PIMCO-Mohamed El-Erian

[DRumsfeld2000]

How to handle the sovereign debt explosion
By Mohamed El-Erian

Published: March 10 2010 19:43 | Last updated: March 10 2010 19:43

Every once in a while, the world is faced with a major economic development that is ill-understood at first and dismissed as of limited relevance, and which then catches governments, companies and households unawares.

We have seen a few examples of this over the past 10 years. They include the emergence of China as a main influence on growth, prices, employment and wealth dynamics around the world. I would also include the dramatic over-extension, and subsequent spectacular collapse, of housing and shadow banks in the finance-driven economies of the US and UK.

Today, we should all be paying attention to a new theme: the simultaneous and significant deterioration in the public finances of many advanced economies. At present this is being viewed primarily – and excessively – through the narrow prism of Greece. Down the road, it will be recognised for what it is: a significant regime shift in advanced economies with consequential and long-lasting effects. To stay ahead of the process, we should keep the following six points in mind.

First, at the most basic level, what we are experiencing is best characterised as the latest in a series of disruptions to balance sheets. In 2008-09, governments had to step in to counter the simultaneous implosion in housing, finance and consumption. The world now has to deal with the consequences of how this was done.

US sovereign indebtedness has surged by a previously unthinkable 20 percentage points of gross domestic product in less than two years. Even under a favourable growth scenario, the debt-to-GDP ratio is projected to continue to increase over the next 10 years from its much higher base.

Many metrics speak to the generalised nature of the disruption to public finances. My favourite comes from Willem Buiter, Citi’s chief economist. More than 40 per cent of global GDP now resides in jurisdictions (overwhelmingly in the advanced economies) running fiscal deficits of 10 per cent of GDP or more. For much of the past 30 years, this fluctuated in the 0-5 per cent range and was dominated by emerging economies.

Second, the shock to public finances is undermining the analytical relevance of conventional classifications. Consider the old notion of a big divide between advanced and emerging economies. A growing number of the former now have significantly poorer economic and financial prospects, and greater vulnerabilities, than a growing number of the latter.

Third, the issue is not whether governments in advanced economies will adjust; they will. The operational questions relate to the nature of the adjustment (orderly versus disorderly), timing and collateral impact.

Governments naturally aspire to overcome bad debt dynamics through the orderly (and relatively painless) combination of growth and a willingness on the part of the private sector to maintain and extend holdings of government debt. Such an outcome, however, faces considerable headwinds in a world of unusually high unemployment, muted growth dynamics, persistently large deficits and regulatory uncertainty.

Countries will thus be forced to make difficult decisions relating to higher taxation and lower spending. If these do not materialise on a timely basis, the universe of likely outcomes will expand to include inflating out of excessive debt and, in the extreme, default and confiscation.

Fourth, governments can impose solutions on other sectors in the domestic economy. They do so by pre-empting and diverting resources. This is particularly relevant when there is limited scope for the cross-border migration of activities, which is the case today given the generalised nature of the public finance shock.

Fifth, the international dimension will complicate the internal fiscal adjustment facing advanced economies. The effectiveness of any fiscal consolidation is not only a function of a government’s willingness and ability to implement measures over the medium term. It is also influenced by what other countries decide to do.

These five points all support the view that the shock to balance sheets is highly relevant to a wide range of sectors and markets. Yet for now, the inclination is to dismiss the shock as isolated, temporary and reversible.

This leads to the sixth and final point. We should expect (rather than be surprised by) damaging recognition lags in both the public and private sectors. Playbooks are not readily available when it comes to new systemic themes. This leads many to revert to backward-looking analytical models, the thrust of which is essentially to assume away the relevance of the new systemic phenomena.

There is a further complication. Timely recognition is necessary but not sufficient. It must be followed by the correct response. Here, history suggests that it is not easy for companies and governments to overcome the tyranny of backward-looking internal commitments.

