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In this episode of Influencers, Andy is joined by Allianz Chief Economic Adviser, Mohamed El-Erian, as they discuss the Federal Reserve's role in the U.S. economy, why Mohamed says 'inflation will be sticky', and his 4 keys to stop us from slipping into a recession.
ANDY SERWER: In this episode of "Influencers," Allianz Chief Economic Advisor Mohamed El-Erian--
MOHAMED EL-ERIAN: So it is bad analysis, bad forecast, too little, too late, and miscommunication. And that's how we've ended up in this mess. We need to get back to a world where the Federal Reserve is credible because that is absolutely essential to the well-being of our society.
We simply are not in a recession. Is the recession-- the risk of recession high? Yes, it is high and getting higher.
ANDY SERWER: Hello, everyone. And welcome to "Influencers." I'm Andy Serwer. And welcome to our guest Mohamed El-Erian, President of Queens' College at the University of Cambridge and Chief Economic Advisor at Allianz. Mohamed, great to see you. Thanks for joining us.
MOHAMED EL-ERIAN: Thank you, Andy. Thank you for having me on your show.
ANDY SERWER: So you said at one point, recently, I think, that you thought inflation had peaked. How did you arrive at that conclusion? Can you elaborate?
MOHAMED EL-ERIAN: Yes, the old-fashioned way. So I looked at the components of headline inflation and, in particular, what's been driving it higher in recent times. And what we have right now is energy and food, in particular, are going to be much weaker drivers of inflation.
So the headline number is going to come down. But, worrisomely, the core number is going to stay stubbornly high. And that just speaks to an inflation process that has become more entrenched and has become more broad-based in our economy.
ANDY SERWER: Right. Transitory, entrenched, broad-based. So what is your prognosis when it comes to inflation in terms of sustainability and severity?
MOHAMED EL-ERIAN: It will come down by the end of the year. It will be sticky. I'm looking for a core CPI in the 4 and 1/2% to 5 and 1/2% range, so well above the 2% target of the Fed. But what I'm most worried about, Andy, is the collateral damage that's going to be associated with inflation coming down because the Fed has been so late in responding.
ANDY SERWER: Yeah, I mean, you've been critical of the Fed in a high-profile way. And so what do you think of their moves to raise rates and combat inflation? I mean, how did they get it wrong? Why did they get it wrong? How wrong has it been?
MOHAMED EL-ERIAN: So they started getting it wrong 15 months ago when they absolutely embraced the notion of transitory when it was an open question. Had they listened to companies, they would have been much more humble in saying, we don't quite understand the inflation dynamics because companies themselves were warning that the supply disruptions they were seeing-- and we know the list-- supply chains, container, ships.
What they were-- what companies were seeing, what they were warning, saying, we're not sure they're going to resolve themselves quickly. And yet the Fed got hooked on this notion that it's transitory. And then it got itself into a cognitive trap. It kept on repeating it and repeating it and repeating it all the way, as you know, till the very last day of November, by which time, it was clear that inflation was a problem.
And then we tied it but didn't move. It could have done more at that stage. And you ended up with this absurd situation that in March, it was still pumping in liquidity.
It was still doing QE in March when the inflation rate measuring for February with a month lag was already at a 7% handle. So it is bad analysis, bad forecast, too little, too late, and miscommunication. And that's how we've ended up in this mess.
ANDY SERWER: A cognitive trap sounds like something we all should be avoiding, Mohamed. So the causes of inflation-- obviously, COVID leading to supply chain issues. Then we have Russia. Those may be transitory, or we certainly hope they are. What about globalization and nationalization deglobalization? Is that a bigger factor and a more worrisome one even perhaps?
MOHAMED EL-ERIAN: So what you point to is really important. So we have two big dynamics going on. One is on the demand and supply. We've gone from a world of deficient aggregate demand to a world of deficient aggregate supply. And you spoke about the elements of that. That's going to resolve itself.
