If he had told anyone two years ago that the United Kingdom could quite possibly vote to leave the European Union, that Donald Trump would be the Republican nominee for president and that one-third of government global debt would be selling at negative yields, you would have told Mohamed El-Erian that he'd flown over the cuckoo's nest.
El-Erian, who coined the term "new normal" at PIMCO and now serves as chief economic advisor at Allianz, says there are a few common elements that explain our current predicament. As the global economy emerged from the Great Recession, policymakers assumed that most of the world's problems were cyclical. Instead, they turned out to be structural and secular.
Several of these problems, like excessive reliance on central bankers and rising inequality, had been lurking right beneath the surface before 2008 and became obvious in the years since. Unfortunately, policymakers were slow to understand the problem.
Weak economic growth encourages "messy," blame-game politics which, in turn, discourages stability, creating a negative feedback loop of sorts, El-Erian said at a press rollout for his new book, "The Only Game In Town." The upshot is that advanced economies are unable "to grow in an inclusive" fashion and low growth rates are becoming less stable. "It will get more and more strange" and risk will increase, he predicted.
El-Erian outlined an optimistic case of where we go from here and a pessimistic one. Those on the sunny side of the street think that policymakers will come to their senses, increase infrastructure spending, cut corporate tax rates and then get out of the way and "let the private sector do the heavy lifting." At some point in the near future, a handful of major innovations will be the final trigger to release us from the current malaise.
The pessimistic case holds that political gridlock will remain the norm or transition to instability, companies will continue to sit on cash and financial assets will become seriously mispriced, setting the stag for a future crisis.
Whatever scenario one favors, the future has serious implications for asset management, El-Erian explained. In a world of negative nominal interest rates, cash becomes a valuable asset, providing resilience and agility in the event of a crisis and optionality should certain asset classes become outrageous bargains.
Starting several decades ago, policymakers had a romance with the wrong economic model. Financial services, where financial companies existed to serve the real economy, became finance, such as investment banks and hedge funds that existed to generate profits solely from their own activities, not from enabling manufacturing and service businesses to finance their growth. Countries from Dubai to Iceland tried to become the next Wall Street or London or Frankfurt.
El-Erian is hoping for a Sputnik moment, one in which U.S. policymakers come to their senses, create a sense of unity and national purpose and rally the nation around the goal of achieving several major innovations. But right now, the global financial system remains fragile and suffers from what he called the "delusion of liquidity," a delusion that sets markets up for "enormous volatility."
Though the yield curve in the U.S. looks like a recession is around the corner, El-Erian says its flat shape is misleading because the flood of European money into the U.S. bond market is distorting the long end of the curve. There is a serious disconnect between professional investors looking for big returns by taking "huge risks" and immobilized companies sitting on cash and not investing in capital equipment.