Top economist Mohamed El-Erian says we are heading not just for another recession, but for 'profound economic and financial change'

Top economist Mohamed El-Erian says we are heading not just for another recession, but for ‘profound economic and financial change’

Investors and economists have sounded the alarm bells over the recession. But a top economist who has seen warning signs build up for many months said this potential recession is different from what we are used to.

This economist is Mohamed El-Erian, former managing director of the highly influential bond market player PIMCO. He also chaired former President Barack Obama’s Global Development Council and wrote several economic bestsellers. Simply put, he is one of the best Fed and market watchers alive, and he hasn’t like what he has seen for some time now.

There is a tendency to view economic challenges as “temporary and quickly reversible,” El-Erian wrote in a commentary for Foreign Affairsciting the Federal Reserve’s initial thinking that high inflation would be transitory or the consensus that a recession might be short-lived.

“The world is not just on the brink of another recession,” he continued. “It’s in the midst of a profound economic and financial shift.”

He referred to economic theory that a recession occurs when a business cycle reaches its natural end point and before the next cycle really takes off, but he said this time will not be another round. of the “economic wheel”, as he sees the world going through major changes that will “outlast the current economic cycle”. He highlighted three trends that suggest a transformation of the global economy is underway.

Three major trends that are transforming the global economy

The first transformational trend, says El-Erian, is the shift from insufficient demand to insufficient supply. The second is the end of unlimited central bank liquidity. And the third is the growing fragility of financial markets.

These help explain “many unusual economic developments of recent years”, he wrote, and looking ahead he sees even more uncertainty as economic shocks “become more frequent and more violent”. Analysts don’t realize that yet, he added.

The first change was prompted by the effects of the pandemic, starting with shutting down the entire system and restarting the government, or what El-Erian called “huge donations”, causing “a increase in demand long before supply”.

But over time, El-Erian said, it became clear that the supply problem “stemmed from more than just the pandemic.” It is linked to Russia’s invasion of Ukraine which led to sanctions and geopolitical tensions, as well as a general shortage of labor caused by the pandemic. These supply chain disruptions have given way to “offshoring,” a more permanent move by companies moving production closer to home, rather than a 2019-era supply chain rebuild. This essentially reflects a change in the “nature of globalization”.

“To make matters worse, these shifts in the global economic landscape come at the same time that central banks are fundamentally changing their approach,” El-Erian said. As he has for months now, El-Erian criticized the Federal Reserve in particular for being too slow to recognize inflation taking root in the economy, and then for its big rate hikes to make up for lost time.

As inflation soared, the Fed opted for aggressive rate hikes, with the last four increases all being 75 basis points, which took the fed funds rate to a range of 3.75% to 4%. But this fundamental shift in approach led to the third problem, writes El-Erian. “Markets recognized that the Fed was trying to make up for lost time and began to worry that it was holding rates higher for longer than would be good for the economy. The result was financial market volatility. .

Markets have been trained to expect easy money from central banks, he said, and the “perverse effect” of this has been that “a significant part of the activity global financial” is pouring into asset management, private equity and hedge funds, among other less-regulated entities. Market fluctuations since the end of the easy money era this year can be understood as this important part of looking for a new home, in terms of investment. It’s fragile at this point.

“The fragility of the financial system also complicates the work of central banks,” he said. “Instead of facing its normal dilemma – how to reduce inflation without hurting economic growth and jobs – the Fed now faces a trilemma: how to reduce inflation, protect growth and jobs, and ensure financial stability.”

El-Erian is not alone in citing multiple threats to the future of the global economy. Veteran economist Nouriel Roubini and financial historian Adam Tooze are two other prominent voices warning of interrelated threats. Roubini has just written a new book called “MEGATHREATS” on no less than 10 giant economic problems facing the world, while Tooze has popularized the term “polycrisis” to describe a group of interrelated and compounding problems.

Roubini himself said Fortune recently that he and Tooze described a similar set of phenomena, although he did not address El-Erian’s criticisms. However, like El-Erian, Roubini explained the multiple factors at play, and because they are so interconnected, it creates a domino effect, contributing to an eventual recession.

“If you raise interest rates, you can also have a crash in stock markets, bond markets, credit markets, and asset prices in general, which causes further financial and economic damage,” he said. Rubini. Fortune. Still, he explained that raising rates helps fight inflation, even if it risks the possibility of a hard landing, all triggered by “negative shocks” to the supply chain.

Going forward, El-Erian concluded, these changes mean economic outcomes will be harder to predict. And that won’t necessarily mean a single outcome, but rather a reflection of a “cascading effect” – in that one bad event could likely lead to another.

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