A decade after the Great Recession, internationally renowned economist Mohamed El-Erian says 2018 could be the year the global economy breaks out of the “low and insufficiently inclusive growth” that has dogged it for years.
“The engines of growth in the global economy are all shifting up in gear at the same time,” El-Erian told the audience at the CFA Society Calgary’s 41st annual forecast dinner on Jan. 18.
“This is starting to be driven by genuine and durable forces of economic growth. It’s multidimensional. We’re starting to pick up signs of a virtuous cycle between consumption, investment and trade,” said El-Erian. “It provides hope for elevated asset prices to finally be validated by the fundamentals.”
In this type of environment, investors need to be more tactical, with “a combination of resilience, agility and optionality,” said El-Erian, chief economic advisor at Allianz, the corporate parent of PIMCO, where he formerly served as CEO and co-CIO. He also chaired former president Barack Obama’s Global Development Council from 2007 to 2014.
While some view this as just a short-term pickup in growth, El-Erian prefers to use the concept of a T-junction to describe what’s happening: “The road you are on ends, and then you are either going to pivot to a much better world with higher and more inclusive growth, or you are going to pivot to a much worse world.”
A better world, as he describes it, would see the validation of elevated financial asset prices (in other words, no financial crisis), less fragmentation in the global economy, and “a political system that no longer has to deal with anger all the time among the population.”
The alternative would be financial instability and a political process that becomes “a lot more complicated, as people become even more disappointed that the disruption isn’t working,” he said.
According to El-Erian, the path will be decided by policy. What’s needed, he says, is the implementation of structural reforms with “more fiscal and less monetary” policy. In Europe, he said serious reforms are needed, and he hopes French President Emmanuel Macron and German Chancellor Angela Merkel “will turbo-charge that process.”
El-Erian sees three major risks for the global economy. The first is geopolitical, with North Korea and the Middle East as the top concerns.
The second is a policy mistake from the world’s central banks—though he’s not worried about the U.S. Federal Reserve.
“I have no doubt that the Fed can continue to deliver a beautiful normalization,” El-Erian said. “What I don’t know, and what keeps me up at night, is what if the European Central Bank, the Bank of Japan and the Bank of China all try to normalize at the same time?”
The third risk is from markets. “It’s not about whether we get a correction or don’t get a correction—it’s that we collectively have over-promised liquidity to the end users,” he said.
This all comes as stock prices are booming and volatility is at record lows—”a very unusual set of circumstances,” said El-Erian, who doesn’t expect things will continue as they are.
In the best-case scenario, he expects slightly higher asset prices that are validated, at least to a great extent, by the fundamentals; higher yields, which he thinks will happen very gradually; and higher commodity prices, with the notable exception of energy.
“The issue of energy is on the supply side,” he said, adding that the only thing to worry about is shale production, which could drive down prices.
“Technologies are evolving very quickly. The cost of production is coming down. Therefore, you are going to enable much greater production. The wise thing to do is plan on stable to lower oil prices,”El-Erian said.
Higher oil prices should be treated “like a windfall,” he said, echoing Alberta Finance Minister Joe Ceci’s comments earlier in the evening. “One has to be careful not to fall into the trap of assuming that higher oil prices will mean durably higher oil prices.”
As for U.S. tax reforms, El-Erian said the changes are “unambiguously positive for growth in the short term. The vast majority of economists believe that we will get a short-term positive growth stimulus.”