Mohamed El-Erian, formerly CEO of PIMCO bond investors, IMF Deputy Director economist and chair of President Obama’s Global Development Council, is lauded for his clear thinking on financial and economic affairs. In the last two weeks he has granted interviews to discuss the crisis. Here are the highlights.
Economic stops are worse than financial stops
“Economic stops [as opposed to financial stops] sneak up on you. They reach critical mass before you realise what is going on. And then dealing with the underlying source is very difficult. In this case it’s a health issue.”
“Economic sudden stops are very unfamiliar to people who haven’t lived in fragile and failed states, who have not gone through a big natural disaster. They bring everything to a halt. They destroy supply and demand simultaneously. It starts small (China) but it spreads, and it reaches critical mass which is what has happened in the global economy.”
Dealing with sudden economic stops
“Stimulus policies do not work. No matter what tax break you give to people; no matter how cheap their loans are; no matter how much cash is in their pockets, this will not let them go out and spend. They will wait. You can help with the balance sheet, but, unfortunately, you cannot reactivate economic activity until your health issue is addressed”.
“The only way you can contain and counter this virus is by denying it the oxygen it needs to spread – people’s contact. People put health before anything else. In California, well before we were mandated to stay at home, my hair cutter said, ‘I’m staying home’. Why? ‘I’m scared’. I asked: ‘but what about your business?’ Answer: ‘I put my health ahead of my income.’”
“Fiscal policy can help people through the sudden stop, support their balance sheets, make sure they can afford payments, or press pause on certain payments, make sure liquidity problems don’t turn into solvency issues.”
After yesterday’s announcement from the Fed that it would buy junk bonds yesterday: “one of the concerns the market had is that we would have a massive round of downgrades – it has already started – and that companies would thereby lose the indirect support of the Fed. What the Fed has said today is: No, I am going to take a snapshot of where the economy was, I want to make sure than liquidity problems don’t become solvency problems, and therefore I will not penalise companies that were downgraded because of liquidity issues. That is a very clear statement, it’s a very strong statement.” Thus some highly indebted large US companies are to be saved.
A market ripe for falling
“In 2019, despite sluggish economic and corporate fundamentals, the S&P 500 was up 30%. More risky assets were up even more. At the very same time that that happened you also made money on government bonds. So, you made money on the risky stuff, and you made money on the risk-free stuff. That is not supposed to happen. And at the same time volatility was very very low. What that tells you is that the marketplace had been conditioned to care about only one thing to the exclusion of all else, and that is central bank liquidity. Particularly the predictable and ample injection of central bank liquidity The result is a market that underappreciated liquidity risk, credit risk and equity risk. And we now, unfortunately, are reversing all three.”
“Every single segment in the economy, except for a handful, will go through the demand and supply destruction that the airline industry has gone through.”
Has the market fallen enough yet?
“I’m pushing back against this notion that we have established a bottom. It’s a counter-trend rally. We are still on a downward trend.”
“Most people haven’t priced in the unc
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Prof. Glen Arnold
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