El-Erian: Worst recession since Great Depression ahead, 2009 will look like a flesh wound
Another 3.84 million Americans filed for unemployment benefits last week. The report comes on the heels of worse-than-expected GDP data for the first quarter. Allianz Chief Economic Adviser Mohamed El-Erian joins Yahoo Finance’s On The Move panel to weigh in on why he says there is more pain to come and how the U.S. can avoid the mistakes of the last recession.
ADAM SHAPIRO: But, right now, we're going to talk with Mohamed El-Erian. He is the Allianz Chief Economic Advisor. And that headline number of 3.8 million new initial claims for unemployment benefits coincides with something you predicted last week, that GDP for this year will contract anywhere from 10% to 14%. Are you more pessimistic? Where are you at this point as to where we're all headed with this economy, Mohamed?
MOHAMED EL-ERIAN: So thank you, Adam. No, I still think that we're going to have the worst recession since the Great Depression. It will make 2008-09 look like a flesh wound, which is a huge statement if we all remember how bad that is. And the numbers so far confirm, unfortunately, that we are on track for that, whether it's today's jobless claims, which, as you pointed out, takes the total number to 30 million in just six weeks, 30 million-- that is 18% of the labor force-- or whether it's yesterday's GDP number that suggests that the second quarter hit maybe as big as minus 40. So these are big numbers that are unprecedented, Adam.
JULIE HYMAN: They are unprecedented, Mohamed. And, of course, we've seen unprecedented response to them as well. We heard, of course, from the Fed yesterday and this morning as well, introducing some new facets to its lending programs. We've had this huge fiscal response.
In the end, though, you know, as Elon Musk said, there are businesses that are still not going to survive this. It seems like there's no way that can be avoided. But what more at this point can either monetary or fiscal be doing?
MOHAMED EL-ERIAN: So if you look at whether it's monetary or fiscal, it's not an issue of willingness. They're willing to throw everything at it. It's not an issue of [? effect ?] [? of ?] [? ability, ?] massive balance sheets that they're willing to use. It is effectiveness.
And you have two problems. On the fiscal side, the pipes aren't in place to get the money there quickly. And, on the monetary side, it operates mainly through asset markets. So you decouple massively the financial markets, Wall Street from Main Street, creating a set of problems.
So I think it's not-- [? it's ?] [? just ?] an issue of effectiveness. We're not built to deal with this. Yes, there will be lots of bankruptcies. And, yes, there will be lots of unemployment. I wish we could avoid it. But, until we resolve the inconsistency that you just referred to, between what this stage of the health care policy calls for, isolation, separation, social distancing, and what the economy is wired for, the exact opposite--
ADAM SHAPIRO: Mohamed, I am curious how you think that the new guidelines we're getting from the Fed on the Main Street lending facility are going to impact what you just said because it's still-- Congress still has to act. And this is just the monetary side of it. But [? what would ?] [? help? ?]
MOHAMED EL-ERIAN: So it is help. And I think the Fed is sensitive to the accusation that, once again, it's Wall Street that's benefiting and not Main Street. So they've basically allowed this program to be used by more companies. So that's good news. But it does increase debt, Adam. I mean, we have this issue where we're going to emerge from this with fewer companies. And they will be more highly indebted.
JULIA LA ROCHE: Mohamed, it's Julia La Roche. Can we talk a bit more about this idea of decoupling Wall Street from Main Street and the problems that it will create? Because it does seem that the Fed is aware that their reputation, going back to the last crisis-- I guess, you could say, maybe in a way, it was a bit tarnished, or the perception of it from Main Street. Do you think there's anything they can do to move the needle? And, if not, what are those problems beyond just the debt?
MOHAMED EL-ERIAN: So they're trying, Julia. And, if you listened yesterday to Chairman Powell, he went out of his way to be sympathetic to Main Street, to point out how the programs are supposed to benefit Main Street. But the numbers are so stock that I worry that his message won't go through.
Is it problematic? Yes. It is problematic because it accentuates the three inequalities we had coming in-- wealth, remember, who owns the assets, [? in ?] [? which, ?] income, remember, who is able to keep their jobs easier, [? in ?] [? which, ?] the more highly qualified who can work at home easily, and opportunity. And you're seeing this in terms of the young, for example, being hit particularly hard by the jobless claims.
