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PIMCO’s El-Erian on surviving the ‘new normal’

As investors faced a “multi-speed world” in which uncertainty about the US and European economies contrasted with emerging markets’ rapid growth, they should not be misled by short-term signals from the markets, said Mohamed El-Erian, CEO and co-CIO at PIMCO.

The different growth rates among developed and emerging economies – with countries such as Australia and Canada situated somewhere “in the middle” – created a “multi-speed world” in which investors’ short-term approaches to markets conflicted with long-term themes, El-Erian said.

With ongoing quantitative easing and high unemployment in the US, fiscal austerity in Europe and emerging economies in “breakout phase”, figuring out ways of digesting massive capital inflows meant investors were living through a time of great fluidity and complexity in the global economy.

“It’s easy to be paralysed by this fluidity and complexity,” he said.

As economies worldwide addressed these “complex challenges on the bumpy journey to the ‘New Normal’ “, in which developed economies grew slowly and emerging economies advanced, he warned that markets would over-react in the short-term.

Markets were responding to immediate signals – such as further US money-printing and eurozone bailouts – but slow to adjust to longer-term themes. El-Erian described this behaviour as “a non-linear approach to paradigm change”.

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Diversification remained important for investors, but was not enough to avoid the impact of good and bad ‘fat tails’, or greater than expected gains or losses, which would be “significantly larger” than previously.

The US economy was focused on a widespread “balance sheet readjustment” involving private sector deleveraging and further fiscal consolidation, he said, and had not solved the problem of its “persistently high” level of unemployment, which hovered near 10 per cent and included the 50 per cent of people entering the workforce who could not find jobs.

Europe, meanwhile, was “focused on the challenge of maintaining institutional integrity while countries are burdened with debt and unable to grow”.

Referring to the eurozone’s bailouts of Greece and Ireland, he said: “You can’t better old debt with new debt.”

“In Europe, we are yet to see a solvency response to a solvency problem.”

It remained to be seen whether the US, through its fiscal responses to the financial crisis, would be “a victim of short-term thinking” or if Europe’s austerity would “choke off growth”.

“The US has an incredible aversion to recessions,” El-Erian said. “It doesn’t enjoy recessions, and unlike Europe doesn’t believe that recessions are cleansing.”

But its reserve-currency status enabled it to run large fiscal deficits while attempting to revive private sector growth. However El-Erian expected that in two years the US would be forced to undertake fiscal adjustment to lower unemployment.

These problems would persist at a time when some emerging markets were grappling with the rapid transition from export-oriented economies to ones led by internal demand.

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