Odd Lots - Episode 19: Pow! Pow! El-Erian Talks Central Bank Ammunition

Episode Date: March 14, 2016

Asset purchases! Currency devaluations! Low interest rates! Negative interest rates! And... more? The world's central banks have unleashed a torrent of unconventional monetary policy since the 2008 financial crisis, hoping to heal economic wounds and revive markets' animal spirits. Rescuing us from another Great Depression is no longer seen as sufficient. Seven years on, doubts are starting to build about the ability of central banks to continually boost economic growth. Talk of central banks "running out of ammunition" reached a crescendo earlier this year and coincided with a dramatic market sell-off. More economists are saying fiscal policy needs to play a greater role, while the European Central Bank last week demonstrated it may still have some bullets left in its armory. We sit down this week with Mohamed El-Erian, BloombergView columnist and chief economic adviser at Allianz SE, as well as Dan Moss, executive editor of global economics for Bloomberg News, to discuss the limits of central banks.See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. Welcome to Odd Lots. I'm Tracy Allaway. Joe Wisenthall is away today, but don't worry because I have with me here a very able and capable replacement co-host. It is, of course, Dan Moss. He's executive editor of economics for Bloomberg News. And he's also the co-host of another Bloomberg podcast. Benchmark. Dan, thanks for being here. It's really great to be here. All right, so Dan and I have a treat for our listeners today. We have with us here in the studio, Mohamed El Arian. He's a Bloomberg View columnist. He's chair of President Obama's Global Development Council.

He's chief economic advisor at Allianz. And he's also a prolific writer. I'm pretty sure he writes more than full-time journalists, which is pretty amazing. Some of us anyway. That's right. And he also has a new bookout. which feeds directly into what we're actually going to talk about today. That's right.

Today we're going to be talking about central banks and the extraordinary influence they've wielded, not just on markets, but on the economic life of nations since the financial crisis. The secondary question is whether they are running out of ammunition, whether their influence is diminishing, or, as a colleague of ours, has put it, whether they've become impotent. And on that note, it's a really good time to talk about it, because just last week, we had the European Central Bank announced a whole raft of new stimulus measures, and we didn't necessarily see the market reaction we might have expected. So this question,

oh, Dan's disagreeing with me. The initial market reaction was quite powerful because they front-loaded a lot of the announcement. Typically, the ECB goes for the rate announcement, and then anything on QE or Special Ops has had to wait for Draghi's press conference. They went out of the gate at 744. New York time and out of the gate strong. I think Tracy, markets retraced that initial move because they heard something else from him, which is that interest rates won't go much lower. And they appeared to listen. All right. We are going to talk so much more about that. But before we do, I want to set the scene a little bit. I want to go back in time to the deep, dark days of 2008, early 2009. Lehman Brothers had just collapsed. Money markets were disintegrating.

a banking crisis, asset prices were falling, and basically it looked like the world was kind of falling apart. But then came the central banks, and suddenly everything was slightly better. And things were pretty good for a while. The economy didn't double dip, as some people had warned it would, though there were occasional bouts of volatility. But then the narrative started to change around the turn of this year. More than seven years after the financial crisis, economic growth still hadn't picked up significantly, despite multiple expansionary programs, multiple steps of stimulus, trillions of dollars' worth of asset purchases. People started talking about this idea, and Draghi confronted this directly, that they'd run out

of ammunition, worrying that they wouldn't be able to keep markets happy forever. Let's hear what Mario Draghi actually had to say about that ammunition question last week. Well, I think the best answer to this is being given by our decisions today. It's a fairly long list of measures, and each one of them is very significant and devised to have the maximum impact into boosting the economy and the return to price stability. So we have shown that we are not short of ammunitions. On the table for today's discussion is basically a market's crisis of faith, let's call it, in central banks. And Mohamed, you're actually perfectly placed to discuss this topic because you've just written a book, and your book is called the only game in town, the only game being those central banks.

How did you come up with that topic? So it came from a central banker. I was at a conference in November of 2014, organized by the Central Bank of France, the Bonn de France. And the outgoing governor, Christian Waiye, opened it. And it was attended by lots and lots of central bankers around the world. And I was sitting there. And he basically defined the conference in the following term. He said, we have become the only game in town.

