Mohamed El-Erian: How Do We Make Sense of This Economy?
December 9, 2020 12:30 PM
Register for this event
Mohamed El-Erian: How Do We Make Sense of This Economy?
December 9, 2020 12:30 PM
RegisterSpeaker(s)
Mohamed El-Erian
President, Queens' College, Cambridge
Moderator(s)
John Culbertson
President and CIO, Context Capital Partners
Mo Lidsky
Principal & Chief Executive Officer, Prime Quadrant
Biography
Mohamed A. El-Erian is the President of Queens’ College, Cambridge, also serving as Chief Economic Advisor at Allianz, Chair of Gramercy Fund Management and Professor of Practice at The Wharton School. He formerly served as Chief Executive and Co-Chief Investment Officer of PIMCO (2007-14). A columnist for Bloomberg Opinion and a contributing editor at the Financial Times, he is a member of the boards of Barclays, UnderArmour and several non-profits. From December 2012 to January 2017, Dr. El-Erian chaired President Obama’s Global Development Council. Prior to PIMCO, he was an international civil servant at the IMF in Washington DC for 15 years and, for two years, president and CEO of Harvard Management Company, the entity that manages Harvard’s endowment.
He was named to Foreign Policy’s list of “Top 100 Global Thinkers” for four years in a row and has published widely on international economic and finance topics. His 2008 book, When Markets Collide, was a New York Times and Wall Street Journal bestseller, won the Financial Times/Goldman Sachs Business Book of the Year and was named a book of the year by The Economist and one of the best business books of all time by the Independent (UK). His 2016 book, The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse, was also a New York Times bestseller and was listed as one of the "25 of the Most Inspiring Books Everyone Should Read."
He holds a master's degree and doctorate in economics from Oxford University and received his undergraduate degree in Economics from Cambridge University.
Episode Transcript
John Culberston 3:56
Mohamed, before we start, I want to just personally thank you for being such a steady, consistent voice of reason. In a year that at times felt like just utter chaos, I think in the crescendo of fear and panic in March and April this year, you were on Bloomberg and CNBC and the FT, writing, speaking almost daily, offering advice and guidance. And I know I speak for my peers in saying thank you for the role you played in this year. So, Mohamed, you have a new job. I hear you have a new job, but it's not the defensive coordinator for the Jets. I heard you made the shortlist after this weekend, but they chose someone else I think. I'm sorry, Mohamed. It's been a tough year. Seriously, you are the president of Queens College in Cambridge. I know you have a long history at Cambridge, congratulations. Tell us a little bit about how that position came to be and what the role was really about.
Mohamed El-Erian 5:10
So first John, let me say, I was going to thank you for your kind introduction. And I was going to thank you for everything that you do and that your colleagues at Context do, but you blew it. You totally blew it by mentioning the Jets, especially after that very, very painful loss on Sunday. You just blew it. So I'm not going to thank you. But I will thank Mo. Mo, thank you for what you do. Thank you for helping so many. It really is consequential. And thank you, everybody, on this call for helping so many people. So in order to understand where I've ended up, you have to go back. I'm a 22-year-old, I'm doing my doctorate at Oxford, I know exactly what I was going to do, which is always going to be an academic. I was excited. My father suddenly died of a heart attack, my mother had never worked and I had a seven year old sister. So, all the plans that I had put in place, went out the window. And I started optimizing a very simple utility function. Who pays economists. That's what it was, who pays graduate economists. Universities did not pay very much. But there were two institutions that did pay graduate economists at the time: the IMF and the World Bank. I ended up joining the IMF, which which I've been fortunate, in fact, I've been fortunate throughout my life that every professional decisions I've made, has been incredible. So, that is sort of the detour I took. And then when I left PIMCO in 2014, and thought, what would I do next, I decided I would only do something where I felt that it would be transformational for others. And I can tell you that nothing is more transformational in my mind, than an education. I'm at a place like Queens and Cambridge University, I went through it, I knew how I started, I knew how I ended up. And if I can help do what this college does extremely well, which is access participation, help people from low-income backgrounds, get access to that education, you transform not only their lives, you transform multiple generations of lives. that is what attracted me back. I didn't know that I would be in the in the business of COVID management full-time. But you know, it is the fact that this is a college that really cares about diversity and inclusion, and cares so much, John, just to give you a feeling is that it has local presence, in disadvantaged communities. And it reaches into the school in think of ninth-grade eighth grade, to encourage people to think big, encourage them to think because often, they don't think big because they're told not to think big. Then to help the teachers, it brings the teachers to Cambridge to sit in interviews of other students to demystify the process. By breaking down these obstacles, you can literally transform generations.
