Mohammed El Erian's recent article in the Financial Times, "How to Handle the Sovereign Debt Explosion", may offer us a glimpse into the PIMCO CEO's thinking about the outcome of the debt crisis. He makes six points, which individually seem totally obvious. When you get to the sixth point, however, you get a definite picture of his thinking about the general nature of the outcome.
Point 1. The current financial crisis is best stated as a generalized deteriorization in the balance sheets of nations throughout the developed world.
No surprise here.
Point 2. The deterioration of public finances is reducing the relevance of "conventional classifications," such as the difference between advanced and emerging economies.
No surprise here. A growing number of the former now have poorer economic and financial prospects than a growing number of the latter.
Point 3. The advanced countries will adjust somehow, but the real questions are whether the adjustment will be orderly or disorderly, its timing and collateral impact.
Yes, we really would like to know that!
The orderly option is a " combination of growth and a willingness on the part of the private sector to maintain and extend holdings of government debt". This will be difficult because of "high unemployment, muted growth dynamics, persistently large deficits and regulatory uncertainty".
He says something else here that seems totally obvious but will become more relevant when we get to Point 6. "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." Italics are mine.
Point 4. Governments will impose solutions by diverting resources internally. Because all advanced countries are in trouble, solutions that depend on other countries will be scarce.
If they can't grow their way out of the crisis, governments have to reduce spending and/or raise taxes. Reducing spending won't be easy, because constituencies will be bitterly disappointed at the loss of entitlements, deteriorating services, long-term unemployment, and other results of austerity. Raising taxes will bring conflict with the rich, put another burden on the middle class, and discourage business. Given the partisan standoff in Congress, it will not be easy to do any of this in the U.S.
Point 5. For the same reason, any government's attempt at getting its own fiscal house in order will be complicated by the actions of other countries.
El Erian does not elaborate, but examples could be competition in the bond markets, trade barriers, currency devaluation, or stresses in organizations like the EU.
Point 6. The deterioration in the finances of the major advanced countries is "not sufficiently well recognized." Further, "We should expect (rather than be surprised by) damaging recognition lags in both the public and private sectors."
I don't know if the problem is really "not sufficiently well recognized." Other than that, it is hard to disagree with him, because governments are hardly accustomed to dealing decisively with novel situations until disaster is upon them.
Even if the problem is recognized in a timely fashion, "history suggests that it is not easy for companies and governments to overcome the tyranny of backward-looking internal commitments." This is another good point, because entitlements, partisanship, special interests, and the complexity of modern society all act to deflect any government actions, let alone one that is sufficiently extreme to be effective.
Uptake. Point 6 seems to be the crux of El Erian's argument. As he said in Point 3, if decisions are not made in a timely fashion, "the universe of likely outcomes will expand to include inflating out of excessive debt and, in the extreme, default and confiscation." Given Point 6, he does not expect timely decisions, which suggests a good chance of a chaotic outcome -- inflating out of debt, default, and confiscation.
If we want to survive the financial crisis and maybe even prosper, we need a mental framework that will help us think about the world realistically and productively. Maybe El Erian's framework seems totally obvious to you, or maybe you disagree with it. I think that we need to consider strategies to cope with possible chaotic outcomes like inflating out of debt, default, and confiscation.
