Mohamed El-Erian

By Mohamed El-Erian

The views expressed are his own.

A new economic order is taking shape before our eyes, and it is one that includes accelerated convergence between the old Western powers and the emerging world’s major new players. But the forces driving this convergence have little to do with what generations of economists envisaged when they pointed out the inadequacy of the old order; and these forces’ implications may be equally unsettling.

For decades, many people lamented the extent to which the West dominated the global economic system. From the governance of multilateral organizations to the design of financial services, the global infrastructure was seen as favoring Western interests. While there was much talk of reform, Western countries repeatedly countered serious efforts that would result in meaningful erosion of their entitlements.

On the few occasions that such resistance was seemingly overcome, the outcome was gradual and timid change. Consequently, many emerging-market economies lost confidence in the “pooled insurance” that the global system supposedly put at their disposal, especially at times of great need.

This change in sentiment was catalyzed by the financial crises in Asia, Eastern Europe, and Latin America in the late 1990’s and early 2000’s, and by what many in these regions regarded as the West’s inadequate and poorly designed responses. With their trust in bilateral assistance and multilateral institutions such as the International Monetary Fund shaken, emerging-market economies – led by those in Asia – embarked on a sustained drive toward greater financial self-reliance.

Once they succeeded in overcoming a painful crisis-management phase, many of these countries accumulated previously unthinkable levels of international reserves as precautionary cushions. They extinguished billions in external indebtedness by generating and sustaining large current-account surpluses. And they increased the scale and scope of domestic financial intermediation in order to reduce their vulnerability to external storms.

These developments stood in stark contrast to what was happening in the West. There, unprecedented leverage, massive debt creation, and a seemingly infinite sense of credit entitlement prevailed. Financial excesses become the rule rather than the exception, facilitated by financial innovation and the erosion of lending standards and prudential regulation.

Suddenly, the world turned upside down: “rich” countries were running large deficits and, in some cases, tipping from net creditor status to net indebtedness, while “poor” countries were running surpluses and accumulating large stocks of external assets, including financial claims on Western economies.

Little did these countries know that their divergent paths would end up fueling large global imbalances, and eventually trigger a financial crisis that has shaken the prevailing international economic order to its foundations.

There is no restoring fully that order. Rather than recovering strongly, sluggish Western growth is periodically flirting with recession at a time of high unemployment and multiplying debt concerns, particularly in Europe. In an amazing turn of events, virtually every Western country must now worry about its credit ratings, while quite a few emerging economies continue to climb the ratings ladder. We can now consider the image of Western delegations heading to emerging countries to plead, cap in hand, for financial support, both direct and through the IMF.

At first blush, this unusual convergence between Western and emerging countries seems to reflect what advocates of a new international economic order had in mind. But appearances can be misleading, and, in this case, they are misleading in a significant way.

Advocates envisaged an orderly process in which economic convergence accompanied and facilitated global economic growth. They foresaw a collaborative process guided by enlightened policymaking. But what is occurring is far different and more unpredictable.

Rather than exhibiting enlightened leadership, Western policymakers have consistently lagged realities on the ground, with a bewildering mixture of denial, misdiagnosis, and bickering undermining their responses. Rather than proceeding in an orderly manner, today’s global changes are being driven by the disorderly forces of de-leveraging emanating from a Europe in deep financial crisis and an America seemingly unable to restore sustained high rates of GDP growth and job creation.

Multilateral institutions, particularly the IMF, have responded by pumping an unfathomable amount of financing into Europe. But, instead of reversing the disorderly deleveraging and encouraging new private investments, this official financing has merely shifted liabilities from the private sector to the public sector. Moreover, many emerging-market countries have noted that the policy conditionality attached to the tens of billions of dollars that have been shipped to Europe pales in comparison with what was imposed on them in the 1990’s and early 2000’s.

Fortunately, despite having lagged rather than led this process of consequential (and increasingly disorderly) global change, it is not too late for policymakers to catch up. But doing so requires more than just better national policymaking in Europe and America; it is also time for urgent and deep reform of the multilateral system and its main institutions. That process requires joint leadership by the emerging world as a true equal and partner of Western powers.

Mohamed A. El-Erian is CEO and co-CIO of PIMCO, and author of When Markets Collide.

Copyright: Project Syndicate, 2011.
www.project-syndicate.org

PHOTO: International Monetary Fund’s Managing Director Christine Lagarde (C) smiles with Nigeria’s Finance Minister Ngozi Okonjo-Iweala (R) as they hold a joint news conference in Lagos December 20, 2011. REUTERS/Stephen Jaffe-IMF/Handout

By Mohamed El-Erian
The opinions expressed are his own.