But we have another phenomenon going on, which is the nature of globalization is changing. And we are going from a very intense focus on efficiency on just in time to another focus on resilience just in case. And that transition is bias nation-- bias nature inflationary. And that hasn't played out fully yet.
That's why it was really important. And it remains really important to ensure that the inflation dynamics don't develop very deep roots across many, many segments of our economy. Otherwise, we may end up with a low-growth, high-inflation environment for much longer than we need to.
ANDY SERWER: Could it ultimately be a good thing, Mohamed that we are reshoring a lot of our supply chain in the United States? And wouldn't technology then mitigate costs over a period of time, and that would perhaps offset inflationary pressures and create jobs in the United States, maybe a win-win?
MOHAMED EL-ERIAN: So I think that's the most likely long-term journey. The problem that we face is that the-- so I said most long-term destination. The problem we face is that the journey to that destination is so tricky that we may end up at another destination.
So, yes, it is a good thing if we get there. But you don't get there without a lot more policy focus, a lot more private-public partnership, and a lot more communication than we've had so far.
ANDY SERWER: What do you think about central banks generally, Mohamed? I mean, there are some people who are critical of the Fed. And it's like you talk to them for five minutes, and it turns out these people who hate all central bankers. I don't think you're quite in that camp. But is there a cult of central banking?
MOHAMED EL-ERIAN: So, first of all, I'm not at all in that camp. I think central banks play a very important role. The reason why I'm so critical is because central banks have an enormous responsibility, and they're given enormous power.
Where else do you have an institution that is so powerful and can make decisions on its own, has political autonomy? And that is an incredible thing to have. And that comes with a lot of responsibility. So you have to be held accountable to your actions.
And I think central banks are absolutely key. And politically independent central banks are essential for economic well-being. So I am not in the camp of central banks, something we shouldn't have and everything else. No, we absolutely need them. But we need them to function well.
And we need them to be honest. When they make a mistake, tell us why you've made a mistake and tell us what you've done in order not to repeat the mistake. You know, it dismays me, Andy, that when the Fed publishes its quarterly projections, people call it laughable.
And who calls it laughable former? Former Fed officials. They also complain. And we need to get back to a world where the Federal Reserve is credible because that is absolutely essential to the well-being of our society.
ANDY SERWER: I also want to ask you about GDP and using it as a measuring tool as a be-all to end-all to measure nations' economies and even actually to measure their societies. I mean, there's been some talk lately about how that's not maybe the best way to measure an economy. What do you think about GDP?
MOHAMED EL-ERIAN: So it is a shortcut, but it's not comprehensive enough. The problem is that you talk about cognitive trap. We've all gotten used to measuring things by GDP. And we're having a huge problem getting out of that.
Also, the nature of your GDP growth is important. Is it inclusive? Is it non-inclusive. That's really important. So, look, it is a useful measure. But it is just a tiny perspective into an economy.
ANDY SERWER: We've been talking a lot about inflation. But what about the R-word, recession? Do you think we're headed for a recession? If so, how severe will it be? What do you see in those tea leaves, Mohamed?
MOHAMED EL-ERIAN: So my definition of a recession is it's a holistic definition. It goes well beyond two quarters of negative GDP. We are not yet into a-- in a recession. We're not.
The labor market is too strong. Consumer spending is too strong. Business balance sheets are too strong. We simply are not in a recession.
Is the recession-- risk of recession high? Yes, it is high and getting higher. Why? One, the Fed is hiking into a slowing economy. Two, as the IMF forecast showed us recently, all the major areas of the global economy are slowing. You know, they called it gloomy and uncertain. These are strong words coming from the IMF.
I was there for 15 years. I know you don't use the word "gloomy" lightly. So we do have a high risk of recession. It's not preordained. There are and should be various measures to be taken in four areas, in particular, to stop us from slipping into recession. But let's monitor it. The risk is certainly high, Andy.
ANDY SERWER: What are those four areas?