John Culberston 08:43
It's such a great story, Mohamed, it really is. I'd like to talk a little bit about leadership. You touched on a little bit of this in your last comments, but you've been a leader in public companies and private educational institutions your entire career. I personally think that we're in some sort of global leadership vacuum or avoid, unfortunately, and it cuts across every facet of life. It's religious and political, economic, social. Can you talk a little about Mohamed El-Erian, his leadership principles and what and who in your life has influenced you in the way you think about leadership?
Mohamed El-Erian 09:26
I'll get to who influenced me at the end, if I may. Look, when I grew up, I had lots of bosses. And the bosses basically fell into three categories. Those who lead by fear and I had a few of those, and I didn't like it. You know, I really did not like having a boss that led by fear. Those who lead by pure inspiration, or had something incredibly special about them. I had a few of those that incredible. But they're not that many out there. And then the third category were those who lead by example, you know, that they would do what you had to do, that they knew what you were going through and they were sympathetic, empathetic but also understood what was my route. So what when I became a leader, quote, unquote, I decided that's the sort of model I want to pursue. I want to lead by example, I want to lead by involvement. And at no point when anybody I lead, feel that I wouldn't do what they're doing, in fact, they, I want them to think that I'm actually working a lot harder than they are. That was my very simple leadership principle. I then said, what are the conditions to do this? One is commit to it and deliver. So work hard on the stand, haven't opened here. Two is have cognitive diversity around the table. And I'll come back to what and why I'm stressing that, understand that we all have biases, that rather than deny the biases we have, there's good scientific reasons why we have them, overcome them by bringing other people in the room with different perspectives. And third, communicate, communicate, communicate. Who had the biggest influence on me? It was my dad, you know, I was a 13 year old, my father had gone from being a civil servant, to being a diplomat, he was drafted into the Egyptian diplomatic service, and he was posted to France. So here we are in Paris, I'm a 13 year old, we get four different newspapers every day. And my father would insist on me weeding, I had no interest in reading a single newspaper. Okay, let alone within four. And I remember being really irritated and saying that if you really want me to read a newspaper, I read one, there's no point in reading or because the news is the news, right? I don't need to wait for if I read one that should satisfy you. And you said you're wrong. The news is the news interpretations are different. And unless you're willing to weed for different newspapers, you're not going to make the right decisions. And that had a huge impact on me. And it was reinforced by all the behavioral science I studied, I was very, I'm still very intrigued in behavioral science that said that we that we all have biases. But the leaders get tested most as they are today, when they have to make decisions under radical uncertainty and unusual uncertainty. And what do you need for that? It's resilience, that if you make a mistake, you can bounce back. It's an open mindset, and it's agility. And it speaks to the same thing if you don't have people around you that are cognitively diverse, which means gender diversity, cultural diversity, education, diversity, if you don't have that around you, you're gonna make lots of mistakes that are non-recoverable.
John Culbertson 13:25
I was going to ask you how, how our educational institution institutions can be doing a better job of raising young leaders. I think you've answered part of that. But is there is there anything you'd add to that? Not just leaders in business, but leaders in life?
Mohamed El-Erian 13:44
So first I feel very strongly about this. What the typical educational institution provides is necessary but not sufficient. Often stop at the necessary part. Can they do the necessary part better? Yes, they can. But most educational, think of themselves as providing a pretty solid foundation. But what a student emerging from university needs is not just a foundation, but a few floors added. And then they add a few other floors. And I think that where we fall short, is in adding these floors. So, the first part is multi discipline, interdisciplinary. We don't teach enough interdisciplinary stuff. Okay, the education we have today is built for my world. And I'm old, my world is basically you came out of university, and you chose a ladder. You chose law, you should finance you chose engineering, and your whole and your parents push you to choose a ladder, and everybody expects you to choose a ladder and then you spend your whole career climbing the ladder. If you fall off the ladder is a complete disaster. And if you think of changing ladders, people say, Oh, you're out of your mind. That is the world I grew up in the world today of our kids is completely different. It's, it's more to us. Sheryl Sandberg has an allergy. It's a jungle gym, they go sideways, they go diagonally, they fold, they come back up, okay. And university that prepares you for jungle dream is not every university that prepares you, for a ladder is a lot more interdisciplinary stuff a lot more, you need an understanding of the world early on, you need to bring in practitioners to talk to you, it you know, it can't just send someone out with a really big, strong foundation. And then you better have diversity. Because if you are in a place that doesn't have diversity, and you get introduced to the workplace, you will make mistakes.
