Inquiring minds are looking at Pimco of Newport Beach, CA, and an interview with its CEO, Mohamed El-Erian. Pimco is the world’s largest bond investor with over $1 trillion in assets…and a lot of that money is invested in government bonds. Mr. El-Erian is front row center in the debt problems of the world making this interview a rare gem:
El-Erian: The US is today running a budget deficit of 10 percent of gross domestic product and has seen its debt-to-GDP ratio soar by 20 percentage points in under two years, which is unprecedented during peacetime. At the same time, the US still benefits from being the provider of the world’s reserve currency and the deepest and most liquid financial markets. In Europe, some countries, such as Greece, have a public debt crisis because of fiscal imprudence. Others, like Ireland, face challenges because they used the public sector balance sheet to assume someone else’s debt, namely that of the banks.
SPIEGEL: Pimco is in regular contact with governments around the world. How would you advise, for example, a Spanish finance minister?
El-Erian: I think it was my colleagues in London who met with him and his delegation, and they did so at the request of the Spanish authorities.
The fireworks start here as Mr. El-Erian begins to answer questions with specifics:
El-Erian: Some do, as do some central bankers from around the world. The typical question we get asked is this: “What does it take for Pimco to make long-term investments in our country.” The answer is always the same: an outlook of high and sustainable growth.
SPIEGEL: And your people then tell the Spanish finance minister: “Sorry, but your bonds are too risky for us.”
El-Erian: We are very cautious about exposures to Greece and Ireland. Spain is under more active discussion, with a lot depending on how they deal with the problem of the cajas (savings banks).
SPIEGEL: Will countries like Greece actually be able to pay back their debts?
El-Erian: Countries like Greece have to deal with their debt overhang, and they must do so in a timely manner. They face the typical debt trap: a situation where the existing stock of debt is so large that new investors are discouraged from coming into the country with new funds. It’s like having a very large, dark storm cloud hanging outside your house. You will not go out; you will wait until it passes. I remember how I reacted to the announcement of Greece’s rescue package almost a year ago. Having worked at the International Monetary Fund (IMF) for 15 years, I had never seen as ambitious a fiscal adjustment program as what the Greek government is trying to do. However, even if they delivered on this adjustment, their debt to GDP would go up from 114 percent of GDP to almost 150 percent. This is what a debt trap looks like. At 150 percent, the stock of debt chokes growth and employment. And if you don’t have growth and employment, the population will not be able to sustain this.
Friends of SurvivingCalifornia will not be surprised on this next phase of questioning. We have been stating the same thing for some time now…the only way out of this situation that we find ourselves in is to inflate our way out:
SPIEGEL: The US also has a huge debt problem. However, the financial markets don’t seem to care much. Why?
El-Erian: Relative to other countries, the US now looks a little bit better. Think of it like a shirt. If you don’t have a completely clean shirt, you will wear the cleanest dirty shirt you have.
SPIEGEL: What makes the US look better then others?
El-Erian: The US has structural advantages. It provides global public goods that others wish to use. The dollar is a reserve currency of the world. The US provides the deepest financial markets. So the market gives the US more time simply because there is no alternative. It takes time for the markets to evolve big enough alternatives to what the US provides today.
El-Erian: There are several ways that a country can deal with its debt issues. I suspect the US will end up with a mix of some fiscal adjustment and inflating its way out.
SPIEGEL: Washington never publicly talks about that option.
El-Erian: Europe and Germany, especially, have been very scared of hyperinflation. The US is influenced by a different historical experience, that of the fear of another Great Depression. So this country has a huge aversion to recession, huge. And if you ask a policymaker if you’re going to make a mistake, which mistake would you rather make, they would say I’d rather make an inflation mistake than make a growth mistake.
SPIEGEL: But, everyone will have to suffer the consequences. The Fed is flooding the markets with another $600 billion that will impact not only the US, but the rest of the world as well.
El-Erian: It’s inflating the whole world, that’s absolutely right. We are concerned that QE2 …
Yes, it is the only way out where our hero (Uncle Sam) lives. Mortally wounded, yes…but still alive.
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