Charting the Economic Course with Mohamed El-Erian
Willy Walker: To have someone like Mohamed here to speak to us, who is not only a PhD by education. Having gone to Cambridge undergrad and gone to Oxford for his master's and for his PhD, but then he went to the IMF, to the World Bank, on to Soly Smith Barney for a stint in Europe before going to PIMCO, running PIMCO’s emerging Markets Investments, then leaving PIMCO to go to Harvard University. Ran Harvard Management Company, then went back to PIMCO to be co-CEO at PIMCO. To have run PIMCO as successfully as he did. And to now, be both the president of King's College, Cambridge, as well as the chief economic adviser to Allianz which owns PIMCO.
Many of you have seen Mohamed on CNBC on a very consistent basis. I have to say you have a real insider's perspective at the Walker & Dunlop Conference, given the amount of time that both Mohamed and Barry Sternlicht spent on CNBC. I think you basically have gotten CNBC's perspective on the entire world today and tomorrow. But I have watched Mohamed. I've listened to his insight and thoughts on the economy. I think one of the things that is hardest for economists to do is not only predict the future but be consistent to the things that they look for in economic data. And I think one of the hallmarks of Mohamed and why he is so good is that while the data may change, he has a framework with which he processes that data and gives all of us insights to give us a sense about what's coming up. So with that, I will turn the stage over to Mohamed El-Erian.
Mohamed El-Erian: Thank you, Willy. That was a really nice introduction that I do not deserve. Is such a pleasure and an honor to be with you. I'm going to pick up on a lot of what we talked about with two important qualifications. I don't have a single slide that has an animal in it, and I apologize for that. And then, in a strange twist, he has more graphs than I do. But I have something else, I have headlines. So get ready for a bunch of headlines from newspapers. I'm going to spend the next 15 to 20 minutes talking about what's ahead for the global economy and for the U.S., and if I'm successful, I'm going to leave you with four main takeaways. The first is we've had this very strange period of large forecasting errors, a series of policy mistakes, and pivots in what the Fed tells us. We haven't had a period like this since I've been doing this, and I'm old. Second, forecasting isn't going to get any easier, but the reason why I am evolving. Third, this is why Jerome Powell is so fixated on data dependency. And I'm going to argue that while that's totally understandable, it is problematic. And finally, I'm going to talk about some clear secular trends that you're going to have to navigate.
So let's start with a bit of history. August 2022, Jackson Hole, central bankers get together. They're all waiting for Jerome Powell to talk for about 40 minutes and take questions. He gets on the stage, talks for eight minutes, and leaves. And uses the word “pain” a few times. The US economy is about to experience significant pain. Why? Because we are having one of the most concentrated interest-rate hiking cycles that we've seen since the 80s. So, of course, we're going to see pain. Of course, we're going to see unemployment. Of course, we're going to see a recession. Two months later, Bloomberg Economics came out, and its model predicts a 100% probability of recession in 2023. They were right about a recession. They just got the wrong country. It happened in the UK. It happened in Japan. It happened in Germany. What happened in the US, Economic exceptionalism. High growth, declining inflation, buoyant markets. And Willy put up the graph that compares us to other G7 economies, and we've completely outpaced other economies. Now that was not the only forecasting problem. Inflation also was a problem.
In 2021, the Fed used that awful word called transitory. There's nothing more dangerous than the word transitory. Because when you tell somebody, something is transitory, you tell them it is temporary, it is reversible. Don't worry about it. Look through it. A huge mistake, but that's not the only mistake. The Fed's forecast of inflation has been consistently wrong. In the fourth quarter of last year, we were supposed to be on a disinflationary trend. All that went out the window in the first quarter. So you have growth being a problem for forecasts. You have inflation being a problem to forecast. And when you have central banks trying to get over inflation. You get the problem of the last mile. Look at the two middle clippings. They are from the Financial Times. The first one, Central Banks scent victory over inflation. The second one, the great bet on rate cuts, is off. The difference between those two is within 30 days. We've had the most enormous amounts of Fed policy pivots that we've ever seen. Economists love the notion of forward guidance. Forward guidance means the Fed tells us what they intend to do, and we do the heavy lifting. Because we believe the Fed. And if we do the heavy lifting, then the Fed, by the time it does what it needs to do, is an orderly adjustment. The problem with forward policy guidance has been totally inconsistent and has been all over the road. Look at all these headlines. It gives you a sense of how confused the Fed itself has been about what's happening in the economy. I say all this because we now have to go from the past to the future. And you need to answer four short-term questions. The first question is the following.
