Mohamed El-Erian, the former PIMCO CEO and current chief economic advisor to Allianz, has an eye-catching prediction.
Within the next three years, the global economy will hit a “T-junction.”
Policymakers will either watch helplessly as the world sinks into a mire of financial volatility and political collapse or they will find a way to unlock the piles of corporate cash sitting on the sidelines, reinvigorating growth.
At the moment, it’s a coin flip.
“The road we’re on is coming to an end,” El-Erian told reporters in London on Tuesday.
The road he’s referring to is the persistent low growth, low inflation, low interest rate path that developed economies have travelled down since the 2008 financial crisis.
Central banks pumped money into the system to push up asset prices, betting rich people would look at their net wealth statements, feel richer and spend more, stimulating corporate investment and a return to growth.
That hasn’t happened.
While the policies worked temporarily, and prices of houses, stocks, bonds and even fine art boomed, money didn’t trickle down the chain into the real economy, worsening inequality and creating an unsolvable debt overhang.
“In the US, the vast majority of new wealth went to the rich, but the rich spent less of it,” El-Erian said.
Meanwhile, the tools central banks used to keep the financial world alive after the collapse of Lehman Brothers are getting less and less effective.
Negative interest rates, asset purchases, and other extreme central bank policies won’t help us avoid the next crisis, only a global policy shift from elected officials to encourage companies to spend money to invest in their business models will do. Which has a roughly 50/50 chance of happening, according to El-Erian.
This all means that “improbable events” — such as Donald Trump’s success in politics and the 3-7% daily fluctuation in the price of oil — will “become more probable,” as the global economy approaches the point of no return.
And if there is a crisis, where will it start? El-Erian points to the bond market as a risk and anywhere else with an “illusion of liquidity.”
Investors in bond funds are promised daily liquidity — the ability to sell assets and pull cash out immediately — but there’s little evidence the wider bond market would survive if everyone tried this at once. With that logic, any financial product that promises same-day delivery, such as exchange-traded-funds, look problematic.
With that in mind, keeping as much as 30% of your investment portfolio in cash “is not idiotic,” even though it will earn nothing or even less.
Buckle up, it’s about to get bumpy.