John Culbertson 15:59
Very well said. Mohammed, you've been very generous to and very supportive of childhood cancer research and treatment efforts. And, and in particular, one hospital in Egypt, which I think is just a fantastic story. Can you talk a little bit about your interest in, in childhood cancer in general, but also this hospital in particular?
Mohamed El-Erian 16:24
So, look, I, I am here because other people made it possible. Okay. And particular parents that my father is a civil servant, believe me in Egypt doesn't earn that much. I remember he went a decade without buying a new suit, in order to put every penny in his kid's education. So, I know that most people stand on the shoulders of others. So, when I was lucky enough to feel well off, strongly that it was my turn, to do the same for others. And then I started, like most people start, which is very innovative this first bit here, but they're a bit here. But then. And then I realized that what happens to a lot of really, really important initiatives are they never get to critical mass. And that if you really want to help somebody, you embrace them, and you get them to critical mass, and you stay with them. So, then I decided what are the two sectors, I care about most? Education and Health then asked the question within health, who do I want to focus on? And then the answer was children in developing countries, okay. So, that is how I got to him was very analytical. And then I came across this this hospital, the special in three ways it is recognize, to provide world class treatment in cancer. It has a survival rate that is very high up among developing countries and almost at the level of an advanced economy. Secondly, it does so for free. That it regardless of your family circumstances, and it has a very equal access process to it. It is known not to be subject to political pressure and everything else. And it's basically because its founder is really stubborn. And then the third thing it does, it had gotten the support of a lot of citizens sending in 50 cents $1. And I was particularly struck by the story of a young girl, who is a cancer survivor, who wrote a letter to back to the place. Actually, I'm sorry, her mother wrote a letter back to the place. And she said, I just want you to know that my daughter now insists that her pocket money or be sent to the hospital. And when I asked her why she said, I never believed that people could give, expecting nothing in return. And that for me, it was while that hospital is being transformational, and I got to know it and it was true on all three counts. And I've been a very strong supporter of that hospital. And it's not easy to be a world class institution in a country where jealousy gets triggered so and they have done a an incredibly good job and I'm really proud of them and I'm proud to be associated with them.
John Culbertson 20:11
Let's transition into the mundane into the, into the economic world. It's been a historic year economically, just along so many dimensions. It's not just because of the damage I think's been that we've seen done by the pandemic, but it's also the nuances and how the pandemic has exposed cracks and seams in the economy and in our society really, for that matter. It's also in some ways shown the robustness of some companies, and the resilience of others, and really the amazing response of the global scientific community. It's really remarkable. Let me just start with you giving us a quick assessment overview of where we are currently in the global economy.
Mohamed El-Erian 21:01
I think in order to understand where we are, you have to just retain four factors. John, you know that I tend to have what's called a reduced form equation, which is, instead of trying to explain everything, find a handful of factors that explain 80%. If you can do that, it becomes much more actionable. Otherwise, you get paralyzed trying to find what the other 20% are. If you are trying to solve the global economy, you would have four variables. One is dispersion. Different countries being at different places. There's this very simple reason w. It's because whether you are in your family, whether you're running a country, whether you are running a company, you are trying right now to solve for public health, as normal economic and social interaction as possible, and individual freedom, and that's really hard to solve for. The only countries that have been able to solve for that have sacrificed one of the three things. Either they've sacrificed because they're able to the Koreas, Japan, Singapore, the Taiwan of the world have collective responsibility. The individual freedom issue isn't that important in solving because the software itself, consistent with the other two alternatives, the China which has I don't care about personal freedom. In the US, UK, Canada, wherever else you look, you're trying to solve for all three, and it's really hard. You get different outcomes. We're going to have what I call these China, W's, Europe, and a square root in the US. You put all this whole thing together, it's a very complicated global economy.
