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Investors and economists are sounding the recession alarm. But a major economist who has seen warning signs rising for months says this potential recession is not what we’re used to.
That economist is Mohamed El-Erian, formerly the chief executive officer of the highly influential bond market player PIMCO. He also chaired former President Barack Obama’s Global Development Council and authored several economic best-sellers. Simply put, he’s one of the best Fed and market watchers alive, and he hasn’t liked what he’s seen in a long time.
There is a tendency to see economic challenges as “temporary and volatile,” El-Erian written in a commentary with Foreign Affairsciting the Federal Reserve’s initial thought that high inflation may be temporary or the consensus that a recession may be short-lived.
“The world is not just teetering on the edge of another recession,” he continued. “We are in the midst of a profound economic and financial transformation.”
He referred to the 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 is no longer one. yet turning the “economic wheel,” as he sees the world experienced. major changes that “exceed the current business cycle.” He highlighted three trends that suggest global economic transformation is underway.
Three major trends are changing the world economy
The first changing trend, El-Erian said, is the shift from insufficient demand to insufficient supply. The second is the end of unlimited liquidity from central banks. And the third is the growing weakness of the financial markets.
This helps explain “many of the unusual economic developments of the past few years,” he wrote, and he expects to see more uncertainty as economic shocks “become – more frequent and more violent.” Analysts have not yet woken up to this, he added.
The first shift was driven by the effects of the pandemic, starting with the entire system being stopped and stimulus from the government, or what El-Erian called “big handouts,” causing “an increase in demand beyond supply.”
But over time, El-Erian said, it became clear that the supply issue “stems from more than just the pandemic.” This is tied to Russia’s invasion of Ukraine resulting in sanctions and geopolitical tensions, along with widespread unemployment brought on by the pandemic. These disruptions in supply chains give way to the “closer,” a more permanent shift of companies that move their production closer to home, rather than a rebuilding of the 2019 supply chain. This essentially reflects a change in the “nature of globalization.”
“Making things worse, these changes in the global economic landscape are coming at the same time that central banks are fundamentally changing their approach,” said El-Erian . He used to be like that months nowEl-Erian criticized the Federal Reserve especially for being slow to recognize the inflation that has entrenched itself into the economy, and then for his steep rate hikes to make up for lost time.
As inflation rose, the Fed moved toward aggressive rate hikes—with the last four hikes all being 75 basis points that raised the federal funds rate to a range of 3.75% to 4%. . But this fundamental change in approach led to a third problem, writes El-Erian. “Markets recognize that the Fed is scrambling to make up for lost time and are starting to worry that it will keep rates higher than is good for the economy. The result is financial market volatility.”
Markets are trained to expect easy money from central banks, he said, and the “bad effect” of that for “a significant part of the world’s financial activity” will spill over into asset management. , private equity and hedge funds, and others not so much. – regulated entities. The gyrations of the markets since the easy money period ended this year can be understood as the significant fraction looking for a new home, investment-wise. It is weak at this point.
“The weakness of the financial system also complicates the work of central banks,” he said. “Instead of facing their normal problem – how to reduce inflation without harming economic growth and jobs – the Fed now faces a trilemma: how to reduce inflation, protect growth and jobs, and ensuring financial stability.”
El-Erian is not alone in citing several threats to the future of the world economy. Veteran economist Nouriel Roubini and financial historian Adam Tooze are two other prominent voices warning of related threats. Roubini recently wrote a new book called “MEGATHREATS“No less than 10 giant economic problems facing the world, while Tooze promotes the term “polycrisis” to describe a group of related and mixed problems.
Roubini himself told luck recently he and Tooze described a similar set of events, although he did not address El-Erian’s criticisms. However, like El-Erian, Roubini explained that many factors are at play, and since they are very interconnected, it creates a domino-like effect, which contributes to a possible recession.
“If you raise interest rates, you can also have a crash in the equity markets, bond markets, credit markets, and asset prices in general which will cause more financial damage and economy,” Roubini said. luck. However, he explained that raising rates would help fight inflation, although it risks the possibility of a hard landing, all of which are caused by “negative shocks” in the supply chain.
Going forward, El-Erian concludes, these changes mean that economic outcomes are harder to predict. And this does not necessarily mean a simple result but a reflection of a “cascading effect” – that one bad event can lead to another.
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