It’s hard to remember a more pessimistic time in the market. The current bear market has already gone on much longer than the 2020 one, which — at just a month long — barely counts. And at the moment, both stocks and bonds are falling, an unusual phenomenon that did not occur during 2008’s financial crisis or even during the dot-com bust. (Lately, no matter what you do, you’re basically losing money; even if you were tucking dollars under your mattress, inflation is still eating into your savings day by day.) The specter of 2008 has clearly been haunting the dreams of many on Wall Street and beyond in recent days, judging by the amount of people who were glued to Twitter over the weekend wondering whether the market was about to have a “Lehman Brothers moment” in the form of a Credit Suisse collapse.
One distinct difference between now and 2008 is that, this time around, there’s a sense that the people who will be responsible for crashing the economy work for the government, not the big banks. What the next crash will look like is something Mohamed El-Erian, a prescient economist who is the former CEO of bond giant PIMCO and now serves as president of the University of Cambridge’s Queens’ College, has been warning about for some six years — including in his 2016 book The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse. El-Erian, an open-minded investor who has opinions on investment classes spanning from bonds to crypto, is not entirely pessimistic. We spoke with him about how bad the coming recession — he thinks there will be one — is likely to be and what he’s doing with his money now. (Spoiler alert: He’s not buying Bitcoin.)
I just saw your tweet in which you said, “What a sobering week.” Have recent events — with the Fed raising interest rates plus the chaos in the U.K. — changed your outlook for the economy?
What I now realize more than before is that policy-makers have gone from being volatility suppressors to volatility amplifiers. That is true of the Fed, and that is true of the U.K.’s government. What’s underneath inflation is that the supply side of the economy, whether it’s goods or labor, has become problematic. And that is different — we haven’t lived with inflation for a very long time. The inflation that we feel is just the tip of the iceberg of a more fundamental change.
When central banks provide liquidity all the time, keep interest rates artificially low for a long time — too long, in my opinion — they become the market’s Best Friend Forever. And there is, at some point, the unintended consequences of distorting the system for so long. It starts to become really problematic, then central banks lose credibility. Central banks play a very important role in the economy, because they are politically independent. And they should be the honest adviser telling us what’s ahead If we don’t change policies. That’s a really difficult thing for central banks to do, because it makes them unpopular.
Add on top of that, policy-makers who are supposed to help us navigate through this have become their own source of volatility. So if you put all these changes together, they are inherently unsettling. And we realize that we are much more fragile. I don’t know how to convey it, but we came very close to a financial accident in the U.K.
How do you define a financial accident?
A financial accident is something that turns finance from an enabler of economic prosperity to a major detractor of economic prosperity. So the financial crisis of 2008 was a financial accident — excesses in the financial sector almost tipped us into a global depression. A financial accident is something that basically pulls the rug out from under the economy and, therefore, from under employment, economic well-being. And most of the time, it is a very big unequalizer — it hits the most vulnerable segments of the population particularly hard.
What are you thinking about the odds now of a U.S. recession — how soon and how severe are you expecting it to be?
The probability is uncomfortably high. And it’s tragic, because it didn’t need to be like this. Our economy is inherently strong. We have a very strong labor market. We have companies mostly with strong balance sheets. We are competitive. We should not be looking at this uncomfortable probability of a recession. But there’s a reason why we’re looking at it. And that is a Federal Reserve that is scrambling to play catch-up. Earlier last year would have been a good time for the Fed to start raising interest rates — that was the equivalent of you easing your foot off the accelerator as you go toward a very uncertain period. Instead, the Fed kept the pedal to the metal. It didn’t retire the concept of transitory inflation until the end of November. Now the Fed is trying to regain its credibility. It risks what is probably one of the biggest policy mistakes it has made, which is slamming on the brakes now as the economy slows down — and that’s what risks tipping us into recession.
That’s what people call a hard landing.
Correct.
Could we see that before the year is out?
The labor market is still strong. So that’s giving us a lot of momentum. But even the talk of the Fed went from soft landing to soft-ish landing to “there will be pain.” And all this was unnecessary. This is self-inflicted.
So if it is a self-inflicted recession, could it be on par with the severity of the Great Recession of 2008?
No, no, no. This should not be the case — unless we make more policy mistakes. We have four things we can do to make this a very short and shallow recession. One is that the Fed has to improve its understanding of the economy and its policy-making. Two is that we need much better protection of the most vulnerable segments of the population. Three is that we need to continue on the sorts of structural reforms that enhance human capital and productivity. And four: We have to pay much more attention to financial-stability risk in the nonbanks of the banking system. The U.K. is a reminder of that. Who would have thought that the state pension system would be the source of systemic risk? And the more we worry about recessions and everything else, the more we delay the actions that need to be taken.
Do you think there’s a way to avoid recession entirely at this point?
It is a low probability. That’s why I said the risk of one is uncomfortably high. I mean, if you compare us to China and Europe, you feel good. For me, a recession in Europe is a done deal. China is actually facing a lot more difficulties than people seem to realize.
Is there a critical time frame? If those actions don’t happen, are we looking at a recession by the beginning of next year?