MOHAMED EL-ERIAN: So, first and foremost, we've got to get control of the inflation beast. And that is a Fed that needs to act in not only tightening its monetary policy but also regaining credibility. It's forward guidance right now is almost meaningless. And that's not a good thing. It's a major tool of monetary policy. So the Fed has a lot to do on the inflation front.
Second, we need to target fiscal policy more to protect the most vulnerable segments of our society. That has massive economic, social, and political consequences. Third, there's a whole host of pro-growth, pro-productivity reforms that need to be done, including to increase labor force participation, to improve what you talked about, the supply chains. They have a domestic angle, and they have an international angle.
And then, finally, let's not forget financial stability. Let's not forget how risk has not only morphed and migrated from banks to non-banks, but non-banks have been encouraged by years of zero interest rates and massive and predictable liquidity injections to go well beyond the native habitat in taking risk. So the non-banking sector is still offside. And we have to keep an eye on the financial stability risk because that could get back, come back and harm the economy.
ANDY SERWER: I want to drill down on number three because we focus so much, or we tend to, both people in my business and people in your business, on monetary policy. But are there fiscal policy tools coming from, say, the White House that can be utilized to combat inflation and to fight recessions? And what are they?
MOHAMED EL-ERIAN: Yes, absolutely. They don't have any immediate effect, but they are important. They basically come down to facilitating the supply side.
Do you remember I mentioned that we've gone from a world of deficient aggregate demand to deficient aggregate supply? And we see it everywhere. You need only go out, and you'll see what labor shortages look like. You'll see what supply chain disruptions look like.
On the labor side, it is critical that we take steps to enhance labor force participation. That comes down to basic issues like childcare. That's really important. Female labor force participation hasn't recovered to the levels where it should be.
We can do more on supply chains. There is a massive set of opportunities for public-private partnership. We should learn from the good things that happened during the pandemic in terms of how private-public partnerships can work really well.
And then, finally, let's not forget that that's an international problem. It's not just national. So collective action becomes really important. I think that these areas, unfortunately, are underemphasized by your profession and by mine because we tend to focus on the urgent and immediate, which is inflation and then the recession risk that comes from having led inflation out of the bottle.
ANDY SERWER: Yeah, I've been focused on this point, Mohamed, of too much looking at these shortcut things, which are GDP, cutting interest rates. You know, it's just-- but there are deeper problems and deeper solutions perhaps, interesting stuff there. In a recent piece, you outlined three upsides of the current economic conundrum that we're in, fascinating. What are they? And are those silver linings or what?
MOHAMED EL-ERIAN: So there were ups of the market situation. You know, if you were an investor and you looked at what happened in the first half of the year, what happened to your retirement, what happened to your investments, it's a pretty depressing picture. Not only have you lost a significant amount of money on your equities, but your bonds that are supposed to be your risk mitigators, they also got hit really hard.
So you've had massive problems of returns, significantly negative. Your correlations, your risk mitigation did not work at all. And it's been pretty volatile. So it's understandable that when people looked at their first half statements, they got quite upset.
Having said that, if you look forward, there are some silver linings. I don't want to, in any way, understate the losses because they are painful. But the silver linings-- one is because valuations are becoming more reasonable, we're starting to see entry points for really attractive long-term investment.
They are selective. They are individual rather than general. So they're not buying the index. But they're buying certain names that have been contaminated much more than they should, given the fundamentals. So there's value being created.
We also, finally, are seeing bonds return to the traditional role of risk mitigation. Why? Because interest rate risk, inflation risk has played out. And now we're looking at recession risk. So that's really important.
And then third, something that people don't think about, we came this close to having a third risk factor. And as you can see, I do like thinking in terms of risk factor rather than asset classes. A third risk factor come together with the other two, which is inflation risk and recession risk. And that is market functioning risk.
There were periods where we saw liquidity really strained. And the good news is the markets held. And we were able to navigate through the repositioning that people wanted to do.