Mohamed El-Erian 22:57
The other thing that we've learned beyond any, any doubt is that COVID is not an equal shot clock, we initially thought you know, the narrative in the beginning is it doesn't matter who you where you are, you can get COVID. Now, we've discovered actually, COVID is a great equalizer. Income distribution has gotten worse, the ability of people to protect themselves has got worse, wealth, inequality has gotten worse. And guess what the inequality opportunity has gotten worse. 30% of the students in the LA School District, the second largest in the country, are no longer in touch with the school. Either they don't have Wi Fi computers, somewhere to work with, they're not interested. They're not coming back. That's risk being a lost generation.
Mohamed El-Erian 23:47
The third element is scoring, you'll hear economists talk a lot about that, that we're going to come back out but we're going to come back out different lots of silver linings, I want to stress and use just noted one, the scientists collaborating, I have a whole list of silver linings. But we're also going to have some long-term effects. And then the fourth is a great disconnect. Is that finance, Wall Street is completely disconnected from reality. And that disconnect is something that we're going to have to deal with over the next few years.
John Culbertson 24:22
There's so much to unpack here Mohamed. What can we is take the US which has a particular way of managing the pandemic? What can we be doing as a society as a country can we be doing to help the people that have been most affected by this, especially economically, become more resilient, become more stable, and it's not just economically it's really across all spectrums of life? And you mentioned the schoolchildren in LA, for example, there's so many ripple effects and I like to hear What you think as a policy and a practical way we could be doing as a as a society to be helping those people?
Mohamed El-Erian 25:07
So, I think two things John, first and foremost, get out of the mindset that is lives versus livelihood. Health versus the economy, it's not. It was discovered this, I think painfully. If you put it that way, you're going to start continuing fluctuating like a pendulum. I'm back in California, for the holidays, so my daughter has somewhere to come home to. I'm back in California, and we just got on the estate, home shelter, shut everything down again. After we re-opened everything right. And we keep on thinking it's live. It's not this thing solves, again, together. And we got to get out of that mindset. Because as long as we in that mindset, we're going to overshoot on one way we're going to overshoot on the other way. So, the first thing is, is how you frame the question is really important. The second issue is when we think of people that are on the receiving end, we think we'll leave. And I can tell you, I'm very involved with the food bank here, where I live, and there's a massive need for relief. And you would not believe who is in line for that. I was very struck, when I was told the story about the baggage handler from the airport, that baggage handler had 20 years of accumulated experience was regarded as one of the best today that that person thought they had income for life. And if you think you have income for life, you don't save rational behavior, right. But they saw that income for life. And that discovered, they didn't have income for life. That's who is in you know, this is the sort of people who are in in, in line in the food bank. So, we live is the right thing. But it's not the only thing. And we until now are not doing enough to provide people with opportunities to bounce back quickly. And I can't stress how important that is because the scarring element is something that's going to be with us. And the most important of all, these are people who came out of schools University entered the labor force in 2020 and became immediately unemployed. And studies have shown over and over again, if you are unemployed early in your career for a long time, you risk being unemployable. You go from short term unemployment to long term unemployment to unemployable, and that's another Lost Generation. So, it's the only thing I would say one is framing it differently. And two, is think beyond relief. relief is not where it stops. relief is an important very important step. But think beyond that.
John Culbertson 28:02
So, do you think this looks like a series of multiyear fiscal programs? Or do you think it's a combination of monetary policy fiscal policy and private citizens? You know, what, what does this look like over the next few years the right policy mix, Mohamad.
Mohamed El-Erian 28:23
So, it's less monetary, smarter fiscal, a lot more productivity, enhancing structural reform and engagement with the private sector. So that's what it is enough monetary is actually in my in my mind counterproductive at this point. It is counterproductive. When Ben Bernanke key announced back in August 2010, in Jackson Hole, that we were going unconventional for not to normalize markets, not to fix dysfunctional market financial markets, but to pursue economic objectives. He said, rightly, it's about quote, benefits, costs risks, and the longer we do this, the lower the benefits, the higher the cost and the risk, we've done it for too long. The wealth channel, the wealth effect, the financial asset channel, which is what the only way monetary policy acts on the economy, okay, has a lot of distortive effects, and we are well beyond where we should be on that. So, take off foot very gradually very carefully of the monetary accelerator, and then press a different type of fiscal policy, press harder, much harder Coco's core productivity, structural reforms, and much harder public private partnerships. And I think that that that sort of policy mix, counters what is going to be what we're looking at, right? Now, which is more inequality, less growth and more financial instability? So, we've got the solution strong. This is a political issue. This is not an engineering issue. It's not a design issue. This is an implementation political implementation issue.
