Mohamed El-Erian

MH: What the economy needs right now. This Week on Firing Line. 

El-Erian: I’m really worried that what they hope is transitory inflation is going to end up being persistent

He is a renowned economist who has served in top posts in academia, in government, and in the boardroom. Mohamed El-Erian has been warning for months that inflation is a real problem — that could last. The time to act was yesterday, he says.

El-Erian: The window to taper is closing. They should have done it. They haven’t done it.

A position at odds with Federal Reserve Chairman Jerome Powell.

Powell: We haven’t decided to taper yet. And we haven’t decided the pace yet.

Now, with confidence in China’s markets shaken and with Washington fighting over spending and the debt ceiling…

Schumer: Playing games with the debt ceiling is playing with fire.

McConnell: My advice to this democratic government: don’t play Russian roulette with our economy.

What does Economist Mohamed El-Erian say now? 

 ‘Firing Line’ with Margaret Hoover is made possible in part by Robert Granieri, Charles R. Schwab, The Fairweather Foundation, the Asness Family Foundation, and by The Rosalind P. Walter Foundation and Damon Button. Corporate funding is provided by Stephens Inc. and Morgan Stanley.

HOOVER: Mohamed El-Erian, welcome to Firing Line.

EL-ERIAN: Thank you for having me.

HOOVER: We are now 18 months into the Covid-19 pandemic. More than 4.7 million people have died worldwide. The virus has shifted the way we live, the way we work. Where do things stand by your assessment with the global economy right now?

EL-ERIAN: So the global economy is in recovery mode. Restarting a global economy is not easy, so it is proving to be a less smooth recovery than we’d like. And then add to that the fact that the pandemic is not over. Add to that the fact that politics gets in the way, and what we’re looking at is a notable recovery, but one that is very unequal across countries and within countries.

HOOVER: Some people are calling this a K-shaped recovery, meaning that certain sectors are recovering faster than others. Do you agree?

EL-ERIAN: So I like the word dispersion because it’s more than just K shaped. There’s multiple K’s. I’ll give you an example. There’s something new in the last few months, and that is the smell of stagflation. Now, you’ve got to be as old as me to have experienced stagflation in the 70s, and that is when you have this very unusual mix of higher inflation and lower growth. Normally you get high inflation, high growth, low inflation, low growth. And what we’re getting now is a mix of high inflation, low growth. So there are many strange things happening in this economy, which means a very fluid environment for everybody.

HOOVER: I want to get to inflation a little later, but first, China has been in the news this week. Chinese developer Evergrande cannot service its $305 billion dollars in debt. Mohammed, what is the significance of this Chinese company’s potential collapse?

EL-ERIAN: So it has significance, but not as much internationally as I think people have made out. So this notion that it is the Lehman moment, the notion that we’re going to go back to the financial crisis of 2008, I don’t think that’s the case. It is something to look at. It is consequential for China in particular. It’s also consequential for investors in China — foreign investors in China — but I do not think it’s a systemic risk to the world.

HOOVER: Is there a chance there are more Chinese companies who have been following the same dubious accounting practices and that could lead to a cascading effect?

EL-ERIAN: So there are definitely other companies, particularly in the real estate sector, that are way beyond where they should be in terms of financial prudence, but I don’t think you get the sort of contagion, the sort of spillovers. Remember, China still controls its banks, still controls lots of parts of its economy. In fact, it has controlled it even more. So what’s going to get sacrificed is Chinese growth. But what’s not going to get sacrificed is global financial stability. I do not think China can contaminate the rest of the world.

HOOVER: You’ve written specifically about shortages as a result of several factors that aren’t just Covid slowdowns, but also a general shift even before Covid in the just-in-time delivery and companies spreading out various components of production to different countries. Are these supply issues transitory?

EL-ERIAN: So I hate this word ‘transitory,’ and it’s used for everything. It’s used for inflation, it’s used for labor market issues, and now it’s being used for supply chains. So it’s important to first understand ‘transitory’ means a few months. And why is that important? Because no one adjusts behavior in response to that impact. It is temporary and it is reversible. I do not think that supply chains, inflation, and labor market disruptions are transitory. There are short term influences, but there are also long term secular influences. You mentioned one of them. For a long time we all fell in love with Just-In-Time delivery, cross-country supply chains, until we realized how fragile those are. So people are rewiring their supply chains and that takes time. You don’t do it immediately. You have to find other factories. You have to get transportation. So when I look at all these factors, I think that this is more than transitory. Companies are starting to believe it’s more than transitory. So I do think that supply disruptions are going to be with us for a while.

HOOVER: How long? I mean, if transitory is a couple of months, these are long term problems, is what you’re saying?