And the second issue that's problematic is it suggests that the Fed can be a quasi-fiscal agency. But it picks winners and losers. And that perception can be quite dangerous. So I do worry. Hopefully, the fiscal side will step up and will allow Main Street to have less damage. But, otherwise, central bank credibility and, I suspect, central bank independence will be under more pressure.
BRIAN CHEUNG: Mohamed, it's Brian Cheung here. That's a great point that you make. And I'm wondering how you think this moment, where the Fed's had to resort to these unconventional tools that are even more unconventional than QE, have kind of changed the paradigm for the central bank operating structure? When we think about Bernanke's '97 paper, when he was talking about, you know, the credit channel not being the priority or the main means by which these central banks do policy, that it's mostly interest rates, that's changed.
Where do you see the role of the credit channel from Powell's view? And how do you think that's really going to change what's probably going to be a decades of low rates, low-inflation environments?
MOHAMED EL-ERIAN: So Brian, that's a great point because we have seen a dramatic change in the use of the credit channel. The fact that a central bank is willing to selectively go into high yield is revolutionary. Remember, central banks are not supposed to take on credit and default risk. But that's what you do when you go into high yield.
Whether it is fallen angels or you buy the index, which they said they intend to do both-- they haven't done it yet. But they intend to do both-- that is a revolutionary change. We are going to come out of this with a massive entanglement of both the Fed and the government in private sector activity. And it's a spaghetti bowl.
This is not something that is being done according to principles. It is a spaghetti bowl that we're going to somehow have to untangle over time. And it's going to be a hit, I'm afraid, to productivity. So we're going to come out of this with higher debt, lower productivity because, in addition to this hit to public-private relationships, we're also going to have the rewiring of supply chains. So it's a different economy [? we're ?] coming up [? how ?] [? to ?] when we get through this crisis.
JULIE HYMAN: And Mohamed, as you said, the Fed can be perceived as being put in a tough position of choosing winners and losers. I'll give credit to Cameron Crise over at Bloomberg-- he's a macrostrategist there-- for sparking this next question. He pointed out that, because of this Main Street lending program, not only will companies have more debt but they'll have debt at very low rates whereas many Americans, who have high-debt loads, pre-existing, for things like student debt are paying astronomical rates, in some cases, on that debt or, at the very least, higher rates than corporate America is paying.
Now, obviously, you're talking about pricing risk here. But, even so, does that need to be addressed? And how?
MOHAMED EL-ERIAN: And it's a difficult one because we don't know how long this crisis is going to last. So far, we have stumbled into the assumption-- and I'm going to use game theory terms. This is not to suggest that this is a game. This is really, really serious and tragic.
But game theory has a way of simplifying issues. It matters whether you're playing a one-round game or a multi-round game. The notion that the government is all in-- imagine the image of poker. You're all in. Suggest a one-round game.
If this turns out to be a multi-round game, then I don't think we're going to have a choice but to extend what is de facto debt forgiveness because, when you lend to someone at much lower rates, at subsidized rates, you're basically subsidizing part of their debt. We're going to have to extend that loan forgiveness. So we are going to have a lot of difficult questions to ask if it turns out that this is a multi-round game.
ADAM SHAPIRO: Mohamed, I want to go back to your spaghetti bowl reference because something the Fed's about to add into that on top of everything else is-- are municipal bonds. And there is this ongoing fight between Mitch McConnell, and Chuck Schumer, and then, of course, the governor in New York about whether states should be allowed to declare bankruptcy.
The bottom line on this is, when they get into this mess with municipal bonds-- and you're talking about loan forgiveness on the corporate side-- there might be demands for states to be able to refinance their obligations to pensioners. Isn't that going to create even more problems down the road?
MOHAMED EL-ERIAN: And that's-- Adam, that's the problem. if it's a multi-round game, then it turns out that a lot of what you're doing now is going to complicate things down the road. The problem is there isn't a better alternative.
That's the irony, is this sudden stop is so deep that this notion of, oh, let them just default, we don't know how to default in an orderly way. Defaults have consequences. And what everybody's trying to avoid is liquidity problems becoming solvency problems.
