Mohamed El-Erian's Thoughts on the World


Mohamed El-Erian, the CEO of bond giant Pimco, has been reading The Economist since he was 15 years old. "So you can imagine how honored I am to be giving this lecture," he began at last week's Buttonwood Gathering in New York, hosted by the magazine.

One of El-Erian's favorite parts of The Economist is its iconic covers. And if he were to illustrate one of the covers himself to portray today's global economy, it would look like this: a group of central bankers bravely tugging along a bickering pack of politicians, while a group of scared and confused businesses and consumers sit somewhere lost in the distance. "They don't know where they're going, but they don't like where they've been," he says.

Here's a summary of my notes from El-Erian's lecture, edited and condensed for clarity.

On risk
El-Erian says, "We should have no doubt whatsoever that we live in a very complex and fluid world." He says you can think about it with a simple test: "When things happen that are unlikely or unfeasible, isn't the system trying to tell you something?"

On central bankers
"Brave and courageous central bankers are pulling along politicians who are more interested in bickering," he says. "There should be no doubt for anyone in this room that central banks are all in. They are all in in terms of buying time for the system so that it can heal." He noted that the European Central Bank has not only committed itself to "doing whatever it takes," but that its leader, Mario Draghi, has literally said, "Believe me, it will be enough."

El-Erian said the ECB's steps "would have been unimaginable not so long ago." He also notes that "ECB is part of the journey, but it can't deliver the destination."

It's similar for the U.S. Federal Reserve. The Fed is providing time for the system to heal, he said, but it cannot heal the system itself. He also stressed that all policy moves come with "costs and risks." Yet "you should have no doubt, no doubt, that leaders of both central banks are committed and will likely do more, and be pushed to do more." He said "the fact that central bankers have fewer constraints than politicians gives them a moral obligation to act."

On politicians
"Without politicians, we will not solve our problems," El-Erian says. There's too little growth, too much unemployment among young people, too much debt in the wrong places, too great political polarization, and too much income and wealth inequality. He says he worked on the Latin American financial crisis in the 1980s, and it was the same situation then. "And that crisis led to a lost decade," he notes.

On politics, he says:

It doesn't take a lot of time to realize neither side can deliver on their promises. Does the election help us operate in the middle? That has to do with if politicians can walk back from commitments. If there's a perception that it's little, then I think you see people [investors and businesses] holding back. No one wants to hold cash at 0% interest. But they also know that cash gives you optionality value. That's why they're hoarding it.

On trust
El-Erian continues:

The longer this goes on, the more disengagement we get from [Main] Street. In Greece it is complete rejection, the economy implodes, and you lose all trust. All of this [political and monetary policies] has to go on while maintaining the trust of the citizens.

On the global economy: The global economy is close to stall speed, El-Erian says. Companies can deal with it if they have cash. And households with global skill sets will do just fine. But too many will suffer under the baseline scenario. Governments will still be saddled with sovereign credit issues. That's the baseline.

The tails of risk distribution -- the odds that something really bad and unexpected will happen -- are much fatter today. People are used to having a high probability of certain, predictable outcomes with narrow tails. But not today, El-Erian says. The baseline scenario is much flatter, and the tails are much fatter.

"When humans face such an outlook, two behaviors dominate," El-Erian says. The first is paralysis. The other is just as dangerous: active inertia. That's when you recognize a paradigm change but do exact same thing as before.

This world requires something else: absorption and agility -- that is, agility as the distribution of outcomes becomes clearer and absorption of the high probability that mistakes will be made. According to El-Erian:

It is very tempting to turn your back on this. But if we do, our childrens' generation will be encumbered with very high debt, very low growth, high unemployment, inequality of wealth, and dysfunctional politics. If that happens, our kids' generation will be worse off than their parents for first time in a very long time.

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