EL-ERIAN: I’m saying it is a reconfiguration of the system. We’re going to emerge from it stronger, but there is a transition. So, of course, there’ll be disruptions that go well into next year. And I do think behaviors are changing. I think one of the most underappreciated issues is the extent to which corporate behavior is changing. We know that household behavior has changed because of Covid, but corporate behavior is also changing.

HOOVER: The Consumer Price Index has continued to climb. It’s up five 5.3% in August  year over year. Unlike some — and I’m going to use the word you don’t like — but unlike some, you have been saying for months that inflation won’t be transitory, that it will last longer. Why– make your case.

EL-ERIAN: So it already has lasted longer. The Federal Reserve has acknowledged that inflation has been, quote, ‘higher and more persistent’ than they expected. Why? First of all, there are supply shortages. Second, demand is ample. We have boosted people’s incomes significantly through all the fiscal transfers, through all the relief payments. These two things are coming together and causing a classic cost-push, demand-pull inflation. You get inflation from the cost side. You get inflation from the demand side. Those are going to continue going forward. And I think inflation will remain higher than the Federal Reserve expects and we’re going to have to do something about it.

HOOVER: So let’s sort of take a step back on inflation and dive into how it impacts ordinary people. Explain how inflation affects ordinary Americans.

EL-ERIAN: Yeah, inflation is the great unequalizer because it tends to hit low income people hardest in terms of what they spend their money on, and low income people don’t have access to inflation protection like investors do. So you get hit harder and you can’t insure yourself against inflation. Study after study has shown that it is one of the most regressive taxes out there. So it’s not just an economic and financial issue, it’s also a social issue, and then it becomes a political issue. So it has to be taken seriously. You know, lots of people watching this program will know what inflation is like because they’ve gone to the supermarket. They have seen prices go up. Now, thankfully, wages are starting to move up as well. That is a good thing from a social perspective and I welcome the increase in wages. But what you risk is this cycle. Higher prices leads to higher wages. Higher wages leads to higher costs for companies. Companies then pass on the high cost into prices, and you start getting that cycle. And that’s when you get not just inflation, but an inflationary process. And that can be destabilizing. So– so that’s why the minute you have a whiff of persistent inflation — and I think we have much more than a whiff right now — you’ve got to do something about it.

HOOVER: In August, Federal Reserve Chairman Jerome Powell said, quote, ‘Inflation at these levels is, of course, a cause for concern. But that concern is tempered by a number of factors that suggest these elevated readings are likely to prove temporary.’ Okay, there has been increasing evidence that the Federal Reserve and Treasury Department’s predictions on how long this inflation would continue were overly optimistic — you’ve pointed that out — perhaps just plain wrong. You know, why do you suppose they were wrong?

EL-ERIAN: So I’m a great believer in behavioral science, that you have to understand a little bit what the confirmation biases are of people. We’ve come from a period where the main problem for policymakers has been on the demand side. There hasn’t been enough demand. Now we have lots of demand in the system. There’s been massive transfers of income to households. The problem today is not deficient demand, it’s deficient supply. It’s a completely different paradigm. And just like coming out of the global financial crisis, it took us a long time to recognize that we are living in a different paradigm, it’s taking us a long time to recognize this time around. The biases kick in and you say, ‘But it’s going to be temporary.’ And there’s a real danger in this. And that’s why I think people have to be much more humble in light of the actual evidence.

HOOVER: In response to the global financial crisis, the Fed implemented a series of emergency policies that continued for more than a decade. Have the low interest rates and the rising asset values actually been one of the drivers of income inequality?

EL-ERIAN: It has been a very big driver of wealth inequality. There is no doubt in my mind. And I just want to stress, the Fed didn’t set out to increase wealth inequality. The Fed started on what it was hoped to be a short-term intervention. If you remember, we came out of the global financial crisis. In 2010 was the emergence of the Tea Party, was the shellacking in Congress, Congress was paralyzed, you had the debt ceiling issue, we shut down the government. Congress was not taking measures. So the Fed became the only game in town. And the expectations were that this is a short-term phenomenon. So like me going to a doctor when I need surgery and I can’t get surgery and that doctor, she gives me painkillers. It feels better for a while, but there’s a limit to how much better I feel. And the more painkillers I get given, the more unintended consequences. Now, what can the Fed do? The Fed can’t increase spending on infrastructure. The Fed can’t improve labor productivity. The Fed can’t do the things that lead to genuine growth. It can try to trick me and you into spending more. So how does it do that? It goes into the marketplace. It raises asset values. You and I see that our 401K has gone up in value. We feel richer. We trigger what’s called the wealth effect — because we are wealthier, we feel that we can spend more. When we spend more, companies say, Wow, there’s increased demand, we better invest more. They spend more. And next thing you know you’ve got a recovery. The Fed goes through the asset channels to do that. Well, we’ve discovered it’s not very powerful. We’ve discovered that you can’t trick people into believing that they are truly wealthier simply because you’re distorting markets more and more. So we haven’t had much of the benefits, and now we’re dealing with the costs and risks. And one of them is increased wealth inequality.

