US Debt Redux – Mohamed el-Erian of Pimco Speaks

July 25, 2011

FOREX, Global Macro

I want to do an important follow-up to this morning’s piece on the US Debt debate after reading an important article from PIMCO I read since my earlier post . But first I just need to give some background to the conclusion I draw at the end.

I like to think of myself first and foremost as a behavioural economist – someone who tries to understand how our “humanness” impacts on our economic decisions and interacts to create the economy in which we live. So I’m always thinking not as people as rational actors but as emotional beings who have biases and aversions who make decisions out of fear and greed and who are more impatient in the short term than they are in the long run but who equally often see current trends and assume they will continue to infinity.

But equally I am passionate about Economic history and what that tells us about how people and economies reacted to certain stimuli in the past and how that might impact the environment we are in now.

So as a behavioualist I am always baffled at how little politicians understand at how their actions and those of their body politic impact on the economy and markets. As a historian i wonder how politicians in America have forgotten what the failure to pass TARP 1 did to markets in the wake of the Lehman’s collapse.

I wrote earlier today and have written in the past that I think the US has kicked a massive own goal when it comes to this debt ceiling debate. They have shon a light on their own fiscal and debt problems to the extent where they are likely to lose both the confidence of investors, the market and, of course, the ratings agencies.

Which gets me back to the catalyst for this piece which was an article by  Pimco CEO and co-CIO Mohamed el-Erian and published in the Huffington Post and PIMCO website this morning to make my point about behaviours (my bolding).

…when the stopgap compromise is reached, many in Washington will declare victory and, in the process, claim credit for averting a national disaster. Yet the resolution will likely be temporary, and the damage will be real and long-lasting — both of which render an already worrisome situation even more difficult going forward. Indeed, by illustrating so vividly to the whole world what is ailing America, the weekend’s political theatrics should make us all worry even more about the world’s largest economy.

He is so right in this context.

Investors make decisions in uncertainty based on their confidence in an outcome. They are not always right but they make calculated risks and wear the consequences of these decisions in their profit and loss account. What the US is doing is increasing the uncertainty both for the immediate period but also into the long run because the light is now on the structural imbalances in the economy and crucially the finances of Uncle Sam.

Equally the kerfuffle on Capitol Hill is also worrying Americans with recent opinion polls showing a loss of confidence in both sides of the aisle. Who in business is going to invest and who personally is going to spend when they are worried about the dire economic outcomes ahead. It all points to a weaker economy and weaker economic outcomes down the line.

el-Erian goes on to say of this,

First, consider the context. America’s already-fragile economic psyche and its global standing have taken a material hit. Forget about “animal spirits” for now. Instead, worry even more about an economy that is already having tremendous difficulty sustaining an acceptable growth momentum, and that already suffers from an unemployment crisis that is increasingly protracted in nature. Analysts will now scramble to again revise down their projections for growth, and up those for unemployment.

Second, remember the content. The debt and deficit issues that are at the root of the debt ceiling drama are, unfortunately, a small part of a much larger set of structural impediments to employment, investment and wealth creation. The housing sector is still languishing, credit intermediation is uneven, infrastructure investment is lagging, job skill mismatches are increasing, and income and wealth inequalities are worsening.

Third, lament the process. Virtually all Americans worry about these problems and too many feel them acutely on a daily basis. Astonishingly, however, our elected representatives and their appointees are just bickering and, distressingly, failing miserably to communicate a vision that provides for even the smallest amount of medium-term optimism. The endless political squabbles compel all to question whether politicians are aware of Main Street’s realities, let alone up to the task of making things better.

Finally, don’t forget the international angle. Anyone who travels will tell you that America’s friends and allies are bewildered at what is going on here (and its enemies rejoicing). This comes at a time when the country can ill-afford to lose the confidence of large foreign holders of US Treasury bonds, overseas manufacturers with factories here, those that use the dollar as the reserve currency, and the many who have outsourced to here the intermediation of their hard-earned savings and pensions.

Yes, after taking it to the edge, it is still highly probable that Washington will manage to step back from defaulting on the national debt. But no one will, or should, feel good about how this happens.

Yep, what he said. I saw a video  with Barry Eichengreen from University of California Berkley, over the weekend (H/T Big Picture Blog) on “Why Economics needs history” which I didn’t put up on weekend reads because it’s a bit wonkish. We need a deep knowledge of history is his point but in the context of this debate he discusses the time period in which the US Dollar became the global reserve currency and how it happened.

The key point is that it all happened in 10 years – a very short time in the context of history and perhaps a window to the future of just how swiftly it might all unravel. Many would argue that China is neither willing or able to replace the USD with the CNY but we are already seeing our big miners either shifting or talking about shifting to denominating trade in CNY.

This US debt debate is, in my view the beginning of the end for the USD and the US as the sole owner of global reserve status. The repercussions for markets will last many many years.

This blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial advice we are happy to help.

Please Email the team at Lighthouse at or Greg directly on

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