Deficit-Cutters Ignore El-Erian’s Growth ‘Denominator’

PIMCO CEO Mohamed El-Erian
Mohamed El-Erian, chief executive officer and co-chief investment officer of Pacific Investment Management Co. (PIMCO). Photographer: Gillianne Tedder/Bloomberg

U.S. and European policy makers arguing about budget deficits and debt may be failing to combat the other plague on their economies: sluggish growth.

With the U.S. Treasury set to exhaust its authority to borrow tomorrow, President Barack Obama said late yesterday that congressional leaders had approved a deal to raise the debt ceiling and cut the deficit, which must be voted on by lawmakers. The austerity drive follows similar consolidation in Europe, where countries from Greece to the U.K. have reduced outlays and increased taxes to bring liabilities under control.

What officials may also need to execute are the fundamental changes needed on both sides of the Atlantic to make economies function better and thus expand more. In the U.S., the budget squabbles threaten to hold back growth, making it harder to tackle entrenched unemployment and a battered housing market, said Mohamed El-Erian, chief executive officer of Pacific Investment Management Co.

“When you look at the debt burden, there is a numerator and a denominator,” El-Erian, whose Newport Beach, California-based firm manages the world’s biggest bond fund, said in a phone interview. “We may end up creating so much damage to the denominator, which is growth of GDP, that what we do in the numerator, reducing the debt, may end up being insufficient.”

‘Healing Process’

In Europe, the focus on belt-tightening has failed to convince investors that the region has put its 22-month old debt crisis behind it and is now on a path of a self-sustaining, broadly shared economic recovery. A “genuine healing process” also requires so-called peripheral economies such as Greece to boost their growth potential by overhauling labor markets to make it easier to hire and fire, according to Dirk Schumacher, an economist at Goldman Sachs Group Inc. in Frankfurt.

“Structural reforms are an important factor when it comes to assessing the long-term growth outlook of the periphery and thus debt sustainability of governments,” he said in an e-mail. “Past experience in countries like Germany suggests that reforms can pay off substantially, though it may take a while before the benefits become visible.”

Rising yields on Italian and Spanish 10-year bonds are “definitely the trend,” according to Gary Jenkins, head of fixed income at Evolution Securities Ltd. in London. Stock strategists at HSBC Holdings Plc last week suggested investors favor European companies with a high proportion of sales outside the continent and identify BASF SE, the world’s largest chemical maker, and French luxury-goods maker LVMH Moet Hennessy Louis Vuitton SA as beneficiaries of their ties to China.

Seeking Elixirs

Spanish 10-year bonds fell today, pushing the yield up 12 basis points to 6.2 percent as of 5:23 p.m. in New York. The yield on the 10-year Italian bond rose 14 basis points, to 6 percent. U.S. Treasuries rose, with the yield on the benchmark 10-year note falling five basis points to 2.74 percent.

Finding elixirs for growth is difficult at the best of times, let alone when budgets are strained and benchmark interest rates are near rock-bottom -- 0 to 0.25 percent in the U.S. If policy makers can’t fan demand enough, the solution lies in making economies more efficient and attractive to companies looking to spend.

Obama’s Proposals

Obama is championing a grab bag of proposals aimed at doing just that, from the creation of an infrastructure bank that would use public and private funds to finance spending on roads and bridges to patent law revision that would let businesses get products to market more quickly. He has also called for passage of free trade agreements with South Korea, Colombia and Panama.

All those steps, though, require approval by Congress, which remains preoccupied by wrangling over the debt at a time when control of the two houses is divided between Republicans in the House and Democrats in the Senate.

The administration is also stepping up its search to find ways to help struggling homeowners avoid foreclosure after Obama himself agreed that the programs he’s introduced so far haven’t made as much progress as hoped.

“We’re going back to the drawing board,” he said at a July 6 town hall meeting at the White House sponsored by Twitter Inc.