HOOVER: You have said that the lesson of the 70s and the 80s was, don’t let the inflationary process get out of control. As you know, the Fed met this week to consider whether it’s time to begin to take the foot off the gas pedal in terms of fiscal stimulus, financial stimulus, that it could begin, start to think about tapering government bond purchases or lifting the historically low interest rates. If you were Fed Chairman Jerome Powell, what would you do right now?

EL-ERIAN: So I’ve been very clear about this for the last few weeks and months. I would have started to taper earlier. There is a window for tapering. And that window was particularly open when the economic recovery was going strong, when people were looking at seven percent inflation. And what you’re basically doing is — think of yourself in a car. During the crisis, you were driving that car uphill. It was really hard and you had pedal to the metal in terms of your accelerator, stimulus. Now the car’s going downhill. And I would have started gently lifting my foot off the accelerator a few months ago. And I’ve said it, that that was the time to start. And the more you delay, the harder it is to do it in an orderly fashion, and the bigger the risk that you’re not going to just lift your foot off the accelerator, that you’re going to have to start hitting the brakes. And if you start hitting the brakes — which is taper plus interest rate increases — quickly, then you’ll get two effects: You will slow down the economy unduly, and you will cause financial volatility.

HOOVER: You’ve said that there’s not a single historic example in which, quote, “the Fed has  been late to the inflation party and that by acting, it hasn’t caused a recession.” I mean, is the Fed too late? Has it missed the window?

EL-ERIAN: It hasn’t missed the window. The window is still there. It is smaller and it is now a more complicated maneuver, but the window is still there. It can move. Every time, like you said, the Fed was late, it ended up causing a recession. So less monetary policy, more pro-growth fiscal policy, more supervision and prudential measures. That is the way you get the transition. It’s not an engineering problem. It’s a political implementation issue.

HOOVER: Let me take you back to 1992. In 1992, on the original Firing Line, William F. Buckley Jr. hosted a debate entitled ‘Resolved: that if you want more jobs, the government should get out of the way.’ Listen to this.

BUCKLEY: A lot of people say they can’t build houses, they can’t afford the interest. Why is interest so high? Because of inflation. Who causes inflation? Only the government can cause inflation. The private sector has never discovered how to do it. A dollar today is worth one sixth of what it was worth in 1950. And we have government to thank for this.

HOOVER: Is that an eternal truth, that one can always rest blame for inflation squarely at the feet of the federal government?

EL-ERIAN: No. There’s no doubt that you can have governments lead to inflation through irresponsible fiscal policy. And in countries where the central bank is not independent that happens quite often, and it is a problem with many developing countries. I don’t think it’s as much of a problem today in advanced economies. I think what most people will readily agree to is that central banks are involved in most inflationary episodes. Some of them, it’s their fault. Some of them, it’s not. If you have a collapse in supply, okay, they didn’t cause that, but they have to deal with it.

HOOVER: And in this case, you do think the Fed is to blame.

EL-ERIAN: I do think that we should not be running emergency measures that were needed that did extremely well in the midst of the start of the pandemic, we should not be still doing this 6 to 18 months later.

HOOVER: You have described what happens if the Fed eases off long standing stimulus practices as analogous to a parent taking candy away from the child who has been getting it every day. And so taking it away could lead to hysterics. The Fed has signaled that it would like to begin to taper. What is the likely effect of that?

EL-ERIAN: And that is a concern to the Fed. I mean, we have two examples. One is in May 2013. And I was on the trade floor when then Chair Bernanke in a visit to Congress said that they would look to ‘taper.’ It was the first time we heard the word taper. Some of us had to go and look up what taper meant. And when people realized what taper meant, you had a tantrum. And in fact, we call it the ‘taper tantrum.’

HOOVER:  Taper tantrum.

EL-ERIAN: Now, the taper tantrum undermined the functioning of markets. And that scared the Fed and come July we had a U-turn. Chair Powell comes in in 2018, and he tried to take some of the candy away. We had financial volatility in the fourth quarter and he did a U-turn. So clearly you will have some sort of tantrum. But to go from saying because you’re going to do that, you should never take the candy away, is simply wrong. Any parent will know the answer to a child threatening a tantrum is not to give them more candy. I cannot guarantee you’re not going to get a tantrum, but I can tell you the earlier we move, the less that’s going to undermine economic well-being.

