimed the idea of "a United States of Europe" as counter to the psychology and history of the region.

"The history of Europe is a history of states," said Aznar, who led Spain from 1996 to 2004, a period of tremendous growth that seems an epoch away. "We must restrict this and not create another thing that does not work."

Better, he said quietly, was to ensure that countries take the "right decisions."

Some applied that label to one decision this week, a bond-buying plan from the European Central Bank that continued to lift financial markets on Friday.

But others noted that the offer by ECB president Mario Draghi is highly conditioned.

"The decision by the ECB is extremely important but ... the ECB is only one instrument (and) if governments do not do their part the ECB will not be able to succeed," said JPMorgan Chase International chairman Jocob Frenkel.

It was easier to find common ground on the question of the United States – with great concerns that country is headed toward another debt-ceiling crisis because regardless of the presidential election outcome Democrats and Republicans cannot agree on how to close a deficit that is digging an ever deeper debt hole.

"The largest economy of the world cannot continue this way without doing any kind of predictability about what is going to happen," said Babican. "We don't know much about the budget of 2012 and we don't know what kind of fiscal policy there will be in 2013. A fiscal cliff is coming."

Also clouding the atmosphere was the slowdown in emerging nations – including China, despite growth there that remains far higher than in the West.

"Seven percent growth may seem high, but for China, which had double-digit growth for 20 years, it really means bad news," said Li Cheng, a China expert from the Brookings Institute. He said there was risk of millions of layoffs which could spark "the largest crisis in (Communist China's) history because it may cause revolution."

The final element of what Roubini described as the "global perfect storm" is the possibility of an attack by Israel or the United States on Iran because "it's clear that negotiations have failed" on stopping Iran's nuclear ambitions. "The last thing the world needs given its fragility is another war in the Middle East and a spike in oil prices," Roubini said.

Israeli President Shimon Peres declined to address the Iran issue but sounded a philosophically optimistic note, suggesting that from his perspective at age 89, crises come and crises go. "Today what we call crisis is more of a profound change that we were not organized to meet properly," he said.

His solution was somewhat deflating to the audience, a graying crowd visibly given to collecting bulky stacks of paper: Hand things over to a younger generation – global, digital, and largely "not so impressed."

"They are better educated, better built, and more up to date."