Mohamed El-Erian: Beware the Bubble in Liquidity

February 10, 2015

by Robert Huebscher

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In 2000, it was technology stocks. In 2007, it was real-estate prices. Among today’s overvalued asset classes, which one will crash most spectacularly when the bubble bursts?

Mohamed El-Erian, the chief economic advisor at Allianz, says it is “liquidity.”

El-Erian was the keynote speaker on February 3 at the Boston Security Analyst Society’s annual market dinner. Prior to his current position, El-Erian was the CEO and co-chief investment offer (along with Bill Gross) at PIMCO. PIMCO is a subsidiary of Allianz.

“I don’t think we realize – even though we’ve been warned a few times – how little liquidity is actually available if there is a need for major repositioning,” he said.

We’ll look at why El-Erian is concerned about liquidity, but first let’s review his forecast for the U.S. economy, emerging markets, the asset-management industry and the country he said faces the greatest geopolitical risk.

Getting to escape velocity

Since 2009, El-Erian has consistently addressed whether the U.S. economy has reached “escape velocity” and fully emerged and delivered from the depths of the financial crisis.

Despite 5.6% unemployment (he spoke before Friday’s figures were released), a budget deficit less than 3% of GDP and almost three million new jobs created last year, El-Erian said it was “questionable whether the U.S. can actually get to escape velocity.” The economy, he said, may not be able re-attain the growth path that it was on before the crisis.

The U.S., however, is the only global economy that is strengthening, he said. He credited entrepreneurship and a lower exposure to geopolitical risks for the relative strength of the U.S. economy.

Europe, he said, only implemented a serious banking system stress test in 2014, something the U.S. had done in 2009.  He described the European Union as an economic system that is supposed to have four legs, but operates on only one and a half. The EU has a monetary union and half a banking union but lacks fiscal and political integration.

Getting to escape velocity, El-Erian said, “drags back potential growth. It becomes an issue for our kinds.”

According to El-Erian, three factors are holding back U.S. growth: ineffective fiscal policy (insufficient investment in infrastructure, labor market incentives and tax reform), a lack of willingness on the part of the government to spend aggressively and some sectors of the economy that remain overleveraged.

He claimed that economists might only disagree with him as to the relative contributions of each.

These issues, he noted, cannot be addressed by the Fed or other central banks. “What central banks can and have been doing is buying time for the system to heal and buying time for the politicians to hopefully make the right decisions,” he said.

“We should thank them for avoiding a global depression. But we should not expect them to be able to deliver good outcomes. They simply don’t have good instruments for that,” he stated.

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