Where does all this leave us? Our sense is that the importance of the shock to public finances in advanced economies is not yet sufficiently appreciated and understood. Yet, with time, it will prove to be highly consequential. The sooner this is recognised, the greater the probability of being able to stay ahead of the disruptions rather than be hurt by them.

The writer is chief executive of Pimco

[Camtender]

Re: PIMCO-Mohamed El-Erian

His video is in the lower part of this article

http://money.cnn.com/2010/03/10/news...debt/index.htm

[thriftyandboringinohio]

Re: PIMCO-Mohamed El-Erian

Here's my translation of this thing.

Every once in a while, the world is faced with a major economic development that is ill-understood at first and dismissed as of limited relevance, and which then catches governments, companies and households unawares.

We have seen a few examples of this over the past 10 years. They include the emergence of China as a main influence on growth, prices, employment and wealth dynamics around the world. I would also include the dramatic over-extension, and subsequent spectacular collapse, of housing and shadow banks in the finance-driven economies of the US and UK.

Holy Mackerel! How did we get so screwed and not see it coming?

Today, we should all be paying attention to a new theme: the simultaneous and significant deterioration in the public finances of many advanced economies. At present this is being viewed primarily – and excessively – through the narrow prism of Greece. Down the road, it will be recognised for what it is: a significant regime shift in advanced economies with consequential and long-lasting effects.

Don't you understand, we've never been THIS screwed before!

First, at the most basic level, what we are experiencing is best characterised as the latest in a series of disruptions to balance sheets. In 2008-09, governments had to step in to counter the simultaneous implosion in housing, finance and consumption. The world now has to deal with the consequences of how this was done.

It's too late to change it; no way out now.

US sovereign indebtedness has surged by a previously unthinkable 20 percentage points of gross domestic product in less than two years. Even under a favourable growth scenario, the debt-to-GDP ratio is projected to continue to increase over the next 10 years from its much higher base.

Many metrics speak to the generalised nature of the disruption to public finances. My favourite comes from Willem Buiter, Citi’s chief economist. More than 40 per cent of global GDP now resides in jurisdictions (overwhelmingly in the advanced economies) running fiscal deficits of 10 per cent of GDP or more. For much of the past 30 years, this fluctuated in the 0-5 per cent range and was dominated by emerging economies.

Second, the shock to public finances is undermining the analytical relevance of conventional classifications. Consider the old notion of a big divide between advanced and emerging economies. A growing number of the former now have significantly poorer economic and financial prospects, and greater vulnerabilities, than a growing number of the latter.

Did that give you some sense of how we're screwed bigger than the world has ever seen -we have no idea how to survive a screwing like this.

Third, the issue is not whether governments in advanced economies will adjust; they will. The operational questions relate to the nature of the adjustment (orderly versus disorderly), timing and collateral impact.

Governments naturally aspire to overcome bad debt dynamics through the orderly (and relatively painless) combination of growth and a willingness on the part of the private sector to maintain and extend holdings of government debt. Such an outcome, however, faces considerable headwinds in a world of unusually high unemployment, muted growth dynamics, persistently large deficits and regulatory uncertainty.

Countries will thus be forced to make difficult decisions relating to higher taxation and lower spending. If these do not materialise on a timely basis, the universe of likely outcomes will expand to include inflating out of excessive debt and, in the extreme, default and confiscation.

This is gonna be either decades of pain or a sudden unimaginable collapse -maybe both.

Fourth, governments can impose solutions on other sectors in the domestic economy. They do so by pre-empting and diverting resources. This is particularly relevant when there is limited scope for the cross-border migration of activities, which is the case today given the generalised nature of the public finance shock.

Fifth, the international dimension will complicate the internal fiscal adjustment facing advanced economies. The effectiveness of any fiscal consolidation is not only a function of a government’s willingness and ability to implement measures over the medium term. It is also influenced by what other countries decide to do.

This time we screwed ourselves - we can't put this off on someone else.

