In the world of finance, Mohamed El-Erian comes with unique expertise and insights, having held top positions in the field of economics and fund management. As Deputy Director at the IMF, and subsequently as one of the world’s top fund managers when he was CEO/co-CIO of global asset management firm PIMCO, the diversity and depth of his experience is exceptional. He is one of most sought after voices in the world of finance and economics.
In a recent interview with bl.portfolio, he shared his views and outlook on global economy and markets. Excerpts:
When we interviewed you in May 2021, you had clearly stated that there was a need for central banks to have an open mind when it came to inflation. Further, in an interview to Bloomberg a few months later, you doubled down on your ‘inflation is not transitory’ call by stating that this was only the 4th time in your professional life that you were this confident about something. What is it that you could see so well, but central bankers and many other economists missed?
I suspect that three things contributed to understanding the clear and present risks of inflation at a time when so many central banks in advanced economies were dismissing the price increases as just “transitory.”
First, combining an appreciation of the big top-down shifts, particularly in the global supply dynamics, with the micro data coming out of individual companies. Second, my early economic maturation that happened at the tail end of the inflation disruptions of the 1970s. Third, my late father who always encouraged me from a very early age to look at an issue from several perspectives, a conditioning that was solidified during my undergraduate economic studies at the University of Cambridge.
Why were the right and cautionary voices like yours just ignored?
The reasons those of us warning of inflation were not listened to ranges from the lack of cognitive diversity among central banks to a mix of excessive hubris and conformation bias. They were amplified by a lack of appreciation of the limitation of models in a structurally changing world and paralysing group think.
You have been much more critical of the US Fed than the European Central Bank. But the ECB too over-extended QE and was late in raising interest rates. Could you explain why the US Fed is more at fault but not the ECB?
I believe so, and for two simple reasons.
First, the degree of difficulties associated with the challenges facing policymakers. This has been more pronounced for the ECB, which has had to formulate monetary policy for an economy subjected to a much bigger energy shock, and less vibrant and agile growth dynamics. Indeed, the policy trade-offs that the ECB faced were much more complicated than for the Federal Reserve.
Second, once the central banks realised their errors, the ECB has been much more open than the Fed about admitting this and, more importantly, seeking to learn from the mistakes. This important process was only forced on the Fed when the damaging consequences of another set of big errors elsewhere, that is in banking regulation and supervision, exploded for all to see.
Finally, it should be mentioned that the ECB has also dominated the Fed when it comes to consistent and clear communication, including in the critical area of forward policy guidance.
As much as you were right on inflation, you have also been right so far in your view that a US recession is not a base case scenario. Is a soft landing really possible?
It is possible but it will need the Fed to stop making policy mistakes and to address a host of self-created challenges. These include an outdated policy framework and target-setting, a lack of cognitive diversity, poor accountability, patchy bank supervision and regulation, and inconsistent communication. Absent that, there is an uncomfortably high risk that the Fed may tip the US economy into an otherwise-avoidable recession.
At a recent ECB Forum meeting at Sintra, Portugal, all central bankers denounced changing the inflation target as it would impact the faith markets have in the system. But with credibility of central banks like the US Fed already dented due to ‘inflation is transitory’ narrative, should that be a big concern? Can economic pain be less and a more optimal outcome possible, if inflation target is increased?
I was not surprised to hear them say that. Indeed, I would have been shocked had they said something else. I would also be surprised if, behind very closed doors, central bankers are not already talking about this but doing so in an extremely discrete and confidential manner.
It is important to remember that central banks in general, and the Fed in particular, are dealing with a huge hit to their credibility – one of their own making. Understandably, given the damage caused by inflation and the tragic fact that it hits the poor particularly hard, they have triggered widespread anger among citizens and politicians.
We also need to remember that there are several ways to appropriately review and adjust the inflation target, from a timing perspective to the use of bands and asymmetrical tolerance. The key is to do so in a careful and measured way.
While you have said the options are limited for US Fed, given they were late to respond to inflation, if you were the pilot now, how would you fly the plane to ensure the best (or least painful) outcome?
First and foremost, I would put in motion initiatives to fix the multiple and compounding slippages I just mentioned. This would include not holding the economy hostage to attaining an inflation target that is not appropriate for this particular juncture of the global economy. It would also include adjusting what is now excessive data reliance by underpinning the policy stance with secular and strategic anchors.
