The European Central Bank’s latest and most dramatic move to stimulate the European economy is another example of a monetary policy that tries to boost growth in one region by taking it from another, says Mohamed El-Erian, chief economic advisor at Allianz and former CEO of PIMCO.
On Thursday, the ECB cut interest rates further, pushing its key deposit rate deeper into negative territory. It also increased asset purchases and announced it will extend those purchases to include and begin a program of cheap loans for banks.
El-Erian said the road that the global economy has been on – stable growth and “repressed financial volatility" maintained by central banks – is ending. “Growth internationally is becoming less stable [and] central banks are either less able … or less willing to repress financial volatility.”
The ECB “wants to devalue its currency,” El-Erian told a gathering of Wall Streeters and journalists at a talk about “America’s Fiscal Future” sponsored by Politico and held at the Nasdaq in New York. “The U.S. did it to promote exports and growth. Now the ECB is trying it” as did Japan and China before, said El-Erian, responding to questions from Politico’s chief economic correspondent, Ben White.
As expected, the euro initially declined following the ECB announcement, but after ECB President Mario Draghi suggested that the central bank wasn’t planning on more rate cuts, the euro reversed course and moved higher.
“We have a dysfunctional global system,” said El-Erian, author of the new book The Only Game In Town: Central Banks, Instability and Avoiding the Next Collapse. “There is competition for limited global growth and there’s no coordination.” He said the ECB was willing probably still able to take more action to stimulate the European economy but was moving closer to becoming ineffective, as the Bank of Japan has, which would be a problem for the global economy.
“You cannot have too many central banks in the Bank of Japan camp,” said El-Erian. “Then you end up with the one policy in place becoming ineffective and then we are in deeper trouble.”
The Federal Reserve is not in the BOJ camp, having reversed its accommodative policy and raising interest rates late last year. El-Erian expects the Fed won’t raise rates again at next week’s policy meeting but will raise rates twice later. He will be looking for the Fed next week to issue “stronger guidance” than what the market expects, suggesting more than one rate hike this year, but will keep options open.
“This is a Fed that is forced … for the first time to look at international issues more than it has in the past,” said El-Erian. “The major uncertainty is the neighborhood … internationally growth is slowing and therefore for the Fed has to keep an eye on it.”
The political system will need to step up to promote higher growth and financial stability. “I hope that Washington realizes we need a major economic wakeup call,” said El-Erian. “We have borrowed market returns from the future. If we don’t validate that by high economic growth then we will have to pay back financial returns.”
In order to stimulate that growth, El-Erian favors tax reform because the current system has an “anti-growth bias,” as well as more spending on infrastructure and forgiveness of some student loan debt.
“It’s absurd we are not investing in infrastructure when interest rates are so low” because the “social return and economic return is huge … and we haven’t invested enough,” said El-Erian. “Infrastructure investment can unleash a ton of private sector investment.”
El-Erian also favors “focused debt forgiveness” to address the student loan overhang, which is a “headwind to growth” that threatens a “whole generation” though not the financial system itself like the subprime loan crisis did.
To those opposed to such a solution, El-Erian noted, “No one wanted to forgive Greece because there was a lot of misbehavior,” but the alternative would have been worse — “multiple lost generations in Greece with a huge impact for the rest of Europe.”
El-Erian rejects calls for protectionism, which have been increasing and intensifying during this presidential campaign season. He doesn’t expect any major moves in that direction no matter who wins the election but does anticipate a greater emphasis on “fair trade.” He expects more questions about whether countries are following international trade rules and why policy coordination and verification is not stronger.
--- Check out Trump, Anti-Establishment Politics Baffle Markets: El-Erian on ThinkAdvisor.