Monday, October 19, 2015

Interview with Mohamed El-Erian

Chief Economic Adviser at Allianz, chair of President Obama's Global Development Council and former CEO at PIMCO

A.B. - Headlines this summer have been all about the slowdown in China, the devaluation of the RMB and the crash in global stock markets. Why is China a problem all of a sudden? What are the implications of the Chinese slowdown on the U.S. and global economy?

M.E. - For quite a while now, markets have been comfortable with the notion of a global economic equilibrium – not a great one but a stable on. While growth would be low in Europe and Japan, this would be offset by a gradual recovery in the United States along with continued robust expansion in the emerging world.

This notion has been unhinged by persistent data out of China and other emerging economies pointing to a notable slowdown. Indeed, with the exception of India, every systemically-important emerging country is slowing: Brazil, China, Russia, Turkey, etc…

Market anxiety has been compounded by something else: lower confidence in the ability of central banks to manage well their policy challenges. With the latest tricky issues coming out of the emerging world – rather than Europe or the US – there is more concerns about the effectiveness of policymaking there. And there is realization that the policy reach of the ECB and Federal Reserve, two highly respected central banks, is a lot more limited in these circumstances.

As regards the spillover, the strictly economic ones can be contained. The big risk is that the financial turmoil, including heightened volatility, spills over onto the real economy by altering both household and corporate behaviors – by making individuals less willing to spend and by making companies less eager to invest.

A.B. - Judging by the strength of its labor market, the US economic recovery has been well ahead of everybody else's. Why has the U.S. succeeded in creating employment while others have failed? Can the U.S. become an engine of global growth?

M.E. - While it is a contributor to global growth, the US economy – by itself – is not in a position to decisively pull the global economy out of its doldrums.

Don’t get me wrong. The US economy is still the most important in the world. And what happens here matters a great deal. The problem is that, while it continues to heal, the US economy is unlikely to attain economic “escape velocity” and “lift off.” And that is what is needed for it to perform the role of a robust global growth engine.

A.B - Can the ongoing turbulences in global markets derail the recovery in the U.S.? Is there a risk of a return to a 2008-type of financial crisis or to a major financial accident? What kind of triggers would take us there? Has the financial system/banks been sufficiently regulated after 2008?

M.E. - It is a risk scenario, and not a baseline. And the major threats no longer come from the banks. 

What made the 2008 financial crisis particularly painful is that it struck the payments and settlement system, the nerve system of a market economy. The trust needed to complete simple transactions literally disappeared, triggering cascading failures and “sudden stops” that brought the global system very close to a multi-year depression.

The payments and settlement system is in much better shape today. Concurrently, the systemic risks associated with banks have lessened now that they have been forced to raise capital, better value their balance sheets, and dispose of dubious assets.

But this is not to say that there are no risks. In fact, some of them have morphed and migrated out of the traditional areas that are closely regulated and supervised. They now reside in the non-banks.

A.B. - What does Europe need to do to generate more sustainable growth and employment? Is the ECB doing enough? Has fiscal austerity been the right policy response to the challenges afflicting the periphery of Europe?

M.E. - Europe needs to move on four policy issues, simultaneously; and as hard as the ECB is trying – and it is trying very hard – it is not in a position to deliver when it comes to these four critical policy areas.

First, countries need to move more forcefully in implementing pro-growth structural reform. Second, they need to attain a better aggregate demand balance. Third, there are still crippling pockets of debt over-indebtedness that need to be resolved. And finally, progress needs to be made on the regional architecture, going from a 1 ½ legs for the Eurozone stool (monetary union and baking union) to a set of 4 legs (those two, along with fisval integration and closer political coordination).

As much as it is committed to do whatever it can to assist the region’s economic and financial recovery, the ECB does not have the right instruments to deliver decisive gains in these four areas. As such, the best it can do is to buy time for politicians to get their act together,

As regards the specific issue of austerity, what is needed now is to evolve to a more responsive approach – I call it “intelligent austerity.” And it is one that better tailors the degree and composition of austerity to the longer-term needs of generating robust growth and generating sufficient jobs,

A.B. - We all have been witnessing the dramatic flow of refugees crossing Europe to reach Germany, and the shameful handling of the situation by the European governments. What should do European countries to give an efficient and humanitarian response to this crisis?

M.E. - As you rightly say, it is a dramatic flow; and it is one that has involved significant tragedies and human suffering.

In simple economic terms, there is a massive imbalance between the supply and demand for refugees.

Escaping awful and lamentable conditions at home, tens of thousands of people are risking their lives in the hope of establishing a more tolerable life for them and for their families – it’s a supply that will not moderate any time soon.

On the other side, the demand for refugees is limited – thus causing huge bottlenecks. While some countries, led by Germany have taken an enlightened approach – mixing humanitarianism with a belief that supporting the refugees can also result in productive workers down the road – most are yet to respond sufficiently to this historic challenge. And, to make things worse, regional coordination has not been up to the task.

A comprehensive solution requires movement on both the demand and supply sides. Brussels’ proposals of country quota is a way of forcing a higher demand for refugees throughout the EU. But even if accepted by member countries, this won’t be a long-term answer unless steps are also taken to improve conditions in the home countries of the refugees.

A.B. - Is the Greek crisis over for good? Would Greece have been better off by defaulting on its debt and leaving the eurozone?

Unfortunately, the Greek crisis is not over; and it won’t be unless Greece is able to generate high growth and sizeable job creation.

A deeper debt restructuring is one of the measures Greece needs. Without that, crippling debt overhangs will continue to hold back investment and undermine the country’s growth dynamics. How best to achieve this is up to Greece and its European partners.

A.B. - The economic crisis in Europe (and the periphery in particular) has shaken its existing political and economic structures. The emergence of the far right and populist movements is radically altering the political landscape in Europe. Is Europe heading back to the 1930s?

M.E. - The “non-traditional/anti-establishment/outsider” wave is one that is apparent in much of the west.

In the United States, it started out with the emergence of the Tea Party, and it is now playing out in the surprising popularity of presidential candidates such as Donald Trump and Bernie Saunders. And, as you note, it is visible in much of western Europe.

This is an important contextual observation as it speaks to the general dis-satisfaction among citizens with the performance of the political establishments; and it is a particularly concerning phenomenon when it translates into support for extremist parties, some of which are also only one-issue parties.

The immediate impact of this is to complicate governance by the traditional parties. And this comes at a time when citizens are looking to their governments to step up to a series of economic, financial, social and geopolitical challenges.

As worrisome as all this is, I do not think that we are heading to the 1930s. But we do need a “sputnik moment” that brings together the political class in a manner that better serves those who elected them.

A.B. - There's also an emergence of secessionist movements across Europe as we saw in Scotland last year and Catalonia today. On Catalonia, are markets worried over the process of independence? Would markets care as to how the process is handled, and whether an independent Catalonia stays within or outside the EU?

Rather than worried, I would say that markets are paying attention -- and understandably so. Catalonia is a notable part of Spain’s economy, the fourth largest in the Eurozone. So of course they care about how this situation is handled. And it matters beyond the Eurozone too.

Assessing what markets care about reinforces the notion that it is in everyone’s interest – Catalonia, Spain and Europe’s – to handle this process in orderly manner. This is particularly so after all the tensions and strains caused by the Greek crisis. As such, it would include maintaining an independent Catalonia within the EU.

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