These five points all support the view that the shock to balance sheets is highly relevant to a wide range of sectors and markets. Yet for now, the inclination is to dismiss the shock as isolated, temporary and reversible.

Why am I the only one screaming - don't you people see this!?

This leads to the sixth and final point. We should expect (rather than be surprised by) damaging recognition lags in both the public and private sectors. Playbooks are not readily available when it comes to new systemic themes. This leads many to revert to backward-looking analytical models, the thrust of which is essentially to assume away the relevance of the new systemic phenomena.

There is a further complication. Timely recognition is necessary but not sufficient. It must be followed by the correct response. Here, history suggests that it is not easy for companies and governments to overcome the tyranny of backward-looking internal commitments.

All those fixes you've heard about won't work - we've never been this screwed in all of recorded history.

Where does all this leave us? Our sense is that the importance of the shock to public finances in advanced economies is not yet sufficiently appreciated and understood. Yet, with time, it will prove to be highly consequential. The sooner this is recognised, the greater the probability of being able to stay ahead of the disruptions rather than be hurt by them.

Believe me, you have no idea how screwed we are and how much this will hurt.

The writer is chief executive of Pimco

I should know how badly we're screwed -me and Billy G and our buddies created this mess.

[BiscayneSunrise]

Re: PIMCO-Mohamed El-Erian

Just so I'm clear on this: You're saying we're screwed?

[jk]

Re: PIMCO-Mohamed El-Erian

here's simon johnson on the same topic. this is the new crisis. greece is the new subprime, as in "subprime is contained." coming to a theater near you....

