London, 22 January 2010

Mohamed El-Erian, CEO and Co-CIO of the US-based Allianz unit PIMCO, is considered one of the world's great economic minds. In his analysis he states, that in the 2nd half of 2010 we will see contractive momentum from the end of the stimulus programs. In order to create an increase in prosperity, a sustainable boost in private consumption is crucial. But because of persistently high unemployment rates in many markets, he anticipates continued cautious and thrifty consumer behaviour.

El-Erian: This expectation of a crash is overdone given the engagement of policy makers around the world. However, a 15 to 20 percent correction of equity prices is possible. Markets moved too fast and too far in 2009. Sustaining current valuation requires economic and corporate fundamentals to catch up with where the markets have gotten to. Remember that growth in countries like the US and UK during 2009 was driven significantly by temporary factors.

The question is, whether we will see a handoff to more permanent factors in 2010. And this remains highly uncertain, especially as the various stimulus packages decelerate and the inventory cycle runs its natural course. Indeed, in the absence of new stimulus programs in the second half of 2010, we will see contractive momentum from this factor. In order to create momentum for the economy, a sustainable boost in private consumption is crucial, but consumption already faces frosty headwinds.

First is persistently high unemployment in many countries. Rates of unemployment in two-digit percent-ranges can become a big problem if they persist. When you get to those levels, it changes the behavior of the employed, and it exerts even further pressure on public finances. When you see unemployment not just high but persistently high, even the employed become more cautious and consume less. So even the employee who has the income starts feeling more constrained.

Second is what economists call the wealth effect. We've all taken a big hit on our private savings for retirement. We now have to save more than we anticipated.

Third, for American consumers, who have been the driver of global growth for a long time, their ATM has disappeared - for a number of years Americans used their houses as ATMs, refinancing as house prices went up. So right now it's very difficult for the US consumer to continue carrying not only the US economy but also the rest of the world.

No, even in the case of an economic recovery, only extremely favorable circumstances will push unemployment significantly below current levels. The pre-crisis level of four to five percent won't be reached anytime soon.

The US is not famous for being a nanny state and the current American social framework cannot properly handle huge numbers of long-term unemployment, is there a perspective for more state assistance?

The recent extension of unemployment insurance has passed Congress with unusual ease. And that's the way we expect it will continue. Piece by piece, in a kind of salami technique, a new social safety net will be created, not totally unlike Europe although less comprehensive. Besides, people are annoyed because losses on Wall Street are socialized losses after huge profits were privatized, and a stronger government is seen more favorably than some years ago. In the coming years, we will see some form of rebalancing of the economy and society, in many respects.

Economies outside the Anglo-Saxon sphere have not depended as strongly on the financial sector. But we live in a globalized economy, and America still represents the heart of the system. The US supplies a number of "public goods"; first, the US dollar as global reserve currency; second, its large and liquid financial markets, which allow other countries to partially, outsource their financial activities. The bulk of the past crises, e.g. defaults of Russia or Argentina, the Asia crisis broke out in the periphery. When the core of the system is strong, the system recovers more easily. This crisis is different, because it broke out in developed countries and in the US itself: When the system is hit at its heart, it will be de-stabilized for years. With the US being hit, also the public goods provided by the US become less stable.

The image I have in mind is the global economy as a huge plane with a powerful engine: the US consumer. This engine kept the plane at a high altitude, but after the financial and banking crisis, nearly no fuel, in the form of private debt-carrying capacity, is left. In the future, there will be several smaller engines instead of the one big engine. The US is one of them. China, India, Brazil and Europe will also be among them. It's absolutely a good thing if the rest of the world starts being all these other engines, and we can move from a world of excessive dependence on the US consumer to a multipolar world.

The trouble is this transition. So going back to my image. Would you like to be on a plane when the captain comes on and says, "I'm going to be switching from one big engine to lots of little engines?" You don't want to be on that plane. You want to be on that plane once the switch has happened. So in the long run, which is probably five years, we should all be better off.

No, a return to the "Old Normal" would be a threat. The "Old Normal" consisted of a global economy that depended too much on US indebtedness. It was a world in which many credit factories had launched artificial booms through structured products and the like with tremendous pace. This world was dominated by a US administration that thought the market would regulate itself at minimum cost and in the best way, and in doing so it lecture the rest of the world. But the global system reached a dead end. Because of the overwhelming debt burden and poor capitalization the world has not been able to continue its path, nor to pursue a new one, as the deleveraging process has overshot and created substantial collateral damage. In view of the high profits that have been privatized and the losses that now are being socialized, it is not surprising that this decline is accompanied by resentment from the population and a new "morality" in parliaments. The "Old Normal" won't come back again.

The "New Normal" is a world in which the US will grow at a lower pace. The growth trend will come down from around three percent to some two percent per annum in the US. Higher regulation, higher taxation, lower credit and government interventions will feature among the factors that limit the pace of non-inflationary growth potential. Unemployment will remain high. And the "New Normal" will be a world in which the role of the state, especially in the financial sector, will be significant. With the retreat of the Anglo-Saxon model internationally, the core of the global system will lose its perceived cohesiveness. In addition, the risks will shift to government balance sheets and rising country risk.

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