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The danger of a Grexit will only be truly negated when Greece is able to grow again, says Dr. Mohamed El-Erian, Chief Economic Adviser at Allianz, adding that in order to do that, Greece needs?actions by its European partners to reduce their contractual claims on the country.
The former CEO and co-chief investment officer at PIMCO, a subsidiary of Allianz, with approximately $2 trillion in assets under management, states that Greece can regain investors' trust and describes the path for central banks and the global economy to??higher growth and financial stability.
Dr. El-Erian interview by Konstantinos Mariolis
You have said that you spent the weekend Lehman Brothers went down at the offices of PIMCO, trying to go through the possible scenarios of the upcoming crisis. Have you ever been “forced” to do something similar due to the Greek sovereign crisis, maybe in 2010 or 2012? In other words, how big was considered the potential impact of a Grexit at that time, when Greece was dominating the headlines all around the world?
Yes. In 2010 and, especially, in 2012, PIMCO colleagues and I worked on detailed scenario analyses related to possible developments in Greece and their implications for Europe and global markets. We looked at a whole range of possibilities, going from a recovery in Greece to a disorderly debt default whose contagion would be so bad as to cause the fragmentation of the Eurozone. These scenarios were refined over time, especially in light of developments on the ground. It was part of contingency planning and scenario analyses that are key to safeguarding the investment, pensions and savings of clients.
Do you think that the danger of a Grexit has been alleviated, due to Alexis Tsipras'' u-turn?
The danger will only be truly negated when Greece is able to grow again, and do so at a high and inclusive rate. Without substantial growth whose benefits are widely shared, there is likely to be the continuation of periodic worries about Greece's debt situation and its financial viability. With that, the economy will continue to struggle, failing to create the jobs needed to deal with the alarming unemployment situation, especially among the young.
You have argued that it is time to give Greece the help it needs, in the form of a proper growth-oriented round of debt reduction. What are the main characteristics of this approach? Are you indicating there has to be a haircut in the nominal value of the debt?
Yes. Greece needs significant debt reduction if it is to have a chance to grow. Indeed, based on the experience of debt overhangs around the world – that is, excessive over-indebtedness that crushes the debtor, including by discouraging inflows of new capital – I would argue that Greece would find it very difficult to grow without actions by its European partners to reduce their contractual claims on the country.
Put another way, debt reduction is a necessary condition for a proper Greek economic and financial viability. For it to also be sufficient, which is equally important, it would need to be accompanied by pro-growth structural reforms and a strengthening of institutions.
Both Germany and the IMF are stressing the need for structural reforms but every single time we have an agreement on Greece, it comes with more austerity measures, due to the so-called fiscal adjustment. How can the Greek economy return to growth and attract foreign investments when the government raises taxes again and again?
It can't. And the experience of the last few years demonstrates this: Despite a substantial austerity effort by Greece, the economy has not been able to sustain any meaningful growth performance; and its potential has remained under considerable pressure. As a result, unemployment remains alarmingly high and poverty has spread.
To be effective in improving the wellbeing of Greek citizens, sustained fiscal adjustment needs to be accompanied by pro-growth structural reforms, the protection of the social sectors, and debt relief.
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You are definitely one of the most prestigious figures in the financial world and a bonds expert. Can you see Greece returning to the markets and regaining investors'' trust in the medium term?
Absolutely Greece can regain investors' trust. As other countries have demonstrated, international capital eagerly returns to countries that have restored financial viability and have growth momentum.
In your book “The Only Game in Town” you argue that our current economic path is coming to an end. You have also said that within the next two years we are not going to be able to maintain the world we''ve maintained for the last five to seven years. What are the key developments we should expect?
Simplifying a little, you can think of the current path as characterized by two main factors. First, global growth that is stable, albeit low; and second, central banks being able to repress financial volatility, thereby boosting asset prices above what would be warranted by fundamentals.
This path is now subject to a growing set of economic, financial, political and social tensions and underlying contradictions – and this for a simple reason: the global economy is not built to sustain a protracted period of low growth, worsening inequality and massive experimental central bank policy involvement.
The signs of growing tensions are all around us if we only look. Indeed, whether its negative nominal interest rates on almost a third of global government debt or the emergence of anti-establishment movements on both sides of the Atlantic, a growing number of improbables and unthikables have become reality.
The current path is likely to end within the next three years as growth becomes less stable and as central banks become less able to repress financial volatility. What comes next is not pre-destined. It depends in large part on what governments do.
If governments step up to their economic governance responsibilities, the current path would hand off to higher growth and genuine financial instability. This would be aided by the productive deployment of significant cash now residing on corporate balance sheets, and by innovations that are in the process of going from being name- and sector-specific to having economy wide effects.
But if governments fail to improve their economic management, low growth in the advanced countries will give way to periodic recessions, artificial financial stability will give way to instability, and emerging countries will find it very hard to navigate all this. On this second possible path, the already high inequality trifecta (of income, wealth and opportunity) would get worse, as does political polarization.
The Fed is about to hike rates – you''ve predicted this will happen by July or September. What is the response needed by other major central banks, namely the ECB and the BOJ, to spur growth?
While the Fed is likely to tap on the policy brakes, albeit very carefully and gradually, the ECB and the BoJ will be inclined to venture even further into experimental policy-land a way to stimulate their economies and reduce the risk of damaging deflation. This divergence in monetary policies will constitute a test for a global economy that already lacks sufficient policy coordination.
While this is what is likely to happen, it is not what should happen. In a better world, Europe and Japan would transition from excessive reliance on central banks to a more holistic policy response that has four key components: pro-growth, productivity-enhancing structural reforms; addressing demand deficiencies by better matching the will and wallet to spend; removing pockets of excessive over-indebtedness; and improving policy coordination in the context of progress in strengthening the regional and global economic architecture.
If I may, I would conclude with a hopeful observation, and one that should cause pause to politicians to think. What is lacking is not an identification of the solution. Indeed, there is quite a bit of agreement on the engineering components. What is missing is the political will to implement in a determined fashion, be it in Europe, in Japan or in the United States.