In a liquidity crisis, most mistakes are recoverable with time. In a solvency crisis, they're not because capital is impaired permanently. And I think everybody is trying to avoid liquidity problems becoming solvency issues. But, if these hits are repeated, if we go into a W pattern, which is a possibility-- hopefully, it's not the baseline. But, if we go into a W pattern, then all your questions will become really relevant. And markets will have to start dealing with a higher probability of capital impairment, which we have not as yet.
BRIAN CHEUNG: In the aggregate, do you see any of the central banks around the world having a higher risk of reaching a solvency issue as opposed to a liquidity issue? You had the ECB this morning, saying, they were going to try to provide liquidity through the PELTRO program-- I can't even keep track of all these acronyms-- but the PELTRO program, targeting money markets through longer-term loans. I'm wondering, do you think the ECB, the BOJ, the Fed, which one of those three, maybe, is at the best, I guess, control right now with liquidity conditions?
MOHAMED EL-ERIAN: So the good news, if you're a central bank with a printing press in the basement and you are indebted in your own currency, you can't go insolvent. You can always refinance yourself. There are consequences to that, very different from emerging markets, where the debt is in dollars and you're printing local currency.
So I don't worry about the central banks becoming insolvent. That's not going to happen. In any state of the world, that's not going to happen in the advanced countries. What you risk, though, is the credibility of central banks-- remember that forward guidance is a very powerful policy tool-- the political independence of central bank, and then the global standing of central bank. That is what you risk. But it's not a solvency risk.
JULIE HYMAN: Mohamed, you talked about the sort of divorce between the market and economy. But we haven't-- and Main Street and Wall Street, all of these sort of breakdowns. We haven't, though, really talked about what investors should be doing right now.
I mean, they've been buying, today not withstanding. We've seen this big rebound in stocks. Do you think that that's the right positioning right now? Or do you think that's particularly high risk?
MOHAMED EL-ERIAN: So the mindset in the market right now, the combined mindset, is we're in a win-win situation. Either it turns out that we're really smart-- we have looked through all the terrible earnings, that terrible economic data, to the other side of the recovery. And let's not forget, the US is a viable economy. The global economy is viable.
So we are simply betting on the future. We win if we get it right. And, if we get it wrong, it doesn't matter. The Fed is already in high yield. High yield is just one level above equities. And, of course, they're going to come back [? in-- ?] [INAUDIBLE] come in.
So that's the win-win strategy. That's a massive amount of moral hazard. To tell the truth, I'm not comfortable with it. I'm comfortable with a different thing that has done as well since the March 23 lows and is outperforming year-to-date, which is the up-in-quality trade. And the up-in-quality trade emphasizes strong balance sheet, so you get resilience, positive cash flow, so you get agility, and a favorable balance between virtual and physical space.
So things of name like Microsoft, Amazon, Google, they have done extremely well. And they have, in some cases, done better at keeping up. In other cases, just kept up with the market since March 23. But, year-to-date, they're still doing. So it's the upside. You've got a claim on the upside while protecting against the downside.
ADAM SHAPIRO: Mohamed, as we wrap this up, I've got a very broad question for you based on everything we've asked. Most of the people watching probably would identify themselves as middle class, maybe upper-middle class, or, as the joke goes, we're comfortable. 10 years from now, will we have the same amount of people saying they're middle class? Or are we really looking at a contraction?
MOHAMED EL-ERIAN: So nothing is predestined, Adam. It depends on what we do. And I keep on stressing we cannot and should not repeat the mistake of the global financial crisis. If you remember, back then, we were also in a war against a global depression.
The causes were different. But we came this close to a global depression. We won that war. But we didn't secure the peace. And we didn't secure a peace of high, sustainable, and inclusive growth.
We have the same situation today, a war against a global depression which, hopefully, we will win. But, unless we think now about your question, we will not secure the peace. There are things we can and should be doing today so that we both win the war and secure the peace.
ADAM SHAPIRO: Mohamed El-Erian is the Allianz Chief Economic Advisor. It's always good to have you here on Yahoo Finance. All the best to you and your family, Mohamed.
MOHAMED EL-ERIAN: Thank you, keep-- stay safe, everybody.