And we don't like it. The title comes from him because it really speaks to the fact that central banks have been forced. They haven't chosen to. They have been forced to take on more and more responsibility, knowing really well that their instruments are badly suited for the responsibilities they've taken on. But they have felt that they had no choice to do it,

and increasingly they became the only game in town, and their success has become a function of somebody else. And that's a very uncomfortable position to be in. and that's why the governor said we don't like it. Well, talk to us about those instruments and what effect they actually have on markets. So like you said, the first part of the story is a simple one, which is post-financial crisis, had they not stepped in with whatever it takes. And that means using balance sheets, flooring interest rates, creating markets where markets were dysfunctional.

We would have had a multi-year depression around the world. that would have undermined this generation and probably the next generation. Then comes phase two. Phase two was in the United States in 2010 and in Europe at the end of 2013. When the immediate crisis is resolved, the patient, if you like, is out of the ICU, but the patient is still not doing really well. central banks looked around and came to the conclusion that no other policymaker was able and willing to step in. So they, like any doctor would do, rather than abandon the patient, they decided that they would continue to treat the patient,

even though the medicine they were using wasn't well suited for that. And they sound at times both resentful and defensive about that. You know, they're absolutely right. They're resentful because they are. going from being part of the solution to now causing complications and potentially becoming part of the problem. And they don't like that. They also know that if our politicians in Europe, in Japan, in the United States, where

to get the act together, there are measures that have been identified that could make things a lot better and that would allow central banks to normalize and remain part of the solution. There's a perception that fiscal policy is out to lunch, that these guys have no choice. In the immediate, very immediate post-crisis period, there was a sense that fiscal and monetary were swimming together. Then that narrative broke down. What do you think happened there? The sense of immediate crisis passed. So I remember very clearly when government officials turned up in Washington, D.C. in the fall of 2008. And they realized that what they were facing at home was a global crisis, that other countries were facing exactly the same thing.

And at that point, there was a common understanding that you need to deploy the whole range of policies, fiscal, monetary, and structural, and you need to do it in a coordinated fashion. And we had the most successful G20 summit in April 2009 in London. Then two things went wrong. One, the mindset remains cyclical. Somehow people believed that since the crisis occurred in advanced countries, advanced countries live in cyclical space. So this would be a V-shaped recovery. You come down very quickly, yes, but you recover very quickly.

There wasn't enough appreciation that this was something much more fundamental. It was structural in nature. It was a new normal. There it is. New normal. Right? And there was no understanding at that point that this was something secular in nature. The second thing that went wrong is with the sense of immediate crisis behind us, politicians started relaxing.

And they didn't realize that anger would start growing in society that would make it even more difficult to take bold actions later on. So I think it was a question of the crisis didn't last long enough and the mindset was wrong. And it's ironic that the fiscal policy makers, and we're talking about governments and legislatures, that undertook those measures during the crisis, many paid the price. And yet the narrative when they were hounded out of office was, you haven't done enough. For me, I'm still feeling like it's a recession, even though technically, the economies were expanding again.

It's pretty ironic, don't you think? I don't know if it's ironic as much as it's a reflection that while the economies were expanding, they weren't expanding fast enough, and the benefits of that expansion were going to a very small segment of the population. The rich. So what you had is insufficient growth,

and the benefits of that growth were not shared in an inclusive fashion. And that's why people started getting angry. And the reason why that happened is because we relied on finance to get us out of the problem. So private finance got us into the crisis, and public finance, i.e. central banks, were relied on to get us out of the crisis. And we didn't invest in genuine creators of economic growth. You're familiar with the arguments of Ben Bernanke and to an extent Paul Krugman who say, look, as long as we're here, we're going to keep swinging. We're not going to be the guys who went down in history as allowing another depression to happen.

You have some sympathy for that view. Yeah, I think of central banks as doctors. No doctor will walk away from a patient, even if they don't have the right medication. They will remain. So yes, they will continue swinging to use your phrase, but they will become increasingly ineffective. But if fiscal policy is perceived to remain out to lunch, then what choice do these guys have? have. So there are four things that need to happen. Fiscal, monetary, structural reforms, and a bit of debt forgiveness. If you rule out three of them and just leave monetary policy on the table,

which what we have, which we've done, not only do you get inadequate outcomes, but you start getting tensions that ultimately undermine the path you're on. And that's where I think we're on now, because monetary policy becomes ineffective. Do you think the political system is up to instituting those three other things you talked about? From an engineering perspective, absolutely. I don't think the engineering of this is difficult. From an implementation perspective, we probably will need some sort of crisis, hopefully a small crisis to wake up the political class.