ANDY SERWER: Yeah, I get that you're talking about, say, March of 2020, one of those little scary points. I want to ask you about just sort of continuing this market conversation part about the big tech stocks and FAANG and all that. You're out in California. You have some exposure to that community as well. What is your thinking on the prospects for those companies who are in the midst of earnings seasons for them as well?
MOHAMED EL-ERIAN: We are. And I think on the whole, the earning messages are things are not as bad as people were afraid of. And that's the good news. But what you're seeing is significant differentiation. Compare a Snap to an Alphabet. So we're seeing [AUDIO OUT], and then we're seeing dispersion happen. If you like, think in terms of a distribution. Big, big tech is going to do fine. And then venture opportunities remain exciting.
It is the middle of the distribution where you don't have scale, where things are getting more difficult. And that's why a Snap is in that direction. So this is a very barbelled situation. And it's going to remain so for the next few months.
ANDY SERWER: Right. So in other words, the venture, you are excited by the prospect of a hockey stick growth chart. And then on the other side, you've got these big, stable legacy businesses. But in the middle where growth has peaked perhaps, market not so happy about that, right?
MOHAMED EL-ERIAN: Right. And they find it much harder to compete with the giants because they don't have the diversified sources of income that the giants have. So they have less resilience, which, in turn, reduces their agility. And you need that agility when you're in that-- at that growth path.
ANDY SERWER: Right. Shifting gears, in another recent piece, Mohamed, you mentioned the implementation of the Debt Service Suspension Initiative and the formulation of the Common Framework for Debt Treatment by the G20, which is a form of assistance to emerging countries during COVID. Were these mistakes? Why or weren't they?
MOHAMED EL-ERIAN: So they were good intentions. Now we go-- we're going back to 2020 first, second quarter when we've realized that this shock was a significant exogenous shock, where the poor countries, in particular, would need to liberate financing for COVID relief. And the official sector came in with these two initiatives that you mentioned.
The Debt Service Suspension Initiative, DSSI, which basically said you don't need to pay us. We are going to postpone your payments. And then the other one was the Common Framework, which was meant to bring different creditors together in order to provide relief to developing countries.
It was a good initiative. It was well-intentioned. The implementation was disappointing and disappointing in two regards. One is you didn't get private sector participation. The private sector ended up being a free rider on this because there was no mechanism to get the private sector involved.
So the private sector continued being paid, while the public sector carried the burden once again. And that's not a repeated game, Andy. At some point, the public sector says, no more. We need fair burden sharing. And then if you don't get fair burden sharing in an orderly fashion, you end up having burden sharing in a disorderly fashion where everybody loses out.
The second issue that was disappointing is that it simply suspended the payments but didn't restructure them in any fundamental way. So now if you look at the profile of debt servicing, there's a big bulge coming in a year and a half's time, which is somehow going to have to be navigated. So good intention, it was the absolutely right approach. But, unfortunately, implementation fell short of expectations.
ANDY SERWER: Another area where you've weighed in is Russia. And you recently-- you recommended we continue our sanctions against Russia. In particular, you've said that we should end exceptions for its energy sector. Why is that?
MOHAMED EL-ERIAN: We're in the muddled middle right now. We have imposed sanctions on Russia for a good reason. We have undermined its economy. But we've carved out the most important sector for Russia, which is energy, and allowed that to be treated relatively favorable.
So the outcome of that is that Russia declares that sanctions haven't hurt it much. And we are disappointed that we haven't been able to encourage China to-- encourage Russia to change its behavior. And the reason why is because of these carve-outs.
So we can continue in this muddled middle. Or we should bite the bullet and end these carve-outs because we've done something else, Andy, that you and I will be talking about in the next few years. We've monetized-- we've weaponized. We've weaponized the international payment system. And we've weaponized the international payment system without any set of standards, safeguards, or anything else.
And if you are in a third country looking at that, you're going to start asking yourself a question as to your vulnerability to dollar-based system. And if we're not careful, we end up fragmenting the global economy.
ANDY SERWER: Can you explain what weaponizing the monetary system means exactly?