The Coming Greek Debt Bubble



By Peter Boone and Simon Johnson
Bubbles are back as a topic of serious discussion, as they were before the financial crisis. The questions are: (1) can you spot bubbles, (2) can policymakers do anything to deflate them gently, and (3) can anyone make money when bubbles get out of control?
Our answers are: Spotting pure equity bubbles may sometimes be hard, but we can always see unsustainable finances supported by cheap credit. But policymakers will not act because all great (and dangerous) bubbles build their own political support; bubbles are invincible, until they collapse. A few investors can do well by betting against such bubbles, but it’s harder than you might think because you have to get the timing right – and that’s much more about luck than skill.
Bubbles are usually associated with runaway real estate prices (think Japan in the 1980s and the US more recently) or emerging market booms (parts of Asia in the 1990s and, some begin to argue, China today) or just the stock market gone mad (remember pets.com?) But they are a much more general phenomenon – any time the actual market value for any asset diverges from a reasonable estimate of its “fundamental” value.
To think about this more specifically, consider the case of Greece today. It might seem odd to suggest there is a bubble in a country so evidently under financial pressure – and working hard to stave off collapse with the help of its neighbors – but the important thing about bubbles is: Don’t listen to the “market color” (otherwise known as ex post rationalization), just look at the numbers.
By the end of 2011 Greece’s debt will around 150% of GDP (the numbers here are based on the 2009 IMF Article IV assessment; we make some adjustments for the worsening economy and the restating of numbers since that time – for example, the fiscal deficit in 2009 will likely turn out to be about 8 percent, which is double what the IMF expected until recently). About 80 percent of this debt is foreign owned, and a large part of this is thought held by residents of France and Germany. Every 1 percentage point rise in interest rates means Greece needs to send an additional 1.2 percent of GDP abroad to those bondholders.
What if Greek interest rates rise to, say, 10% – a modest premium for a country which has the highest external public debt/GDP ratio in the world, which continues (under the so-called “austerity” program) to refinance even the interest on that debt without actually paying a centime out of its own pocket, and which is struggling to establish any sustained backing from the rest of Europe? Greece would need to send at total of 12% of GDP abroad per year, once they rollover the existing stock of debt to these new rates (nearly half of Greek debt will roll over within 3 years).
This is simply impossible and unheard of for any long period of history. German reparation payments were 2.4 percent of GNP during 1925-32, and in the years immediately after 1982, the net transfer of resources from Latin America was 3.5 percent of GDP (a fifth of its export earnings). Neither of these were good experiences.
On top of all this Greece’s debt, even under the IMF’s mild assumptions, is on a non-convergent path even with the perceived “austerity” measures. Bubble math is easy. Hide all the names and just look at the numbers. If debt looks like it will explode as a percent of GDP, then a spectacular collapse is in the cards.
Seen in this comparative perspective, Greece is bankrupt today without a great deal more European assistance or without a much more drastic austerity program. Probably they need both.
Given there’s a definite bubble in Greek debt, should we expect European politicians to help deflate this gradually? Definitely not – in fact, it is their misleading statements, supported in recent days (astonishingly) by the head of the International Monetary Fund, that keep the debt bubble going and set us all up for a greater crash later.
The French and Germans are apparently actually encouraging banks, pension funds, and individuals to buy these bonds – despite the fact senior politicians must surely know this is a Ponzi scheme, i.e., people can get out of Greek bonds only to the extent that new investors come in. At best, this does nothing more than postpone the crisis – in the business, it is known as “kicking the can down the road.” At worst, it encourages less informed people (including perhaps pension funds) to buy bonds as smarter people (and big banks, surely) take the opportunity to exit.
While the French and German leadership makes a great spectacle of wanting to end speculation, in fact they are instead encouraging it. The hypocrisy is horrifying – Mr. Sarkozy and Ms. Merkel are helping realistic speculators make money on the backs of those who take seriously misleading statements by European politicians. This is irresponsible.
What should be done?
1. The Greeks and the Europeans must decide: do they want to keep the euro, or not.
2. If they want to keep the euro in Greece, the Greeks need to come up with realistic plan to start paying back debt soon. Any Greek plan will not be credible for the first few years, so the Europeans must finance the Greeks fully. This does not mean 20bn euros, it means making available around 180bn euros – i.e., the full amount of refinancing that Greece needs during this period.
3. If they don’t want to keep the euro then they should start working now on a plan for Greece’s withdrawal. The northern Europeans will need to bail out their own banks, because Greek debt must fall substantially in value – euro denominated debt will need to be written down substantially or converted to drachmas so it will be partially inflated away. The Greeks can convert local contracts, and deposits at banks, into drachma. It will be a very messy, difficult transition, but the more the debt bubble persists, the more attractive this becomes as a “least awful” solution.
Regardless of the decision on whether Greece will keep the drachma or give it up , the IMF should be brought in to conduct the monitoring and burden share. The Europeans flagrant deception which we now observe – claiming the Greeks have made a big step and encouraging people to buy Greek bonds – proves they do not have the political capacity to be realistic about this situation. Who can now be believed on needs for Greek financial reform and what is truly a credible response? The only credible voice left with the capacity to act is the IMF – and even the Fund risks being compromised by the indiscreet statements of its top leadership as the bubble continues.
If such measures are not taken, we are clearly heading for a train wreck. The European politicians have been tested, and now we know the results: They are not careful, they are reckless.

http://baselinescenario.com/2010/03/...ble/#more-6757

[GRG55]

Re: PIMCO-Mohamed El-Erian

here's simon johnson on the same topic. this is the new crisis. greece is the new subprime, as in "subprime is contained." coming to a theater near you....

The Coming Greek Debt Bubble...

When the tech/telecom bubble burst in 2000, people like EJ were certain the Central Bankers and governments wouldn't inflate a bubble in "the only asset remaining" that was big enough to replace tech...property. So certain in fact that apparently that was one of the reasons for iTulip to go dark [for a little while].

As the real estate bubble become more inflated, observers like Bill Fleckenstein were certain this was the "last bubble", since there was no observable asset class big enough to replace property.

Now we have found that asset class...sovereign debt....:p

[DRumsfeld2000]

Re: PIMCO-Mohamed El-Erian

Interesting article JK. I read this from Gartman this morning:-

http://www.businessinsider.com/gartm...the-emf-2010-3

Gartman: Here's Why Europe Is About To Dump Lots Of Gold Onto The Market
PrintVince Veneziani | Mar. 11, 2010, 10:39 AM | 3,125 | 15
Tags: Dennis Gartman, Analyst Research, Gold, Europe, China

This morning's Gartman Letter is all about gold.