John Culbertson 30:19
A little controversial, but do you think that the feds, most recent, aggressive monetary policy has contributed to income inequality?
Mohamed El-Erian 30:30
Yes, I mean, I don't, I don't know how to cite it is definitely contribute to wealth inequality, wealth inequality, okay. Income inequality is harder to, to, to argue, right. In fact, there was a view that by running the economy hot, you improve income inequality, women income equality, I that could really well be the case, there's better ways of doing it, but there could be better okay, but in my mind, it is unambiguous. In fact, it is an objective of the policy, I mean, understand how this policy works. The Fed cannot lower taxes, increased spending, the Fed cannot provide with retraining retooling to the labor force, the Fed cannot do education reform, it cannot do skill acquisition, it cannot do infrastructure cannot do all the stuff we need. But what can the Fed do? It can take asset crisis sky high, first by putting interest rates to zero or negative in the case of the ECB. And making us feel that there's no alternative to risk assets. Because we want to get paid something, we have to earn some sort of return, especially if we're a pension fund, and we have obligations. And then if that's not enough, it goes in and buys assets. And you and I know that there's nothing more reassuring to an investor than the knowledge that someone behind you is going to be buying and that someone behind you has a printing press in the basement is a non-commercial buyer. They're not price sensitive. That's great. And the hope is that by all this happening, as a crisis go up, which they did, people get a 401 K, they open it up, they're wealthier, you trigger the wealth effect. People go spend more because they're wealthier. And as they spend more companies look and say, Wow, demand is picking up, I better invest more. And then you unleash animal spirits. So, you have the welfare tech, the animal spirits. And next thing you've raised the economy. Well, we've had 10 years of that, and we know it does not work. It works really well, in financial assets and housing. We know that. But beyond that, it does not work. Okay, so you end up contributing to wealth inequality, but it's not a means to another end, it ends up being an end in itself. And that becomes problematic.
John Culbertson 33:05
Should there be a third mandate for the Fed?
Mohamed El-Erian 33:08
Oh, there was an implicit mandate, which is financial stability. But I must say that, that it hasn't been in focus. And the reason is you've got to understand what a central bank is, like, I spent 15 years at the IMF. And the IMF is like, global central bank. Okay, it does the lender of last resort function to countries. And the very first thing you're taught, when you join that institution is the following quote, we are not in the business of creating crises when the business of avoiding crisis. Okay, so that was often two things central banks will end up by not overreacting, or not preemptively reacting to the threat of financial instability, because they're afraid that they're going to cause it themselves. Okay, so it is there. But they want Prudential approach to it. They don't want a proactive monetary policy approach. And then the second thing it makes it turns central banks into doctors, what's so special about a doctor, she or he will never walk away from the patient. If they don't have the absolutely right medication, that will give you whatever medication there is to buy you time until you get your surgery until you get something okay. And a central bank is like a doctor never walks away from the patient. And even if the giving medicine that's not the right one, they will continue giving it because that's their DNA. And if you wonder why go back to the IMF. Why do you think the IMF always lends to Argentina How often has Argentina been the problem? The problem child? Has the IMF ever walked away from Argentina? No. That's not what they do.
John Culbertson 35:10
So, this sounds like a coordinated effort. It is a coordinated effort. Does that coordination between legislature's and independent central banks concern you? Can you in a crisis have coordinated efforts, and then in normal, normal life, go back to independence.
