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Davos Moguls Adjust to Fast, Slow, Reverse: Mohamed A. El-Erian

Davos Moguls Adjust to Fast, Slow, Reverse
Mohamed El-Erian, chief executive officer and co-chief investment officer of Pacific Investment Management Co. (PIMCO). Photographer: Gillianne Tedder/Bloomberg

Whether it’s at Davos or other international forums, policy makers would benefit from a more balanced analysis of the risks and opportunities facing today’s global economy. This is the key to promoting growth and employment, increasing the chances of successful trade negotiations, lessening the risk of currency wars and ensuring better cooperation on regulatory changes.

After two extraordinary years during which too many unthinkable and improbable events turned into possibilities and realities, policy makers can (and should) now take a longer-term perspective in their discussions. To do so, they must condense the complexity of the post-crisis global economy to a small set of testable and actionable theories.

Much can be boiled down to a two-part proposition that captures most, though not all, of the dynamics in play. Specifically, policy makers must navigate a multispeed world, and they must do so when too many short-term policy priorities conflict with longer-term realities. The trick is to recognize the two components and their interactions.

Evidence of the multispeed world is all around us, including in the notable and widening divergence among countries in growth, inflation and sovereign-credit trends.

Witness the average growth-rate differential of 6 percentage points a year in favor of emerging economies. Because of this, the output gap has closed in systemically important high-growth nations while it remains at an unusually wide 2 percent of gross domestic product for the U.S., Europe and Japan.

Economic Challenges

Inflation trends have also diverged. The average rate in emerging economies is now 4 percentage points higher than in industrialized countries. And as commodity prices soar in the context of abundant global liquidity, both the average rate of inflation and its divergence will increase, posing economic, political and social challenges. No wonder some countries, such as Brazil and China, are tapping the brakes by raising interest rates and reserve requirements.

Meanwhile, divergent trends in government debt and deficits have resulted in unusual volatility in market measures of sovereign risk. After widening during the financial crisis, the spread on emerging credits is back to its tight end-2007 level. In contrast, the spread for industrialized-nation governments has more than doubled, with some European countries remaining at alarming levels.

Breakout Phase

These dynamics are being driven primarily by secular forces. Simply put, several emerging economies are in an economic breakout phase while their counterparts in the industrialized world are still adjusting to the end of the great age of leverage, credit and debt.

These structural changes are further complicated because too many countries are facing short-term policy priorities that conflict with longer-term realities. This makes it harder for the global economy to accommodate and reconcile global differences.

Witness the extensive debate in the U.S. between the stimulus to counter stubbornly high unemployment and the need to restore balance-sheet equilibrium over the next few years.

In Europe, leaders have been fixated on liquidity solutions for the debt problem in the periphery nations, doing too little to address solvency concerns that will strangle future growth and employment.

Hesitant Embrace

The systemically important emerging economies are only hesitantly embracing the transition from huge reliance on exports to unleashing domestic demand.

And, at the international level, the required re-alignments in global governance continue to be frustrated by stubborn adherence to historical roles that bear little relevance to the realities of today’s world.

In effect, too many policy responses have yet to embrace the difficult structural reforms needed. While understandable, this increases the likelihood of frictions and tensions.

International forums such as Davos can help policy makers overcome these problems. There is much to be gained by focusing on the realities of our multispeed world and policy inconsistencies. In this way, Davos can assist in shaping perspectives, mindsets and reactions. Failing that, too many policy makers will remain hostage to active inertia while others will be paralyzed into inaction.

(Mohamed A. El-Erian is Pimco’s chief executive officer and co-chief investment officer, and the author of the book “When Markets Collide.” The opinions expressed are his own.)

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