PIMCO CEO Warns about Dangers of Feeding the Easy Money Dragon
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Here is a new acronym for you, GGIRC, or the great global interest rate convergence. The acronym was coined by PIMCO CEO Mohamed El-Erian. In commentary posted on CNBC.com, El-Erian described the GGIRC as a phenomenon whereby interest rates steadily converge to zero in both advanced economies and emerging market economies, excluding "financial basket cases" such as Spain.
In theory, GGIRC is good for the global economy. Text book economics say lower interest rates are beneficial to companies and equity markets. They make it cheaper to fund investment and consumption, and they make it easier for companies, governments and individuals to carry a given stock of already-accumulated debt.
But be weary. In practice, warns El-Erian, the "situation is much more complicated and not so benign". In time, GGIRC could "morph" from being seen as part of the solution into part of the problem.
"Today's market-based economies, and the accompanying institutional setup, do not function well at such artificially repressed interest rates," states the CEO. “"This limited scope for benefits comes with the growing reality of collateral damage and unintended consequences."
It may be only a matter of time until they are challenged by asset market bubbles and irresponsible lending, thinks El-Erian.
"What the world economy needs today is a coordinated set of measures to promote growth, allocate financial losses, match healthy balance sheet with those that are challenged and reforming, and improve the functioning of the labor and housing markets."
In short, low interest rates simply are not enough. Instead, to sum up El-Erian's views, we have artificially low interest rates without balance. It is like feeding a baby dragon. At first it might be cute and make equity investors happy, but the dragon may not be so easy to handle once it grows into an adult.
In theory, GGIRC is good for the global economy. Text book economics say lower interest rates are beneficial to companies and equity markets. They make it cheaper to fund investment and consumption, and they make it easier for companies, governments and individuals to carry a given stock of already-accumulated debt.
But be weary. In practice, warns El-Erian, the "situation is much more complicated and not so benign". In time, GGIRC could "morph" from being seen as part of the solution into part of the problem.
"Today's market-based economies, and the accompanying institutional setup, do not function well at such artificially repressed interest rates," states the CEO. “"This limited scope for benefits comes with the growing reality of collateral damage and unintended consequences."
It may be only a matter of time until they are challenged by asset market bubbles and irresponsible lending, thinks El-Erian.
"What the world economy needs today is a coordinated set of measures to promote growth, allocate financial losses, match healthy balance sheet with those that are challenged and reforming, and improve the functioning of the labor and housing markets."
In short, low interest rates simply are not enough. Instead, to sum up El-Erian's views, we have artificially low interest rates without balance. It is like feeding a baby dragon. At first it might be cute and make equity investors happy, but the dragon may not be so easy to handle once it grows into an adult.
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