Mr. Gartman predicts that we'll soon see a "rather severe" sell off of gold from legacy central banks of Europe to fund the oft-rumored European Monetary Fund or EMF.

And it doesn't stop there. China has no intention of buying gold on the open market. He quotes an anonymous official, saying:

"It is not feasible for China to buy IMF gold as any purchase or even intent to do so would trigger market speculation and volatility."

China must, under any circumstance, suggest it is interested in buying gold. It would no doubt trigger a huge swing in the commodities market. Gartman suggests that in the future, China will boost its reserves to level up to other central bank averages.



I also read recently that Europe has to roll over about $1trl in sovreign debt this year. Add this to the approx $2.5trl for the USA and the problems become obvious. Still the markets keep going up!

[BiscayneSunrise]

Re: PIMCO-Mohamed El-Erian

The article doesn't say why CB's will be selling gold. Desperate to raise cash? relief the crisis is past?

Don't CB's have a habit of selling PM's at bottoms and buying them back at tops?

[marvenger]

Re: PIMCO-Mohamed El-Erian

when you look at Japan it can certainly go on for a long time

[jk]

Re: PIMCO-Mohamed El-Erian

When the tech/telecom bubble burst in 2000, people like EJ were certain the Central Bankers and governments wouldn't inflate a bubble in "the only asset remaining" that was big enough to replace tech...property. So certain in fact that apparently that was one of the reasons for iTulip to go dark [for a little while].

As the real estate bubble become more inflated, observers like Bill Fleckenstein were certain this was the "last bubble", since there was no observable asset class big enough to replace property.

Now we have found that asset class...sovereign debt....:p

fleck has for some time been saying that the endgame would be a
"funding crisis," which is what greece is facing now, what the u.k. may face in a bit, and what the u.s. will ultimately face in the last act, when the dollar will dive and/or interest rates will spike.

when you look at Japan it can certainly go on for a long time

japan, unlike the u.s., is full of savers, both individual and corporate. the japanese pension system, the largest holder of jgb's, has recently announced that it is about to become a net SELLER, as the japanese population ages and more and more become eligible for pensions. i read an article yesterday suggesting this might serve to weaken the ultra-strong yen, and restart the yen carry trade.

[marvenger]

Re: PIMCO-Mohamed El-Erian

ouch, there's just not much good news anywhere, so true about shorting and timing and luck(or goldman sachs inside info)

[GRG55]

Re: PIMCO-Mohamed El-Erian

fleck has for some time been saying that the endgame would be a
"funding crisis," which is what greece is facing now, what the u.k. may face in a bit, and what the u.s. will ultimately face in the last act, when the dollar will dive and/or interest rates will spike...

I've never really been quite sure what he meant by a "funding crisis".

Even today Greece does not appear unable to sell bonds...it simply needs to pay a higher risk premium to attract buyers compared to other Eurozone sovereign borrowers. Is a funding crisis when that premium exceeds some level? If so, what level?

Is the funding crisis when a nation is no longer able to find lenders at any price? Will that actually happen?

Or is a funding crisis when the absolute level of sovereign debt and the cost of funding that debt clearly beyond the future taxing ability of that nation's government to service that debt [which may well be where Greece is today for all I know]?

[c1ue]

Re: PIMCO-Mohamed El-Erian

I've never really been quite sure what he meant by a "funding crisis".

Even today Greece does not appear unable to sell bonds...it simply needs to pay a higher risk premium to attract buyers compared to other Eurozone sovereign borrowers. Is a funding crisis when that premium exceeds some level? If so, what level?

Is the funding crisis when a nation is no longer able to find lenders at any price? Will that actually happen?