Going from policy formulation to policy implementation, I would work in a more coordinated policy fashion, particularly at the domestic level but also internationally while re-establishing consistent and more credible policy guidance.
Milton Friedman famously said persistent inflation is entirely a monetary phenomenon. Do you agree it is a monetary phenomenon?
Yes and no. Indeed, I worry that this Friedman saying is often taken out of context and overly simplified.
A monetary perspective of inflation is necessary but not sufficient. It needs to be supplemented by an understanding of the structural evolution of the economy, behavioural aspects, and balanced risk management.
Are we past the threat of bank failures?
No, the threat is still there. What is critical to remember is that, unlike 2008, we are not talking about a problem of the banking system as a whole. Rather, it is the problem of a handful of banks that are structurally vulnerable.
It is also important to keep an eye on the non-banks or which is now called the NBFIs (non-bank financial institutions). Of these, consisting of pension funds, asset managers, hedge funds, private equity managers and the like, some overdid their risk-taking during the era of artificially low interest rates and massive injection of liquidity by central banks. They will have problems refinancing financial commitments that make no sense in what is now a less distorted and less artificial financial and monetary policy regime.
Markets have been remarkably resilient. Unprecedented interest rate increases, geopolitical crisis, bank failures, etc, haven’t halted the optimism of equity investors. Your thoughts?
The equity market has been impressively resilient in the face of higher interest rates, a deep inversion of the yield curve, and repeated analyst warning about an impending recession. Still strong “animal spirits” have something to do with this, as do two other main factors: the resilience of the US economy and the “all weather” characteristics of some important stocks due either to their riding a huge secular wave (such as AI) or being structurally less sensitive to economic cycles (such as several big tech names).
Do you think decoupling in markets is ever possible? Like, for example, India has been at the centre stage due to better economic growth. Can that enable its stock markets to decouple?
Decoupling is certainly possible, both across markets and within them. Indeed, I think that dispersion is a major theme going forward, both for markets and the global economy.
Politics and national security will be the main drivers of decoupling, overwhelming economic considerations. It is part of a much larger process of changing domestic and global economies as once dominant outwardly-looking economic narratives give way to more internally-oriented ones that emphasise “de-risking”.
Other factors contributing to changing globalisation include corporate behaviors as more companies look to increase resilience, build in redundancies, and put as much emphasis on “just in case” as they have done on “just in time.”
Look for the decoupling to increase dispersions in economic outcomes, leading to a broader range of market performances.
This is an environment in which a few countries are well-placed to turn this process into a growth tailwind, attracting foreign direct investment and international supply chains away from China and also, in the case of India, benefiting domestically from being a large and relatively less-open economy.
Amidst numerous macro uncertainties that are undiscernible even for the experts, how is the common man supposed to analyse and invest?
I am often asked this question and I respond that it is impossible to provide a good answer as readers’ situations vary so much. Rather than try to provide an answer with spurious accuracy, allow me to say please that it is particularly important to internalise two related issues: First, that we live in an unusually uncertain world that is subject to more frequent and more violent shocks. Second, that while we should do our utmost to avoid mistakes, some are likely, given the scale and scope of uncertainties that are economic, financial, geopolitical, institutional, political, and social in nature. As such, and especially as many investment mistakes are corrected over time, it is critical to be crystal clear about the difference between recoverable and non-recoverable mistakes.
Could you give some insights on your darkest and best days in your professional investing career? Which were the most challenging phases and how did you tide over them? And your best phases – what were the actions and discipline that made it possible?
There have been a few dark days, most notably when markets and the economy did not immediately behave consistent with forecasts I had favoured. I remember in particular being too early in the call on Argentina in exiting the investments there during 2000-2001, before its eventual default in 2002, and being too early on the recovery call for Brazil shortly thereafter. Fortunately, I was able to navigate this, maintaining appropriate conviction and foundation.
I have been extremely blessed in having the better days outnumber by far the dark ones. A main cause of this has been, and remains, the incredible work colleagues I have been blessed to be around, over so many years. They have made me smarter and inspired me, and we have shared quite a few laughs too!
What are the value systems that you believe in/imbibed that — in your assessment — made your remarkable success and achievements possible?
I am extremely privileged to have had my late father as a role model. He taught me to respect others, always keep an open mind, remain humble, and be grateful. He led by example and in an incredibly impactful manner for me.