Mohamed El-Erian 35:35
So, we've had it in fact that, first of all, let me tell you that, that I and I had the chance that a context event, wonderful, complex event, to interview Stephanie Kelton of the money modern monetary theory mmt. And that modern monetary theory basically says central banks and fiscal should be one right hand in hand, they go hand in hand, and a central bank should print money and, and fund deficits, etc., etc. And you heard me say I'm with you part of the way, but I'm not with you all the way I'm with you, in part of there should be coordination, especially during crises with you that when interest rates are low for long the speed limit for debt goes up. But I'm not with you beyond that point. Okay, because I think that that central banks should be technocratic fiscal agencies are, by definition, political. And if you have a short political cycle, it is almost inevitable that that's going to dictate a lot of the policymaking. You know, politicians, rightly so understandably so want to be reelected. And there are certain ways of being reelected. You want the economy too hot for a while. That's one way, another way of being reelected is you don't pay attention to what are called structural reforms, you don't pay attention to measures that involve short term sacrifice for long term gain. Right. So, we've got to be careful. You need you need some technocratic institutions, that in the system, otherwise, it becomes a very short-term focus.
John Culbertson 37:33
How do you remain How do you remain optimistic that it's particularly in the US that we can close this income and wealth gap without significant disruption?
Mohamed El-Erian 37:46
I do. I think that you're seeing people starting to realize what you've often heard me say John. You've heard me say, for years to people, companies, and wealthy people. You cannot be a good house in a bad neighborhood. If you have this notion that you can be the great house, and you don't care about the neighborhood. Well, let me warn you that that's not the case. The neighborhood will influence the house. You wouldn't buy a good house in a bad neighborhood. Do you really want to become a good house in a bad neighborhood? You've also heard me say over and over again, the people who work for you care about these issues. Whether it's the environment, whether it's governance, whether it is inequality, they really care. We have a new generation coming up, who feel aggrieved. They feel that my generation has borrowed growth from their future. We've destroyed the planet, we have added to debt, and they are much more socially conscious. If businesses don't understand that they're not going to be able to attract and retain the best talent.
John Culbertson 39:03
Mohammed, it's obvious that we're going to deficit spend globally to try to correct this income and wealth imbalance, whether it's a new Green Deal or whether it's infrastructure on the right. The debt markets, the currency markets don't seem to mind at the moment. What are the early signs? At what point do the markets begin to care about the size of public debt?
Mohamed El-Erian 39:38
It's important to say markets don't care in in most countries, but there are other countries where markets care, right? Argentina markets care, Ecuador, markets care, Lebanon markets care, right? So, there is a point out there. It is much further away. If you issue that in your domestic currency and if you're a reserve currency. In general, markets right now underestimate pre-threats. For good reasons. We should talk about why the market conditioning is so strong and I understand it. Right. It's like if a surfer on a surfboard on a huge wave in California. Does the surfer know is going to break at some point? Yeah. Are they going to get off that wave early? No, of course not. It's really enjoyable. And we had more record levels yesterday we're not going to get off this wave, we're going to need unambiguous evidence that that wave is breaking, before we get off it, because it has been so incredibly rewarding. We're really conditioned to buy the dip; we're really conditioned that there's no alternative. The fear of missing out is really, really strong. In the process, we are underestimating three risks. One is liquidity. We've assumed the system is much more liquid than it actually is. Rather than draw that lesson in March, when the Treasury market was lacking liquidity, you and I know that draw, we know what it was like, we've John the wrong lesson, which is central banks will always provide liquidity. Well, those parts of central banks can't get to. It's really important to remember that. There are certain parts that they cannot get to, and there's a lot of risk taking going on there. The first risk that's being underestimated by market is liquidity. The second waste has been under risk is a significant steepening of the yield curve. People think that central banks can control the whole yield curve unless they go into very clear yield curve targeting which they can, I don't think they will, but they can. This yield curve is going to continue to steepen. As it steepens, things are going to break. It doesn't require a change in monetary policy. It's really important for people to understand that. All it requires is for us to get through to the vaccine and for this economy to come back to 70-80% operations, and then inflation expectations are going to shoot down. That risk is really, really underappreciated in the market right now.
John Culbertson 42:24
Yeah, I agree completely Mohamed. The cross-asset liquidity gaps that we saw in March were just shocking. The most liquid assets in the world just dried up. How does the Fed begin to decondition market participants to this sense of what happened in March? The Fed stepped in and didn't just buy treasuries, they bought bonds, corporate assets. Just the Fed can't wake up one day and just say, "hey, by the way, we're no longer going to backstop the markets, you're on your own now". But what does that deconditioning process look like? How long does it take? Do you think they acclimate to that fairly smoothly? I'm sure there's a risk that they don't, but what do you think the most likely outcome is?