The Fed needs to restore sufficient credibility, and right now, its credibility has really been hurt. I’ve never seen a central bank issue projections every quarter and former Fed officials say they are unrealistic and dismiss them. And people who worry most about hard landings will tell you that because the Fed looks at lagging data, it doesn’t realize how quickly the economy slows. And they’re not moving these things. So that’s the worry.
Right now, you have a bear market in stocks and bonds, which is rare. So if you’re an average investor and you’re looking out into the markets, are there any good options for your money?
That’s a good question. When the Fed was injecting liquidity and had become the market’s Best Friend Forever, or was perceived to be, there was this notion of “Don’t worry, the market will never go down, because the Fed will always bail us out,” so returns only go in one direction. Basically, you saw volatility collapse, because people became conditioned to buy every dip. And because the Fed was buying bonds, you had this strange situation in which the price of your safe asset went up while the price of your risky asset also went up. So if you look at 2021, it was a wonderful year. You made money in every asset class. Now that the Fed has misjudged inflation (and instead of injecting liquidity, it’s withdrawing liquidity), all this goes into reverse. So you have negative returns. You have incredible volatility. And you have the worst correlation, because your government bonds no longer offset the risk on your equities — they all go down together. And it’s been a horrible year for the 60-40 portfolio — 60 percent stocks, 40 percent bonds — because you’ve lost money on both sides.
That is why people have felt there’s nowhere to hide. And I really sympathize — even cash is not attractive to some people, because they say inflation is 8 percent and I get paid a very low return savings rate, so I’m guaranteed to lose purchasing power. That’s why we’ve had this anxiety — people don’t know how to protect their savings. So where do you go from here? The good news is we started to get the distortions out of the system. I call this a very bumpy journey to a better destination. You’re starting to get paid more money on cash, so cash is now less of a problem as a safe asset than it has been before, and that’s good. Bonds have repriced, so we’re getting to a better place, but it’s very bumpy. And investors are rightly anxious, because the three major things they care about have all turned against them.
Is keeping your money in cash a good option in the meantime?
Cash is an option. Look, I don’t like making general statements, but let me give you my example. Because I’ve been so cautious, I significantly reduced my exposure to financial markets, and I went into cash. I was willing to accept the negative real return, because I was worried about the major losses. Now did I know that NASDAQ would go down by 33 percent? No. Did I know that government bonds would go down by 16 percent? No, but I had a feeling that they were overvalued and distorted. So now, I see a lot of attractive opportunities. But I’m not putting my cash to work yet, because I’m worried about another policy mistake. I would like to see greater stability, even though there are already attractive valuations.
You’re still kind of in wait-and-see mode.
I am wait-and-see, yep.
You briefly owned Bitcoin in the past. What do you think about Bitcoin and crypto these days?
I do not believe that Bitcoin is the next global currency. That’s not going to happen. And therefore, I don’t think that there are incredible gains ahead, infinite gains almost, that come from worldwide adoption of a global currency. Neither am I in the camp that it’s a big fraud, that there’s nothing there, that it’s going to collapse tomorrow. Bitcoin and cryptocurrencies live as part of the ecosystem, a small part of the ecosystem. They perform a role that has to be respected. We need better dialogue between the industry and regulators. They don’t understand each other — it’s as if they speak different languages. And unless they understand each other, there’s going to be recurring tension between regulators and the industry. You should think of it not as a currency but as an asset — a volatile asset. Currently, I don’t own any Bitcoin (before you ask).
Recently, people have noted that Bitcoin has seemed more stable than government currencies. So you don’t believe Bitcoin is going to be less volatile than fiat over the long term?
No, because at the end of the day, you can’t escape the formal financial system. You can’t escape regulators. Ask yourself, “Will issuers of currency give up all the advantage they get from issuing currency to Bitcoin?” It’s not going to happen. Now, we may see a digital central-bank currency — we’re going to see a lot of the underlying technology in the crypto space adopted widely — but that’s the technology as opposed to Bitcoin becoming a global currency.
People used to talk about Bitcoin as a potential inflation hedge. Do you think that argument is dead now?
Bitcoin has performed miserably this year — the high was $68,000, and we’re now at $19,000. But that’s not a reflection of Bitcoin not being able to navigate inflation. This is a reflection that Bitcoin benefited enormously from the injection of liquidity by the Fed. And now, like every other asset, it is suffering from the withdrawal of liquidity.
When you look at the economy, are you seeing signs of a recession? Apple said that people are buying fewer iPhones. Facebook is freezing hiring. Do you see these as recession indicators? How are you feeling about everything?
If I’m just looking at the U.S., I’m worried. I’m clearly worried that our economy is slowing. I don’t think a recession is a done deal, because we have the policy tools for avoiding recession. Our issues can be addressed through policy adjustments. So while I’m worried, I’m not overly negative. The biggest risk I see is another Fed policy mistake.
When you say “mistake,” are you saying the Fed should stop raising interest rates now?
I don’t think they can stop now. Because their credibility is so damaged that if they were to stop now, people immediately say, “This is the Federal Reserve of the 1970s. This is the flip-flopping Fed, and we will have prolonged stagflation.” And if people start believing that, they will behave in such a way that will produce prolonged stagflation. So if you were to tell me, “Well, the Fed should just stop, because the economy’s slowing very quickly,” I’ll tell you that the consequences of that are worse than the consequences of the Fed continuing.
This interview has been edited and condensed.