I mean, if anything right now, it seems like we're veering even more towards isolationism, protectionism, and populist outrage at authorities in general. You're absolutely right. Certain things happen when you grow slowly and when inequality goes up. Most importantly, people get angry. Now, what do you do when you get angry? You blame your neighbor. And if your neighbor happens to be a foreigner, that's even better.

So it's not surprising to me at all that there's a populist movement. It's not surprising me at all that we're hearing both sides of the political spectrum in the United States talk about protectionism. That is what happens when economies grow slowly for a prolonged period of time. It's rhetoric right now. I don't think that we are going to swing from where we are now to protectionism because it's actually very difficult to get lobbies for protectionism today because we are consumers and producers at the same time. But what we will get is an emphasis on fair trade.

So you'll hear less to phrase free trade and you'll hear more. the phrase fair trade. Let's go back to monetary policy for a second, because we've been talking about fiscal policy, the assumption here being that fiscal policy is possibly the only thing left to help boost economic growth at this point. Is that your thinking? It's one of the four components. So monetary policy can play a role if supported by fiscal policy that matches the will and the

wallet to spend. We have separated the will from the wallet to spend. So we have a problem of aggregate demand. We also need to deal with structural reforms to promote genuine engines of growth. That means investing in infrastructure. That means corporate tax reform. That means greater emphasis on labor retooling. And there's a lot of scope for private-public partnership.

And then we have to do the very difficult thing. And I would hate doing it because there's huge issues of fairness. but we need to also look at excessive indebtedness in the system and deal with it. This is particularly acute for Europe in the case of Greece, and it will become acute in the United States with student loans. So debt forgiveness on the table, potentially? Selective debt forgiveness in the next five years for part of younger people who have taken on way too much student debt

and whose return on education will never be high enough. we've learned a few things from episodes of excessive indebtedness, particularly what's called the debt overhang. It's one of the contributors to the last decade in Latin America in the 80s. When you have too much debt, two things happen. First, it crushes you directly. Second, it discourages any new capital from coming in. So you end up in a vicious cycle that's almost impossible to get out.

You see it in Greece every single day. And now there is a risk that we, may have this as a headwind to growth. It's not an immediate crisis, but it will be a headwind to growth. And yet, Muhammad, the central bankers seem resigned to playing this role that has outlived its usefulness. Mario Draghi said at his press conference, quote, the measured driver of the economy and the recovery basically remains our monetary policy. How do they get out of that? So they need, we all need the handoff. We need the handoff from prolonged and excessive dependence on central bank policies

to a more comprehensive policy response. Remember, when the first central bank went unconventional to pursue economic objectives, as opposed to normalize dysfunctional financial markets, which is August 2010 in the case of the U.S., Ben Bernanke made it. very clear. He said, when you go unconventional, it's about, quote, benefits, costs, and risks. And the longer you say unconventional, the greater the threat that the benefits come down and the risks and the costs go up, i.e. that the collateral damage and the unintended consequences exceed the benefits. Central bankers know that. They know that. And yet, they're unable to hand off

to the more comprehensive. So they are in a really difficult situation. And that's why I said at the beginning, they no longer control their destiny. And that makes them really uncomfortable. Do they worry that the independence of central banks, which has really been a hallmark of the past 30 years, began in the US, but it spread to the UK,

it spread to the Euro system members, and in the late 90s to Japan? Is that at risk? In other words, their very identity, is that at risk from these populist pressures that you've said are growing? Ultimately, will there be a legislative response, and is that what they deeply fear? They do, and it is at risk. We already saw the Japanese Parliament go crazy over the Bank of Japan, when the Bank of Japan took great negative. In the U.S., there are calls for greater audit of the central bank. We are very close to a politician realizing that when they expand their balance sheets, as the ECB announced, would do more of last week, that they really are quasi-fiscal agencies. And the minute you put fiscal in the phrase, even if it's quasi-fiscal, there's a question, why aren't they coming to Parliament for approval?

So, yes, central banks are worried and their right to be worried. Will they lose the independence? I don't think it will happen very quickly, but they will find that they will become more political than they have in the past. Do you think one of these days, one of these bills in Congress will sneak through? It's really hard to say then. I mean, so many crazy things are happening on the political side, and some of them are not very rational.

