The global economy is at a crossroads, says Mohamed El-Erian, chief economic adviser for German insurer Allianz, who warned years ago that economies had entered a sustained period of sluggish growth dubbed the “new normal.”
Now this slow-growth period, enabled by massive central bank easing around the world, is coming to an end, El-Erian, the former CEO of money manager Pimco, said in an interview with The Fiscal Times. The question is whether growth will accelerate to match prior recoveries or disappear altogether.
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The answer depends largely on government policy, says El-Erian, who has also managed Harvard University’s endowment. Structural reform and debt reduction are a must. If that doesn’t happen, both economies and financial markets are at serious risk, he maintains. And El-Erian sees the odds as evenly stacked between the good and bad outcomes.
Dan Weil: What is your outlook for developed market economies—the U.S., Europe and Japan?
Mohamed El-Erian: Growth in the developed world is likely to stay low and uneven in the next year or two. The U.S. is likely to come in at 2–2.5 percent, while the Eurozone and Japan will struggle to maintain their recent growth rates of around 1.5 percent.
What comes thereafter is a lot more uncertain. Indeed, there are mounting indications that the current path of the global economy — anchored by low but relatively stable growth, and by central banks both able and willing to repress financial volatility — is getting exhausted. In all likelihood, we are heading toward what the British call a “T junction.” And, to make things even more interesting, the probabilities attached to the two roads out of the junction are pretty similar at this point.
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If governments in the advanced world were to finally step up to their economic policy responsibilities, we could transition to a world of higher inclusive growth and genuine financial stability. Such a recovery would be turbocharged by the productive deployment of significant cash on corporate balance sheets, together with the impact of some exciting innovations economy-wide.
What should governments do?
Adopt a more holistic approach that has four key components: pro-growth structural reforms; addressing deficient demand by better matching the will and wallet to spend; removing pockets of excessive over-indebtedness; and improving policy coordination in the context of strengthened regional and global economic architectures.
And if they don’t?
If the current political polarization continues, low growth would give way to periodic recessions, while artificial financial stability would yield to more frequent bouts of unsettling instability. This second possible outcome would be associated with even greater political polarization and a worsening of the inequality trifecta of income, wealth and opportunity. It would also be one that would challenge even the better-managed emerging economies.
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What's your assessment of monetary policy for the Federal Reserve, the European Central Bank and the Bank of Japan?
The Fed has embarked on what I think of as the loosest tightening in its history. Contrast that with the BOJ and the ECB, which are likely to venture even deeper into experimental policy terrain.
Specifically, I expect that the Fed will hike rates once if not twice this year, while the other two central banks will expand their asset purchase program. The resulting divergence will be yet another challenge for a world economy that already lacks sufficient global policy coordination.
What's your outlook for China? And what's your view of Chinese economic policy, as the government tries to deal with the deceleration of growth?
While keeping an eye on the financial imbalances there, I am not a buyer of a growth collapse. Instead, I believe the economy will “soft land” with 5.5-6.5 percent growth. And it will be bumpy for three reasons.
The country is in the midst of the most difficult developmental phase, or what economists call the middle-income transition. It is navigating it at a time when the global economy has slowed. And all this happening in the midst of pockets of financial excesses.
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But we should not confuse a bumpy journey with an ill-fated one. Chinese policymakers have quite a few policy tools at their disposal; and they do not have to worry about a forced deleveraging of the system such as the one experienced by the advanced economies in 2008-09.
What lies ahead for stocks and bonds in developed countries?
The longer-dated bonds of American, European and Japanese issuers will continue to trade in a range-bound fashion, particularly the highly rated ones (governments and high-quality corporates). But you should expect a widening differential between the U.S. and most other advanced countries when it comes to shorter-dated maturities that are more sensitive to central bank policy.
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Stocks will fluctuate in a widening range over time. A breakout here is likely within the next three years, especially if governments fail in the much-needed policy transition from prolonged excessive reliance on experimental central bank policy to the more holistic approach I mentioned.
How about developing markets?
Overshoots — both up and down — will provide more tactical opportunities for investors than there will be secular and structural ones. The key is a solid focus on fundamentals that exploits a technically fragile asset class whose dedicated investor base is too small to anchor it in the context of unusual uncertainty in the advanced world.
What's your prognosis for the dollar and other currencies?
This is a tough one as the prolonged excessive reliance on unconventional monetary policy changes price formation dynamics, most notably in foreign exchange. Indeed, this may have already happened for the Japanese yen given how close the BOJ is to (if not over) the line that separates effective measures from ineffective, if not counterproductive, ones. [The dollar recently fell to an 18-month low against the Japanese currency, despite the BOJ’s prodigious easing.]
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If you were to force me to put on a longer-term trade now it would be long dollar. My preference, however, would be for more opportunistic positioning, probably with a flat bias overall.