A Shadow of Its Former Self

Posted on May 13, 2009
Filed Under Uncategorized |

I’m not smart enough to add anything to what El-Erian wrote, which is a sobering read but exactly the kind of informed debate that should be dominating public policy discussion instead of populism fueled cover-my-ass soundbites politicians in Washington and every state capital are broadcasting.

For the next 3–5 years, we expect a world of muted growth, in the context of a continuing shift away from the G-3 and toward the systemically important emerging economies, led by China. It is a world where the public sector overstays as a provider of goods that belong in the private sector. (As one of our speakers put it, we have transitioned from a world where the private sector provided public goods to one where the public sector provides private goods.) It is also a world in which central banks and treasuries will find it difficult to undo smoothly some of the recent emergency steps. This is particularly consequential in countries, such as the U.K. and U.S., where many short-term policy imperatives materially conflict with medium-term ones.

The banking system will be a shadow of its former self. With regulation more expansive in form and reach, the sector will be de-risked, de-levered, and subject to greater burden sharing. The forces of consolidation and shrinkage will spread beyond banks, impacting a host of non-bank financial institutions as well as the investment management industry.

How does inflation behave in the new normal? For now, it is hard to project any imminent pickup in inflation given the severity of the collapse in global demand and the resulting large output gap. Private components of global demand will not recover quickly and fully. Yet, one should not fixate just on demand when transitioning from a cyclical to a secular mindset. Supply also matters.

[From PIMCO - Secular Outlook May 2009 El-Erian]

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