So it's hard to say it really is a risk. And that would be a disaster. It's gone from being very much a fringe view in Congress to almost a mainstream view. The audit the Fed, for example, each year gets more and more adherence, but it can't quite get through. That's why I wonder whether one of these days

something is going to get through. It's certainly a risk. I want to go back to the ammunition question for a bit because it seems like late last year we did suddenly see a chorus of voices expressing concern over the idea that central banks had fired off all the monetary policy shots they had in their collective armory, I guess, to stretch the analogy. What do you think about that, Mohamed? Is that true?

So they have instruments. I don't think the issue is whether they have instruments or not. I think it's how well-suited are the instruments for the objectives that are trying to pursue. And from day one, they weren't perfectly suited, and the longer they've relied on imperfect instruments, the greater the collateral damage. Go back to the example of the doctor. If she or he prescribes you the wrong medication because the right medication isn't available, you will worry about the side effects. And we're starting to worry about the side effects. It's the old notion that at some point, the side effects totally overwhelm the good that the medication was doing. So people should be worried. But it's not because of the lack of instruments. It's just

that the instruments aren't well suited for the objectives that are being pursued by central banks alone. Mohamed, one last question before we let you go. To use your doctor analogy again, how should we be judging the success of central banks? You know, if they're doctors, they've kept markets alive for this long, but they haven't really treated the underlying illness. So I would give them a plus for effort throughout the whole. whole period. Ouch.

A plus for effort. You know, they have really done enormous. I'll give them A plus between 2008 and 2010 for the Fed for helping us to avoid a multi-year depression. I would give them a B for buying time for the system between 2010 and 2015 in the hope, the misplaced hope, as it turned out, in the hope that our political class would respond. And I would give them an incomplete as to whether they become part of the problem, having been part of the solution. All right.

Mohamed Al-Aryan, thank you so much for your time. Thank you. All right, Dan, have we come away from that any clearer on whether or not central banks are running out of bullets? I think we've come out of this with the understanding of the framework that that debate is happening in. And few, if any, people are as articulate on the subject as our guest. I thought the idea of fiscal policy is really interesting, especially since we seem to be hearing more and more economists and analysts talk about the need for these sort of measures.

The thing that concerns me, which Mohammed touched on, was this idea that suddenly we're going to have an epiphany and be able to come out of all the politics surrounding those issues and actually tackle things like debt overhangs. How positive? Do you think that is? I don't know. There's almost an element of tragedy about this. The central banks were widely perceived to have, if not saved the world, then staved off a second great depression. They're not getting much thanks for their action now.

And yet, as Muhammad pointed out, there's little sign that fiscal policy makers are willing to help them out of this trap into which they've got themselves. It is tragic, don't you think? It's definitely tragic. It's also definitely interesting times, and I mean that in the classic Chinese curse use of the word, right? Okay. Thanks again to Dan for being my co-host for this episode of Oddlots. And thanks to Mohamed El-Aryan, his book is the only game in town, Central Bank's instability and avoiding the next collapse. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway. You can also follow Mohamed El-Aryan. He is at El-Aryan. M. I'm Daniel Moss. You can get me at Daniel Moss, D.C. Thanks for listening.

The news doesn't stop on the weekends. Context changes constantly. And now Bloomberg is the place to stay on top of it all. Hi, I'm David Gura. Join us every Saturday and Sunday for the new Bloomberg this weekend. I'm Christina Rafini. We'll bring you the latest headlines, in-depth analysis, and big interviews. All the stories that hit home on your days off. And I'm Lisa Mateo, watch and listen to Bloomberg this weekend for thoughtful in enlightening conversations about business, lifestyle, people, and culture. On Saturday mornings, we put the past week's events into context, examining what happened in the markets and the world. Then on Sundays, we speak with journalists, columnists, and key political figures to prepare

you for the week ahead. Join us as soon as you wake up and bring us with you wherever your weekend plans take you. Watch us on Bloomberg Television. Listen on Bloomberg Radio, stream the show live on the Bloomberg business app, or listen to the podcast. That's Bloomberg this weekend. Saturdays and Sundays starting at 7 a.m. Eastern. Make us part of your weekend routine on Bloomberg Television, radio, and wherever you get your podcasts.

What separates good leaders from transformational ones? I'm Jessica Chen, and in season two of Leading By Example, we'll sit down with executives like Grace Chen of Bertie Gray to find out. It's important to understand where you spike, but also really acknowledge where you don't and find people who can fill. those gaps. Listen to leading by example executives making an impact on the IHeart radio app, Apple podcast, or wherever you get your podcasts.