Chief economic advisor, Allianz
Mohamed El-Erian, chief economic adviser at Allianz, has been at the forefront of money management throughout his career. His early days were with Pimco and Salomon Smith Barney, then on to Harvard Management Co., where he was president and managed Harvard University's endowment, and then back to Pimco in 2007 as chief executive and co-CIO with the company's founder, William Gross. During his tenure, Pimco's assets doubled to $2 trillion. Mr. El-Erian resigned from Pimco in 2014 after his daughter wrote him a letter listing 22 events in her life that the executive had missed because of work.
His thinking is innovative — original and prescient. Mr. El-Erian coined the phrase "new normal" at the nadir of the financial crisis in early 2009, foreseeing an economy defined by low growth over the long term. His most recent book is "The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse" (Random House, 2016).
InvestmentNews spoke with Mr. El-Erian about the global economy, central banks and income inequality.
John Waggoner: Looking across the economic landscape, what's your outlook for 2018?
Mohamed El-Erian: I have less of a consensus view, but also less of a definitive one. We've been in the "new normal" for a while as growth has not just been low, but not inclusive enough. While the new normal has allowed for financial healing and job creation, it has also aggravated the inequality trifecta of income, wealth and opportunity. The easiest prediction is that it will continue, and that has now become consensus.
But the new normal has sowed the seeds of its own destruction. It fuels political anger, it threatens growth potential, and it contributes to global trade and currency tensions. It's not clear that we can continue on this road for many more years.
What's more likely is that we tip, and we can tip in one of two directions. In one direction, low growth becomes higher and more inclusive, elevated asset prices are validated by better economics and the politics improve. Otherwise, we could see low growth giving way to recession and artificial stability leading to unsettling volatility, and we would see international relations become tricker.
JW: How would we get the more optimistic outlook?
ME: The irony here is that most economists agree on the basic engineering of this. It's not a great analytical mystery. It's a political implementation issue. We would need to move forward on pro-growth measures, such as tax reform, skill acquisition, infrastructure and education. We need more fiscal stimulus and less monetary stimulus in Germany and the U.S. We need to update trade agreements to reflect today's realities. And we need to start thinking about relief for pockets of excessive indebtedness, such as in Greece and certain elements of student loans.
JW: What mistakes are investors making now?
ME: Nothing works better in the markets than a strategy that rewards you repeatedly, and today it is the notion that central banks are always there to support asset prices. Investors are being conditioned to not just buy the big dip, but any dip. Corrections are less frequent, shorter in duration and less extreme. Investors have totally embraced the BFF syndrome: They think central banks are their best friends forever.
JW: Central banks, however, are now leaning more toward tightening. Are investors being like the proverbial frog in a pot of water on the stove?
ME: I think they realize the water is getting warmer, but they have tremendous confidence in being able to hop out of the pot. And so far, it has been a really comfortable pot — the water is really nice as valuations rise and volatility remains low. There's no inclination to hop out early.
I remember in 2007, someone making very clear to me that the risk markets were like an upside-down U, and saying we were very near the top. And I asked how they were positioned, and they said with maximum risk on, because they didn't know where the top was, and they felt they could get out when the there was unambiguous evidence that markets were on the way down.
The central banks stepped in in 2008 to normalize malfunctioning markets. We would have been in a multiyear global depression without them. When the central banks looked to hand off some of their economic burdens to other policymakers with better tools, however, it was a time of polarized politics, and there was no one willing and able to accept the hand-off. Banks wanted to build a bridge, but the destination was not theirs to deliver.
JW: What are your biggest worries about the markets now?
ME: The one that worries me the most is that certain investors have been overpromised liquidity. Take the example of the high-yield and emerging-markets ETFs. The implicit contract is instant liquidity at reasonable bid-offer spreads. That contract makes sense when it's an ETF based on highly liquid markets such the S&P 500 or the Treasury and investment-grade corporate bonds. Yet these products are proliferating in areas with a lot less liquidity, thereby increasing the risk of asset contagion. What we have seen, over and over again in the past, is that when investors can't sell what they want to sell, they sell whatever they can, and that's where you get cascading disruption.
– John Waggoner