MOHAMED EL-ERIAN: You know, Russia is a G20 member. Russia is the 11th largest economy-- or was the 11th largest economy in the world on the eve of its illegal invasion of Ukraine. And the notion that you would put sanctions on its central bank, the notion that you would take it out of the payment system and wouldn't allow it to settle sort of payment system was one that was almost unthinkable. That is the nuclear weapon of sanctions.
Trade sanctions, sanctions on individuals, this is something we know. And you know what? There is a system that governs the trading sanctions, et cetera. But this was something really different. It's very powerful. If you don't have carve-outs, you can bring an economy to its knees.
I mean, imagine that I suddenly stop you from using any credit card, debit card you have. And all you have is a bit of cash, and I tell people you can't accept Andy's cash anymore. No matter what you want to do in terms of paying or receiving, you won't be able to do it. That's how powerful sanctions under payment system is. So we've weaponized a really powerful tool without having the safeguards that come with weaponizing a really powerful tool.
ANDY SERWER: The other big actor in this equilibrium or disequilibrium is China. And I wonder how concerned you are right now about the US-China relationship.
MOHAMED EL-ERIAN: So it is not getting any better. It is-- if anything, it is getting worse. It is particularly concerning for countries that I call having the dual option model.
I, mean, think of Australia. For a very long time, Australia looked to China for its economic prosperity-- that's where most of its exports went. That's where economic activity was expanding really rapidly-- and looked at the US for national security. It was part of the Five Eyes, the intelligence system. And that dual option model had a very low price.
As tensions between China and the US started to increase that model became less sustainable. And as you know, Australia, ultimately, was forced to make a choice. And it opted for US national security. And as a result, its economic relationship with China has been significantly damaged. So this tension between the US and China has implications that go well beyond the US and China and has also implications for the functioning of the international monetary system.
ANDY SERWER: I know you've talked about climate change as well in the past. Does that kind of take a backseat with all these other problems going on? And is that an unfortunate consequence of, say, tensions with Russia and what Europe's going through?
MOHAMED EL-ERIAN: It's a disastrous occurrence. [AUDIO OUT] when we think of what we're going to leave our kids, we need to take the threat and the reality of climate change much more seriously. And the responses, the short-term responses-- you are talking earlier about the immediate versus the long term. The short-term responses to the implications of the Ukraine war has been to go backwards.
Coal mines are being opened again. Some governments are subsidizing the use of fossil fuel in order to alleviate the cost of living crisis. There's other ways they could have done it. It's unfortunate that they chose that measure. So it is a concern that we are going backwards on something that already we are behind on. And that is the fight against climate change.
ANDY SERWER: We seem to be in a bit of a crypto winter, Mohamed. And I'm wondering just how cold is it? And how long will this chill continue? I don't mean to be flip. How serious is this? And what's your take on crypto these days?
MOHAMED EL-ERIAN: So any innovation that I know of, any major innovation that I know of goes through winters, OK? And it's really important to understand the steam engine went through winters. The fiber optics went through winters. Securitization famously went through more than a winter. I don't know what you call that. And there's a reason for that, which is human behavior.
If I suddenly lower the barriers to entry, to an activity and do it suddenly, you get, typically, overproduction and overconsumption. That's what we do when we suddenly allow to do something that we couldn't do before, we hadn't thought of before. We overreact. So it is not surprising to me that innovations are never linear. They go through winters.
This, depending on how you measure it, is either the second or the third winter for crypto. What it's doing is it's shaking the system. It's cleansing it of its excesses.
You know, I'm a believer that crypto is here to stay. I do not believe that we're going to have Bitcoin as the reserve currency of the world. But neither do I believe that the whole crypto is one big joke that has suckered a lot of people into it.
I think crypto has significant innovation that we're going to see play out in fintech. We're going to see play out in other areas. And what you're getting is a bit of a flushing out of the system. And I think if you are a long-term player in that space, particularly in the application of the innovations that come with crypto, that, at the end of the day, is going to end up being a good thing for you.
