Sense on Cents

Pimco CEO Mohamed El-Erian

I am increasingly impressed by Pimco CEO Mohamed El-Erian. Why? I believe El-Erian consistently provides a thoughtful and informed opinion and analysis of the global economic landscape. I witness his sagacity again this morning in reading his Financial Times commentary, Return of The Old Ways of Thinking Threatens Recovery:

We are at the point of maximum confusion in the multi-year transition of the global economy, markets and policymaking. We have left the global growth regime that was driven primarily by debt-financed consumption in the US, but we have not as yet reached a position of more balanced, albeit anaemic, growth. Those who lack a robust anchoring framework, be they investors or policymakers, risk being misled and backtracking to outdated ways of thinking.

I concur with El-Erian’s premise. As much as consumers, investors, bankers, and politicians may want to return to ‘business as usual,’ the fact is the global economy and the markets are a dramatically changed place. While market analysts and government policy wonks feed us a steady diet of ‘green shoots’ and ‘positive change in the rate of change,’ El-Erian properly frames the debate by focusing on the absolute levels expressed in economic and market data rather than merely the rate of change in those levels.

I made a less eloquent attempt at stating this premise this past July 29th in writing, “Economy and Markets: Improving, Declining, or Adapting?” I asserted:

While most economists and market analysts are looking at statistics and data to determine whether the economy and consumers are improving or rolling over, my take is different. I view the economy and consumers as adapting to the new dynamic at work in our country.

While those on Wall Street and their friends in the media would revel in short term developments and daily market swings, I view our market and global economy as akin to running a marathon. As such, I would place us at best at the 7 mile mark. El-Erian makes a similar assessment and states as much in writing:

Today’s lack of appropriate anchoring frameworks appears to be exacerbating short-termism. The issue goes well beyond the still-limited appreciation of the multi-year realignment of the global economy, which is gaining momentum. It also relates to tendencies well-documented by behavioural economists – such as framing the problem wrongly and refusing to question past approaches.

Given all this, we would be all well advised to follow the admonition of Mervyn King. Last month, the governor of the Bank of England stated bluntly: “It’s the level, stupid – it’s not the growth rates, it’s the levels that matter here.” Investors have not yet accepted his insight that the absolute levels of income, debt, wealth and unemployment, not just the rates of change, are what matters today. They need to, and soon.

What ‘heart rate monitors’ does El-Erian utilize to assess the overall health of our global economy? He offers the following:

>First, consumer indebtedness is still too high relative to income expectations and credit availability, particularly in the US and the UK.

>Second, some banks’ balance sheets are still too geared for the comfort of regulators or their own managers. This will inhibit them from lending to the real economy at a time when certain sectors (such as commercial real estate, but also residential housing) still require significant refinancing, and when consumers need time to work down their excessive debt loads.

>Third, unemployment has risen well beyond expectations, and is likely to prove unusually protracted.

>Finally, public debt has grown so rapidly as to spark concerns about future debt dynamics. This would inhibit the effectiveness of future stimulus measures, as well as complicating the formulation of exit strategies.

I encourage readers to take Mr. El-Erian’s assessment to focus on the absolute levels of economic and market data. In the process, please then incorporate that approach into the report on deflation I offered yesterday in writing, “Will Deflationary Forces Overwhelm Global Fiscal Stimulus?”

I commend Mohammed El-Erian for properly framing the debate. He is helping us all see the ‘forest for the trees’ as we navigate the economic landscape.

LD