With the European crisis continuing to dominate the news, many people now realize that today’s global economy faces an unusually uncertain outlook. Indeed, Europe’s turmoil is but one of the multiple global re-alignments in play today. What may be less well recognized is the extent to which specific sectors are already changing in a consequential and permanent manner.

This is particularly true for global finance where volatility has increased, liquidity is evaporating, and the role of government is pronounced but inconsistent. This is a sector where the functioning of markets is changing, along with the outlook for institutions. The implications are relevant for both economic growth and jobs.

The recent volatility in financial markets – be it the dizzying swings in equities around the world or the fragmentation of European sovereign bonds – far exceeds what is warranted by the ongoing global re-alignments. We are also seeing the impact of a consequential shift in underlying liquidity conditions – or the oil that lubricates the flow of the credit and the related ability of savers and borrowers to find each other and interact efficiently.

Facing a range of internal and external pressures, banks seem to be limiting the amount of capital that they devote to market making. Combine this with the natural inclination of many market participants to retreat to the sidelines when volatility and uncertainty increase, and what you get is a disruptive combination of higher transaction costs, reduced trading volumes, and abrupt moves in valuations.

We are also witnessing a loss of trust in instruments that many market participants – from corporations to individual investors and institutional ones – use to manage their balance sheet risks. The reduced ability to hedge current and future exposures is even forcing some to transition from using markets to manage their “net” exposures to simply reducing gross footings.

Meanwhile western banks, whether they like it or not (and most do not), are now embarked on a journey – away from what some have called “casino banking” to what others label as the “utility model.” Whether in America or in Europe, banks are under enormous pressure from both the private and public sectors to become less complex, less levered, less risky and more boring.

By withholding new credit, private creditors are forcing certain banks to de-lever – a process that is amplified by the sharp decline in bank stocks and the accompanying erosion in capital cushions. At the same time, the banks’ traditional global dominance is under growing competitive pressures from rivals headquartered in healthy emerging economies.

The result of all this is a further, across-the-board shrinkage in the balance sheet of the western banking system. This is led by Europe where some institutions (e.g., in Greece) are also experiencing meaningful deposit outflows.

After the 2008-09 debacle of the global financial crisis, governments also want their banks to be better capitalized and more disciplined. And while implementation has been both far from consistent and less than fully effective, the intention is clear: Much tighter guardrails and better enforcement to preclude any repeat of the wild west experience of over-leverage, bad lending practices, and inappropriate compensation approaches.

The influence of central banks and governments are also being felt in other ways that impact the functioning and efficiency of markets. Some of the implications are visible and largely knowable while others, by their very nature, are unprecedented and therefore less predictable.

For three years now, central banks have been pursuing a range of “unconventional policies,” particularly in America and Europe. The goal has been to reduce the probability of prolonged recessions and severe financial dislocations.

In doing so, central banks have gone well beyond their prudential supervisory and regulatory roles. They have become important direct participants in markets – essentially using their printing presses to buy selective securities, and doing so not on the basis of the usual commercial criteria that anchor the normal functioning of markets.

Market predictability is also being impacted by the erosion in the standing of sovereign risk in the western world. The cause is the twin problem of way too little economic growth and way too much debt. The effect is a less stable global financial system now that there are fewer genuine “AAA” anchoring its core.

All this will translate into a very different financial landscape. The change will be most pronounced for banks.

Look for western banks to be less complex, less global, somewhat less inter-connected and, therefore, less systemic. With some banks teetering on the edge, certain European governments (e.g., Greece) will have no choice but to nationalize part of their financial system.

Also, with the western banking system shrinking in scope and scale, look for new credit pipes to be built around those that are now clogged. With the aim of supporting growth and jobs, particularly in longer-term investments such as infrastructure, some of these pipes will be directed or enabled by governments.

Have no doubt, the financial landscape is rapidly evolving. Some of the changes are deliberately designed and implemented. Others are being imposed by the quickly changing reality on the ground.

The ultimate destination is a smaller and safer financial services sector. When we get there, a better balance will be struck between private gains and the common good. Banks will be in a better position to serve the real economy without exposing it to catastrophic risk and harmful abuses.

The next few months will shed light on the extent to which governments and, to a lesser extent, business leaders are able to properly orchestrate the process. The more they fall short, the less growth and fewer jobs there will be.

Photo: A money exchanger speaks on the telephone in his shop in Sanaa January 5, 2011. REUTERS/Khaled Abdullah