Mohamed El-Erian 43:16
Remember what it was like when we used to take candy away from our, from our toddlers? Okay that they like it know that we have to put up with a few minutes of pain. Yeah. But was it the right thing to do? Yes. So, look, there's been two attempts in the last two years. Both incoming heads of central banks, Chair Powell, and the ECB. Both of them came in recognizing that this codependency between the Fed and the markets had gone to have gotten bad. But this notion that there's always a Fed put, not only fed put, okay, it was a Greenspan, Ben Bernanke. He put any other input and now a PowerPoint, it gets personalized, right? That that's not a good thing that markets don't function well. And a market-based system needs really well functioning. mock financial markets because they allocate capital, let's not forget what the financial markets for is for allocating capital. So, if you distort the financial market, you're going to pay for it. So, both of them came in recognizing this and both of them tried. And if you remember, Chair Powell tried and then it took December 2018 when he did a huge U turn. But I'm like God, you turned much earlier. She came in and said something along the lines of the ECB is not in the business of capping Italian yields. Within 48 hours, she was in the business of capping it down meals, it is inevitable that the markets just like a toddler will yell and shelled. Right. But that is not policy is not determined by how loud the yelling is under shouting his policies determine are you picking up market dysfunction? And are you risking the economy? In neither you turn cases where we were we picking that up? Right. So, you know how we do it is carefully very carefully how we do this quickly, in terms of you don't wait till the perfect situation, because it's not going to come. And meanwhile, you're reinforcing, and more people are taking more risk, which is more painful to unwind, and just have a very, very high-level analysis of the functioning of markets. Was it a good time to do this in March? April, May? No, of course not. It wasn't. Was it time to do that in in September, October, November, December? Yeah, it was actually. Okay. But we didn't, instead, we're going to in fact, I expect the ECB tomorrow to press hard on the accelerator, and I expect the Fed is going to press hard on the accelerator. And let's not also forget that the Fed made this decision, which for me, is a complete and utter puzzle of buying high yield bonds. The high yield market wasn't dysfunctional at that time. Right. I'm not quite sure what they were thinking. But now that they bought high yield bond, I think a lot of people in the marketplace, say whether they're taking on default risk. So, what's stopping you from buying equities? And I think you've got to stop that behavior. It actually, it may make us feel good, like candy, like our kids with candy in the short term. But the after the aftereffects are not that great.
John Culbertson 47:03
Ahmed, you're so good at distilling such complex concepts into great analogies. And it's, it's very well said, let's transition for just a couple minutes from current-to-current markets where we're all allocators of capital on this call. And I know of course, you're not managing money these days. But when you when you look at the horizon, the 10-year horizon, when you think about how to allocate capital in an environment where interest rates are zero, and in the short term, or worse or lower, and pegged. When you look at asset valuations through equity valuations through something like Kate metric, or traditional p metric, you get one set of numbers and you adjust them for interest rates, you might get a different set of numbers, what's the right framework, especially given what you just described, with these risks of liquidity and inflection points and policy? What's the right valuation framework to use to think about how to allocate capital over a long horizon?
Mohamed El-Erian 48:08
So let me just say, I really feel sorry for everybody else that has to make decisions with other people's money. You know, when I bump into my colleagues from PIMCO, and I say how things are going, so you know, what, I'm really glad that I don't have to decide for retirement fund, or for I just wouldn't, I would, I would hate to be doing this right now. Because I know what I would be doing, I'll be holding my nose. Right and riding the wave, okay, because we understand how deep the conditioning is. But I wouldn't, that's not how I like to invest. I like to invest, because I can argue that the fundamentals evaluation, I always look for at least two of three criteria. And right now, honestly, most risk assets don't satisfy any of them. You just are on the liquidity wave. And that's not how I like to do it. So, I don't have an easy answer other than to tell you that over the long term, you need to ask yourself a few questions. One is, what themes are really betting on? Right? If I'm betting on, if my theme is the continuation of liquidity for 10 years, that's your timeframe. That ain't a good thing. Okay. If my theme is on AI is on big data. If my theme is on green technology, if my theme is on where the world is going with the terminal value, looks higher and for good reason. Okay, that's a good that's a good way to invest. A second principle I always say is, be honest. Recognize that you're likely to make a mistake at some point in that journey, not the destination, but at least the journey at some point is going to look like you've made a mistake. Is it a recoverable mistake? You and I know john that most mistakes in investment are recoverable with time. There's one that's not total capital impairment. Okay? So be very honest about what mistake and you afford to make. Which takes you to quickly, what is a recoverable mistake was a non-recoverable mistake. ask yourself that question. I've been in many investment committees and the minute you say, what is the mistake, we cannot afford to make people get really uncomfortable? It's hard enough to get them to talk about mistakes. They just want to talk about what goes well. And then the third thing I always tell each other is what resilience do you have? You've heard me say in a perfect world, you want resilience, optionality, and agility? Okay, what's your resilience? Okay, point to the resilience of your investment. Okay, so that those are the sort of principles that I'm guided by. But I can tell you, this is a really, really tricky time. It's a very, very tricky time.
