A New Normal

Mohamed El-Erian

The Context

The context for this year’s Secular Forum was defined by three distinct factors. First, delineating where markets are coming from – or, to use the PIMCO phraseology, the “initial conditions.” We found ourselves drawn back to the 2008 Secular Forum’s characterization of the global system having reached a “dead end:” unable to continue on its recent path due to debt exhaustion and poorly capitalized activities, yet also incapable of embarking smoothly on a different path as the ravages of de-leveraging result in disruptive overshoots and considerable collateral damage.

Second, recognizing that snce the last Secular Forum, the global economy and markets suffered what economists call a “sudden stop” after the disorderly failure of Lehman Brothers in mid-September: every section of the rich data book for the Forum highlighted the severity of this cardiac arrest, raising legitimate questions regarding the depth and duration of the underlying breakage.

Third, arguing that recent events extended the de-leveraging dynamics into a broader phenomenon with longer-term consequences: the DDR, to use the terminology of one of Bill’s recent Investment Outlooks. This potent cocktail – a self-reinforcing mix of De-leveraging, De-globalization, and Re-regulation – inevitably entails economic and political forces that disrupt the normal functioning of markets and the global economy.

Together, these factors constituted a strong unanticipated blow to the gut of virtually every economy. (See Charts 1 and 2 for an illustration). Most are still on the floor trying to regain their breath. Indeed, as one of our external speakers put it, if you were the global economy, you would not wish to start a journey from here; yet, you also cannot go back to where you were.

If it had been left to its own devices, the global economy would have gone through an even more wrenching cleansing process. Unemployment would be spiking even higher, additional institutions would be failing and larger market segments, nationally and internationally, would be dysfunctional.

No democratically elected government is able to stand on the sideline when its electorate faces such a situation. Almost regardless of political persuasion – and, more importantly, of whether they have the right diagnosis and tools – governments inevitably find themselves dragged in to address the mounting damage to human welfare. In the process, they resort to unconventional responses that, by definition, are uncertain in their effectiveness yet consequential in disrupting some long-standing relationships. Think of this as the economic equivalent of a drug trial being applied to huge populations: there is a case for the medicine, yet there also remains considerable uncertainty about effectiveness, lags and side effects.

The alternative to the exceptional scale and scope of recent government intervention could well have been worse. Nevertheless – and especially for people like me who, in a previous career at the IMF, lived through various experiments with forms of directed credit, price controls, import substitution and industrial policies – it is discomforting to see the public sector become a notable price setter in certain markets. It is even more discomforting to see it own and control some modes of production, exchange and distribution that normally (and should) reside only in the hands of private enterprise. The public sector’s role as major supplier and allocator of credit is also unsettling.

Given the initial conditions of the global system and the strong medication being administered by governments, the major intellectual and analytical challenge for our Forum was to figure out how the process of “getting up off the floor” would evolve over the secular horizon. Would it be simultaneous or sequential? Would those managing to get up pull others up with them, or would they push them down farther? And how long would it take for those able to get up to stand up straight again?

In the process, we inevitably found ourselves discussing how the balance would play out among such complex factors as:

• Past market failures vs. future government failures
• Paper wealth destruction vs. real wealth destruction
• Globalization vs. nationalism
• Economic desirability vs. political feasibility.

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