Federal Reserve Chairman Ben S. Bernanke has called the housing market the “epicenter” of the troubles facing the economy and has singled it out as a major reason why the recovery has been slower than central bankers had forecast.

Growth Weakness

Gross domestic product climbed at a 1.3 percent annual rate last quarter after expanding 0.4 percent in the first three months of 2011, the worst performance since the start of the recovery in June 2009, the Commerce Department said on July 29.

“The U.S. economy is still struggling to emerge from the Great Recession and unable to move to a path of vibrant and sustainable growth,” Dan DiMicco, chairman and chief executive officer at steelmaker Nucor Corp. in Charlotte, North Carolina, said on a July 21 teleconference with stock market analysts.

The slow pace of the rebound -- the economy has yet to recoup all the ground lost in the recession -- has spawned a host of proposals from economists about ways to boost output.

A task force sponsored by the New America Foundation in Washington has called for tougher enforcement of U.S. trade laws, particularly against China, and firmer buy-American procurement requirements in government contracts.

Encouraging Business

The Kansas City-based Kauffman Foundation advocates a series of steps to promote business start-ups, from special visas for immigrant entrepreneurs to tax breaks for investors in early-stage companies. It also calls for removal of regulatory barriers to business formation.

Such an approach might work especially well in Europe, said David Mackie, chief European economist at JPMorgan Chase & Co. in London. Economies such as Greece’s are unlikely to ever be able to compete with manufacturing giants like Germany and should instead aim to evolve new businesses, he said.

“Growth is all about doing new things and some of these economies have barriers to doing that,” said Mackie. “It’s about allowing people to be creative, innovative and entrepreneurial.”

In the case of Greece, analysts at Brussels-based research group Bruegel say the EU could use structural funds to raise the quality of its universities, support loans for small and medium sized enterprises and create business zones for areas such as biotechnology.

Cameron’s Policies

In the U.K., Prime Minister David Cameron’s government last week created four enterprise zones and set out plans to help small retailers by removing regulations covering the sale of items including televisions and Christmas crackers.

Tim Morgan, global head of research at Tullett Prebon Group Plc in London, said 70 percent of the British economy is in an “ex-growth lockdown” after previously relying on borrowing and consumer spending for power. Electronics retailer Dixons Retail Plc said on June 23 that the economic backdrop remains “challenging.”

Because Cameron is undertaking the biggest fiscal squeeze since World War II, Morgan says the only available route to stronger growth is a “liberty agenda” of streamlining taxes and safety regulations for small businesses while outlawing contingency litigation.

‘Tide of Debt’

“The global economy is afloat on a tide of debt,” he said. “We’re going to have to generate organic growth rather than borrowing growth.”

In the euro area, some steps are being taken to buoy growth. The 17 euro countries are pursuing a “euro plus pact” aimed at boosting competitiveness in ways such as corporate tax harmonization and abolishing wage indexation. Greece is opening up more than 150 occupations, from taxi-driving to hairdressing, to competition, Spain raised its retirement age to 67 and Portugal plans to cut employers’ social security contributions.

While the German government last week lobbied its companies to consider investing in Greece’s telecommunications and renewable energy sectors, Anton Boerner, president of Germany’s BGA exporters group, said “the ball’s in the Greek court to create a framework for investment.”

Greece is ranked 109th by the World Bank for the cost of doing business there and the World Economic Forum places it 83rd for competitiveness, below Rwanda and Guatemala.

Allen Sinai, president of Decision Economics in New York, said the U.S. and other debt-strapped, slow-growth economies are between a rock and hard place. The policies normally prescribed for promoting recovery -- tax cuts and government spending increases -- would enlarge the deficit, while the steps needed to reduce debt risk hurting growth.

The answer, he said, may be for the U.S. to overhaul the tax code, promoting economic growth through lower rates while sparing the government a loss of revenue by doing away with loopholes and deductions for special interests.

“We have a growth crisis as well as a deficit crisis,” Sinai said. “We need to tackle both the numerator and the denominator of the debt burden.”



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