ANDY SERWER: Mohamed, you've lived all over the world. And now you're bouncing back and forth between the UK and the United States. What is the UK versus the United States like now? How has that changed? Maybe they used to be a parody in some regards. Are things different, not part of the EU anymore? What's it like?
MOHAMED EL-ERIAN: So I think the US is much more resilient than the UK. Just look at what's happening right now. Yes, the US is having difficulty with inflation at 9%, with growth slowing. But in the UK, it's called the cost of living crisis.
And that cost of living crisis is giving rise to industrial action. There are strikes. People feel that it is the summer of discontent. So the systems are different in terms of the ability to absorb shocks.
And then the second issue is what you've just said. The UK is still redefining its relationship with the rest of the world. It had exited one regime, one paradigm, the EU, but it hasn't re-established an equilibrium yet in a new paradigm.
Whereas the US is pretty stable in its paradigms with the exception of China. So it's an issue of resilience and stability. That's what the big difference is right now.
ANDY SERWER: Mohamed, this show is called "Influencers." And you are-- you certainly are one. And I'm curious as to how you see using your influence on the world.
MOHAMED EL-ERIAN: So what I try to do, Andy, is through my writings, through discussions like that with you, through social media is share with people things that I find interesting, thought-provoking, and hypotheses. I don't try to tell you what to conclude, Andy. I try to say here are the certain things that you should think about.
And there are a few things-- there have been five so far as far as I know when I feel really strongly and only one in which I use capital letters throughout, where I will try and not only inform your thinking but go well beyond and try to strongly influence it. But my role is to try and inform people so that they make better decisions.
And what I appreciate most is when people come back to me and say, you're wrong. Have you thought of this? Have you thought of that?
ANDY SERWER: Quickly, what were some of those five things and, in particular, the all caps one?
MOHAMED EL-ERIAN: So February 2020, in the beginning, was an all-cap world when saying-- when I said this, what is happening in China and increasingly happening in Italy, take it seriously. This is not a thing that will stay, that COVID will not stay. The coronavirus, as we call it then, will not stay there. The global financial crisis, inflation--
You know, I wrote a book, as you know, in 2016, "The Only Game in Town," that looked at what would happen if we continue to rely on central banks, and central banks were forced to stay out of their well-defined area of operation for such a long time. So it's that sort of thing. And, of course, it was Argentina's default, which I couldn't understand in 1999 and 2000 why people were continuing to allocate so much money to a default that I thought was almost preordained because of past policy failures.
ANDY SERWER: Got it. Last quick question, you know I have to ask you. You are a big New York Jets fan. So I have to ask you, what are their prospects for the coming season? And second part, in the UK, which EPL team do the Jets remind you of?
MOHAMED EL-ERIAN: OK, so the prospect for the Jets, I'm going to go through the same cycle. And you know it well, where I'm hoping that we can have a winning season. And within the first two games, first, against the Ravens, we're going to come to the reality that this is going to be another losing season. And let's just hope we can beat the Patriots.
In terms of-- look, it's really funny because if you look at the teams I support, they had one or two big days, and that's it. The Jets, they haven't won anything since 1969. The Mets, they haven't won anything since 1986.
And then if you go to British football, English football, I support a team that's not even in the top division anymore, that has fallen. It's called Queens Park Rangers, QPR. So I somehow have two traits. I pick losers, and I'm incredibly loyal to them.
ANDY SERWER: You like the underdogs, and you're loyal.
MOHAMED EL-ERIAN: Or I turn winners into losers, and I'm loyal.
ANDY SERWER: [LAUGHS] All right, you're being too harsh on yourself. Mohamed El-Erian, President of Queens' College at Cambridge, Chief Economic Advisor at Allianz. Thank you so much for your time, Mohamed.
MOHAMED EL-ERIAN: Thank you, Andy. It's a pleasure.
ANDY SERWER: You've been watching "Influencers." I'm Andy Serwer. We'll see you next time.