HOOVER: Democrats in Congress are currently working on a $3.5 trillion dollar spending plan that includes child care and climate change and education and health care initiatives. You have indicated that this kind of investment would be advantageous for the economy, but is that much spending on top of historic levels of spending in the Trump administration and through the pandemic advisable right now?

EL-ERIAN: So I would argue yes. And you may be surprised, because I’m known to be conservative financially, but I would argue yes. Why? Because what you fund with debt depends on how confident you are that you can get higher growth. A student loan makes total sense when it allows you to go to university and changes your income stream forever. So before we talk about the debt that’s going to be created, we have to look at what are we funding? And I think there’s general agreement on physical infrastructure — bridges, roads, technology. And both parties, I think, would agree readily if the issue was just physical infrastructure. Where we get the political divide is on human infrastructure. I look at our labor force participation, it still hasn’t recovered properly. I look at the fact that we have record levels of job openings today — over 10 million. Why is it that labor force participation remains relatively low? And I think it is about education. It is about health care. It is about other things that are not enabling people to participate in the labor market. So when I look at this, I see justification for spending money on both physical and human infrastructure. And I think if it’s done properly — which is a big if –if it’s done properly, then the growth benefits will far exceed the risk that comes with the debt.

HOOVER: I’d like to ask you about the shareholder versus stakeholder debate. Two years ago, the Business Roundtable released a statement on the purpose of a corporation that was signed by more than 100 CEOs of U.S. public companies committing to all stakeholders — employees, customers, suppliers, for example. What did you make of that?

EL-ERIAN: If you’re a CEO today, you’ve got to pay attention to your labor force. And many people feel very strongly about the environmental, social, and governance commitment of their companies and express their views. And it is a major issue in your ability to attract. Your customers are also much more sensitive today to these issues than they were in the past. So my own experience is most companies are literally pushed into this by their stakeholders and by having to make decisions about what is it that keeps our business viable. So I think of it as a grassroots movement, and that has forced CEOs to adjust and that in turn forced the Business Council to adjust.

HOOVER: It forced them to adjust their rhetoric, but it didn’t actually change — at least in the review of some who have really looked at the analysis of these companies — it didn’t force them to actually change their behaviors.

EL-ERIAN: Correct. So this is exactly like the cycle that we’ve had with diversity, equity and inclusion. The first thing you do is the average person sort of talks about it — doesn’t do very much,  talks about it. Then it becomes, ‘let’s talk about it and it’s a good thing to do.’ And then it becomes, ‘we can’t afford not to do it.’ And we are going through — I don’t want to suggest that we are finished, this is a work in progress and we have a whole lot to do — but we are going through that on a whole set of social, environmental, governance issues. And it takes time. The world has changed. The world of the past — and particularly the world of Milton Friedman that stressed just shareholders, that’s our only responsibility — was a different world. And people listening to us today with teenage kids and kids in their 20s will be living it at home.

HOOVER: You mentioned people who are living at home with kids. You’ve spoken about how your then nine year old daughter confronted you about missing so many milestones in her life because you were always prioritizing work, frequently traveling. This is when you were running PIMCO, a global financial firm. And her list of everything that you had missed, ultimately led, in 2014, you to step down from your role as the CEO of PIMCO. Do you think living through Covid is going to reshape more broadly that work-life balance that she caused you to confront in a way that will broadly impact the economy?

EL-ERIAN: I do, and I think it already has, and I think it partly explains what’s happening in the labor markets. Behaviors are changing. People are revisiting their priorities. In my case, as you said, it was a shock to have your young daughter produce a list of 22 things you missed that school year that includes her first day at school, her first soccer game, parents-teachers. It was for me like a cold shower. Oh my God. And for her to then show you a picture where I did turn up to a school event, and I’m sitting on a tiny little stool looking at my BlackBerry. And she says to me, ‘Dad, even when you’re here, you’re not here.’ That for me, was a huge shock. And I think Covid has been an equivalent shock. Now, some of us can do this. And we are very, very privileged that we can do it. A lot of people can’t. And my heart goes out to them.

HOOVER: Mohamad El-Erian, thank you for your time. Thank you for your insights. I appreciate you joining me here on Firing Line.

EL-ERIAN: My great pleasure. Thank you again very much for having me.

‘Firing Line’ with Margaret Hoover is made possible in part by Robert Granieri, Charles R. Schwab, The Fairweather Foundation, the Asness Family Foundation, and by The Rosalind P. Walter Foundation and Damon Button. Corporate funding is provided by Stephens Inc. and Morgan Stanley.