Or is a funding crisis when the absolute level of sovereign debt and the cost of funding that debt clearly beyond the future taxing ability of that nation's government to service that debt [which may well be where Greece is today for all I know]?

This is a good point, and the answer will likely be a combination of all of the above.

The least creditworthy nations - Greece for example - will eventually hit a point where they cannot get credit for any price. The examples of Argentina et al speak to this - once the world sovereign debt crisis is factored in.

Note that the Greek crisis has only just begun - it isn't the present funding situation that is the problem, it is going to be the funding situation in 18 months or so when it becomes very clear what Greece will or will not do regarding its creditor-requested austerity scheme. Though its fiscal situation is extremely dire, it hasn't quite reached Ponzi levels - but these levels are a heartbeat away.

The historically creditworthy nations which are still more or less economically stable - the OECD core - will pay higher interest rates and thus enjoy lower growth.

The historically creditworthy nations which are economically imploding - the US and UK - will get even higher interest rates, even lower growth, and if continued abuse occurs (i.e. unconstructive deficit spending), then a full stop ensues. Somewhere before the endgame the confiscation of wealth will start occurring.

The providers of credit - or more correctly the providers of value be it low cost manufactured goods, oil, strategic minerals, natural gas, whatever - it is these nations which have a choice.

What that choice is, is still unclear to me: economic expansion, geopolitical expansion, national solipsism, or something else?

[Southernguy]

Re: PIMCO-Mohamed El-Erian

I think El Erian correctly describes the scam going on when authorities try to sell Greek bonds to unaware or tied up (pension funds) investors.
What is incredible is to think, after the overwhelming evidence available, is than an adjustment IMF type policy, such as traditionally recomenden and implemented in Latin America, can bear positive fruits. Such policies reduce economic activity, which reduces as well state fiscal turnout.
Then fiscal deficits increase, instead of decreasing, and of course, debts problems turn worse.
Greece has to paths togo: Go out of the euro or a debt default.
The first seems the best, as it would enable a devaluation and better competitivity.
But as the problem is really a european problem, Greece being the first victim but certainly not the last, the same path shall be followed by the rest of Europe.
Which is. by the way similar situation of the USA and UK.
The ultimate cause of all this is the world is reaching the limit of its natural resources.
It is not possible that 1,3 billion people in China reach a Western standard of living.
And it is not possible for westerners to keep their insane consumption levels any more.
Of course vested interests shall make this adjustment process chaotic and full of distress.

I've never really been quite sure what he meant by a "funding crisis".

Even today Greece does not appear unable to sell bonds...it simply needs to pay a higher risk premium to attract buyers compared to other Eurozone sovereign borrowers. Is a funding crisis when that premium exceeds some level? If so, what level?

Is the funding crisis when a nation is no longer able to find lenders at any price? Will that actually happen?

Or is a funding crisis when the absolute level of sovereign debt and the cost of funding that debt clearly beyond the future taxing ability of that nation's government to service that debt [which may well be where Greece is today for all I know]?

[thriftyandboringinohio]

Re: PIMCO-Mohamed El-Erian

I've never really been quite sure what he meant by a "funding crisis".

Even today Greece does not appear unable to sell bonds...it simply needs to pay a higher risk premium to attract buyers compared to other Eurozone sovereign borrowers. Is a funding crisis when that premium exceeds some level? If so, what level?

Is the funding crisis when a nation is no longer able to find lenders at any price? Will that actually happen?

Or is a funding crisis when the absolute level of sovereign debt and the cost of funding that debt clearly beyond the future taxing ability of that nation's government to service that debt [which may well be where Greece is today for all I know]?

I think a funding crises is a continuous function not a discrete event and you have described very well the beginning of the curve:
"simply needs to pay higher...to attract buyers..."

the middle of the curve:
"..the cost of funding that debt...beyond..the..ability..to service that debt.."

and the end of the curve
"...no longer able to find lenders at any price."

The important point is to recognize that Greece is on the curve and headed toward the end point along with others.