John Culbertson 51:12
dd, when I won't hold you think about back to New York. Going out your eyes. You think, in years,
Mohamed El-Erian 51:27
so, I missed that first bit? What roadmap? I can hear you on and off. I don't know if it's my mind on yours. I'm looking at a credit card. Given I heard 10-year yields. Is that right? Is that better? Better? Yes, that's much better. Is it 10 year yields he awesome? I'm
John Culbertson 51:54
What do you think real returns would look like out 10 years, given the current asset prices?
Mohamed El-Erian 52:09
I don't know. But it's hard to believe that they're going to be the seven to 8% that a lot of people are having. Yes, okay. I mean, ironically you know, go to an asset class where this happens a lot. Okay? emerging markets, make the best secular returns, happens when you avoid an accident and get back in immediately after the accident. Right. And I think that that the best secular return will come When, when, right now in my days, you could have a structural investment base hypothesis, you could have a secular investment base hypothesis, and feel that you've done your job. Today, you need a tactically based investment hypothesis. Right. And that tackle the base has is influencing and informing your other two decisions much more than there has ever been in the past. And when do I say that people say, Oh, you want to turn me into a day trader? I said, No, I don't want to turn in a day trader. I want you to appreciate market technicals. It's very different. Right? So, you know, I think the reality is that we are depending on when you start investing, so if you if you tell me, you have to invest today for 10 years, and you give me an option, that I can exercise that investment, say same investment. At any time over the next 12 months, I would pay a lot for that option. Because we are going to get better entry points.
John Culbertson 53:49
Our time is short. I just want to say something personally, you've really had an extraordinary career and your story is so inspiring. But what I find most impressive about you is your genuine humility, and your humaneness. You've been you've been a leader, a global leader, but you've also been a very human person and very, very humble about that. And I greatly appreciate that. I have one last question for you. What one simple piece of advice would you give a younger Mohamed alerion knowing what you know now about life?
Mohamed El-Erian 54:46
So first of all, thank you for your kind words. It's funny because I'm much harder on myself then than you'd ever imagine. You know, I think that I could have done so much more with my life. For other than I did, and I kicked myself for not doing so. Look, I mean, I, I lack a lot of things, and I've liked Believe it or not self-confidence. You know, I never put my hand up. When I remember I started early I remember being you know, I remember being elected to be the captain of my college football team soccer, okay was the UK football team there. And I never put my hand up, it never occurred to me, it never occurred to me that other people wrote one recap. When I won when I won the FTB book of the business book of the year, it never occurred to me that should any chance of doing it, I was sitting in the room. And you'd think that I said, well, even if I have a 10% chance, I better have something to say when I get to the podium. It never occurred to me. So, you know, I would say to myself have a bit more self-confidence. Don't become don't become arrogant, okay, because arrogance, I don't think people quite realize how off-putting arrogance is to other-to-other teammates. But be a little bit more self-confidence. That's what I would tell myself. But you know, if I was to take the risk, the type one type two type one is, is insufficiently self-confident or type two, be arrogant. I'd rather err on the right type one risk don't like to.
John Culbertson 56:33
Once again, very, very well said Mohamed. Thank you so much for your time.
Mohamed El-Erian 56:39
No, thank you. I want to thank you, Mo, and everyone else for doing this. There's a lot of pain and suffering out there. So, thank you very, very much for what you're doing.
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Mohamed El-Erian: How Do We Make Sense of This Economy?
December 9, 2020 12:30 PM
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