May 14, 2013
The global economy is operating at three distinct speeds, according to Mohamed El-Erian, and investors need to understand the implications of the divergent paths that key countries are following. Japan and most European countries are going backward, he said, and could continue in that direction for decades. The U.S. is “healing,” but not quickly enough to get to “escape velocity.” Certain emerging markets, meanwhile, are adapting technology and innovation and are growing rapidly.
El-Erian said investors need to answer three questions: How long will each country remain at its current speed? How long can the global economy sustain this multi-speed environment? What should policymakers do to address the situation?
“Every time you invest, you are expressing an answer to those questions,” he said, “so let’s be very explicit about it.”
Major economies, including the U.S., are heading down a road that will end in a “T” intersection; a right or left turn will signify the speed and direction of their recoveries.
El-Erian is the chief executive officer and co-chief investment officer of PIMCO. He spoke May 3 at the Strategic Investment Conference in Carlsbad, CA, which was sponsored by Altegris Investments and John Mauldin.
Let’s look at El-Erian’s answers to the three questions he posed and the implications they carry for investors.
The ECB’s decision
The multi-speed environment can persist, El-Erian said, but not forever. He started with the slowest speed economies – in Europe’s periphery.
El-Erian said Cyprus’ banking system grew to seven or eight times the size of its economy, attracting capital from Russia that was ultimately invested partly in Greek sovereign debt, until Greece’s economy collapsed.
The first lesson of Cyprus’ downfall, he said, was that the “troika” – the International Monetary Fund, the European Central Bank and the European commission – is no longer operating in a coherent fashion. That was evident when the troika disavowed Cyprus’ initial decision to tax insured depositors.
The second lesson is that the creditors are “fatigued,” El-Erian said. “This is now four years into the financial problems and they see no end to the checks they are writing,” he said.
Cyprus is an example of a country that lacks not only growth, he said, but a growth model. Its model was built on a leveraged banking system, which has now been shown to be unsustainable.
For Europe as a whole, El-Erian said the choice for its T-juncture lies primarily with the ECB. The ECB can make a further commitment to the Eurozone, and the choice in primarily political. If Europe opts for a fiscal union, it will endure “a little bit of distraction,” he said, but the EU could endure. The other choice at the T-junction, he said, is “fragmentation,” which would be very messy.
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