Investors and economists have sounded the recession alarm. But a leading economist who has seen the warning signs rising for many months says this potential recession is different from what we are used to.
That economist is Mohamed El-Erian, formerly the chief executive officer of influential bond market player PIMCO. He also chaired former President Barack Obama’s Global Development Council and wrote several business best-sellers. Simply put, he’s one of the best Fed and market watchers alive, and he doesn’t like what he’s seen in quite some time.
There is a tendency to view economic challenges as “temporary and rapidly 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 could be short-lived.
“The world isn’t just teetering on the edge of another recession,” he continued. “It is in the midst of profound economic and financial change.”
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 said this time it won’t be another spin of the “economic wheel.” as he sees the world experiencing major changes that will “survive the current economic cycle”. He highlighted three trends that suggest a transformation is underway in the global economy.
Three major trends transforming the world economy
The first transformative 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 of the 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 aren’t realizing this yet, she added.
The first shift was driven by the effects of the pandemic, starting with the shutdown of the entire system and government stimulus, or what El-Erian called “huge subsidies,” causing “surges in demand well ahead of supply.” .
But over time, El-Erian said, it has become clear that the supply problem “comes from more than just the pandemic.” It is linked to the Russian invasion of Ukraine which has resulted in sanctions and geopolitical tensions, coupled with a widespread labor shortage brought about by the pandemic. These disruptions in supply chains have given way to “nearshoring”, a more permanent shift of companies moving their production closer to home, rather than a 2019-era supply chain rebuild. This essentially reflects a shift in the “nature of globalization”.
“To make matters worse, these changes in the global economic landscape come at the same time that central banks are fundamentally shifting their approach,” El-Erian said. As he has done for months, El-Erian criticized the Federal Reserve in particular for being too slow to acknowledge the inflation that has taken root in the economy, and then for its sharp rate hikes to make up for lost time.
As inflation has risen, the Fed has pivoted to aggressive rate hikes, with the last four hikes all by 75 basis points taking the federal funds rate to a range of 3.75% to 4%. %. But this fundamental shift in approach has led to the third problem, writes El-Erian. “Markets recognized that the Fed was struggling to make up for lost time and began to worry that it would keep rates higher longer than was good for the economy. The result was the volatility of the financial markets”.
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 global financial activity” has poured into wealth management, private equity and hedge funds, among other less-regulated entities. The swings in the markets since the era of easy money ended this year can be understood as that significant chunk looking for a new home, investment-wise. It’s brittle at this point.
“The fragility of the financial system also complicates the work of central banks,” he said. “Instead of facing the normal dilemma – how to reduce inflation without hurting economic growth and jobs – the Fed is now faced with 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 world economy. Veteran economist Nouriel Roubini and financial historian Adam Tooze are two other prominent voices warning of related threats. Roubini has just written a new book called “MEGATHREATS” about no fewer than 10 gigantic economic problems plaguing the world, while Tooze has popularized the term “polycrisis” to describe a group of related and combined problems.
Roubini himself told it Fortune recently that he and Tooze are describing a similar series of phenomena, although I haven’t touched El-Erian’s criticisms. However, like El-Erian, Roubini has explained the multiple factors at play, and because they are so interconnected, it creates a domino effect, contributing to a possible recession.
“If you raise interest rates, you can also have a crash in stock markets, bond markets, credit markets and asset prices in general that cause further financial and economic damage,” Roubini said. Fortune. However, 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 that economic outcomes will be harder to predict. And it won’t necessarily mean a simple outcome, but rather a reflection of a “cascading effect,” as one bad event could likely lead to another.
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