Crisis be damned. Last Thursday’s Business Book of the Year Awards was a
jovial and well attended affair. Business big shots from both sides of the
Atlantic gathered at the Plaza Hotel in New York for the annual award
sponsored by Goldman Sachs and the Financial Times.
Having come through the worst financial meltdown in living memory, the crowd
milled around amiably before dinner, greeting each other like shipwreck
survivors. Lloyd Blankfein, Goldman’s chief executive, looked remarkably
rested considering he can’t have slept much in the past month, and even
managed a few jokes. Only the winner seemed gloomy - but then he believes
there is worse to come.
Taking to the stage to receive his award for When Markets Collide - Investment
Strategies For the Age of Global Economic Change, Mohamed El-Erian said:
“When I wrote the book, I thought I was writing about the future. When it
was going to press, I thought it was about current affairs. Now I wish it
was about history.”
Writing is not his day job but of all the people publishing histories of these
momentous financial times, few are as qualified as El-Erian. The son of an
Egyptian diplomat, he is a former deputy director of the International
Monetary Fund (IMF) and once managed Harvard University’s $35 billion (£20
billion) endowment fund.
Now he is co-chief executive of Pimco, manager of the world’s largest bond
fund. For all his gloom at the awards ceremony, El-Erian was also one of the
few people in the room to be benefiting from the shakeout. Immediately after
last week’s ceremony he had to jet straight back to Pimco’s California
headquarters. The firm had just been handed a key role in the management of
US Treasury secretary Hank Paulson’s $700 billion bailout plan.
Talking after the ceremony, El-Erian said he hoped his book would act as a
guide to negotiating a future that looks set to contain many more shocks
similar to the ones rocking financial markets around the world.
The present crisis had been triggered because the international financial
system had undertaken activities that had “far outpaced the ability of the
infrastructure to sustain them”, said El-Erian.
And it was not just the markets that could not cope with their own changes,
but governments as well. Significant weaknesses had been exposed “from the
firms, to the regulatory agencies, to governments, to multilateral
oversight”.
“Turbocharge that with financial innovations, which history tells us we tend
to overproduce and overconsume, and it’s inevitable that you will get a
series of market accidents,” he said.
When we do eventually return to some sort of stable environment, the world
will be a very different place. Cynics might argue that everything must
change so everything can stay the same and, El-Erian argues in his book,
that history has shown that great upheavals often lead to a return to the
status quo. This time, he said, things are different. “There are no reset
buttons like on your Blackberry. You can’t return to where you were before
things crashed,” he said.
Significant new trends were already changing the nature of global markets
before the crisis. The rise of the emerging economies of Brazil, Russia,
India and China and the power of sovereign wealth funds from oil-rich Arab
nations were trends firmly embedded before the credit crunch. Now the crisis
has made some changes of its own.
“Institutions are disappearing. There’s no way back,” said El-Erian. “We no
longer have an investment-banking industry in the United States. The balance
between unfettered market forces and the role of government is changing.
Most importantly, the willingness of society to have a system that
privatises massive gains and then socialises massive losses is dissipating
very quickly.”
There are more changes to come, he said. El-Erian foresees a series of events
following the credit crisis. He said the next likely blow would be in
“nonbank financial institutions” - insurance firms and companies like
General Electric that have large financial arms. Such organisations have
already come under pressure. “This is not something that can turn on a
dime,” he said. More crises will follow even after a huge global policy
response from the world’s governments.
Two unique features of the credit crisis will deepen uncertainty in the short
term, he said. First, this crisis was generated from within. Usually
financial crises start outside America. “The US system does not deal well
with a shock to the centre,” he said. Second, America’s role at the centre
of the financial world makes this crisis harder for those outside the US to
deal with. “There is a hesitancy. People are going back to the sidelines,
which is making the crisis deeper and more unpredictable,” said El-Erian.
Unfortunately it is not just America and its financial institutions that have
lost trust. “This is a global crisis that requires a global solution,” he
said, “but bodies likes the G7 and IMF [International Monetary Fund] have
failed to keep up with the changing financial world. The IMF is not trusted.
It is widely understood - and Gordon Brown has talked about it - that the
IMF has a legitimacy and representation deficit.”
In part, argues El-Erian, this is an organisational matter. The IMF’s voting
system appears to be operating on almost colonial lines. Belgium (population
10.4m, GDP $376 billion) has almost the same voting power at the IMF as
China (population 1.3 billion, GDP $7,099 billion).
El-Erian argues that this will be a growing problem for the IMF as the balance
of power shifts even further to the emerging markets. As El-Erian points
out, “when measured using purchasing power parity, China and India each
contributed more to global growth in 2007 than did the United States, the
European Union and Japan”.
At the same time as the emerging powers are distrustful of the IMF and World
Bank they are increasingly mistrustful of America and its financial system.
It is much harder for America to lead policy in this crisis because the
problems arose within its borders. El-Erian points to the enthusiasm for
Brown’s bank bailout compared with the American model. “It is very difficult
for the US to take the lead.”
And once the dust does settle, El-Erian believes the world will have to get
used to a new financial system that doesn’t rely so heavily on America for
guidance or money.
The global economy has been like a plane powered by one very big engine - the
American consumer, said El-Erian. “It was inevitable that the plane would
come down. It was flying on one engine and that engine was fuelled by debt.
There was no way to keep that plane flying for a long time,” he said, the
only question was how it was going to come down and whether there would be a
crash when it did.
In the future, El-Erian believes the global economy will be kept aloft by
“many small engines”. The emerging economies will provide some of that lift,
Europe and America will also remain leading contributors. The strain of
keeping the plane aloft, he hopes, will be more evenly spread. Meanwhile,
investors are in for a long and very bumpy ride but El-Erian feels it will
be worth it in the end.
“I have a good feeling about the destination but the journey is unpredictable.
Usually you have certainty about the near future but the destination is
uncertain. This time it is the other way round,” he said.