- Will U.S. exceptionalism continue? And that I will argue is a function of the Fed. We are starting to see significant weakness in the lower ends of the income for households and in smaller businesses, tremendous pressure. The only thing that's keeping them going right now is income. They've run down their pandemic savings. They've used up whatever debt capacity they had. Some of the small businesses are having to refinance themselves at significantly higher interest rates, and they're being really squeezed. The question in everybody's mind is this general weakening or is what's called a decaying economy, meaning the lower end goes down, up, and goes up, and on average, everything is fine. This is a critical question. Because the Fed is data dependent. So if the Fed is data dependent, there's a risk that it may not appreciate how much the economy is weakening, and it may be too late in cutting rates. And if it's too late to cut rates, we go into recession. So the first thing you've got to figure out is how the Fed will react.
- The second thing is you've got to figure out what's going to happen to China and Europe. They're trying to bounce back. They are structurally challenged. And they have a trade-off between short-term stimulus and fixing what ails them. How will they get this right? I'm going to give you answers to all this in a minute.
- The third question is what's called the swing states, the middle powers. We don't talk about them much. When someone presents about the global economy, it's the U.S., China, and Europe. But you have a set of middle powers that are becoming systemically important, and they're being squeezed. They're being pulled by China on the one hand and the U.S. on the other hand. How will they respond? This determines things like oil prices, determines all kinds of stuff. And I'm going to argue that it's a set of countries. And if you get good at your flags, you see the top ones India, Saudi Arabia, Turkey, UAE, and Brazil. That can play China and the U.S. off. They can live in the in-between. But there's another set of countries Australia, Singapore, New Zealand, and Mexico are going to have to make a choice. And if they don't make the right choice, the global economy gets a lot more complicated.
- And then the final question has to do with tech, AI. There's a massive competition going on and there are two polls emerging. How will these polls coexist?
If you think these are hard questions that you've got to answer, there are four more questions of a longer-term nature. You also have to answer.
- The first one is divergence. We're coming from a period where countries were subject to common shocks and had common policy responses. That was the past. Now we have countries facing different outlooks, and they have to tailor their policy responses. What Europe needs to do is very different from what the U.S. needs to do. Japan is on a completely different planet and so is China. And somehow, that's got to add up, and it's got to solve. How is that going to solve?
- The second major question has to do with the economic paradigm. I grew up when life was really simple. It was all about the Washington Consensus. Everybody agreed that in order to have a flourishing economy, a prosperous economy. You need to deregulate. You need to liberalize. And you need fiscal prudence. Those are the three elements of the Washington Consensus and people agreed on them. Look at what's happening in Washington today. Deregulation has been replaced by tighter regulation. Liberalization has been replaced by the weaponization of tariffs and the weaponization of investment sanctions. And fiscal prudence has been replaced by fiscal irresponsibility. It was unthinkable before now, that you could have 30 straight months of the unemployment rate at 4% or below and have a fiscal deficit of 6 or 7% was totally unthinkable. Why? Because, as President Kennedy said, “You fix the roof when the sun is shining.” And when you have unemployment below 4%, the sun is shining. You don't want massive fiscal deficits because you're going to need those fiscal deficits when unemployment goes well above 4%. So we're living in a completely different paradigm, and that's not going to change. No matter who wins the election in November that is not going to change. We also live in a completely different international environment. It's no longer about globalization. The ever-closer integration of goods, services, and people, it is about fragmentation. Allocating supply chains according to commercial considerations is now subject to nearshoring, French shoring. This is a different world. This is a world where little pipes are being built around the US. The US stays at the center of the global economy and is simply not as dominant. It cannot inform, influence, or impose outcomes like it used to be before. Put differently, have the image of a conductor of an orchestra. In the old days, the sheets of music were the same, and everybody listened to the conductor. In the global world we live in today there are different sheets of music, and there's no conductor. That is what's happening to the global economy.
- And the final issue, which I'm not going to talk about much, but adds to everything I want to say, is politics and geopolitics. Remember when President Clinton's speechwriter said, “It's the bond market you've got to worry about.” That was a notion that driving the car was economics and markets. Politics, geopolitics, and national security were sitting in the back because economic prosperity meant that all three get better. That's not the world we live in. Economics is lucky to be in the back of the car these days, and it's all about geopolitics, national security, and politics. So think of a world that's being shaken from above. And then think of a world that's been shaken from below. Why is it being shaken from below? Because there are at least seven sectors going through fundamental change. Technology and generative AI is going to fundamentally change not what we do but how we do it. Life sciences is going to change a lot of how we live. And sustainable energy, as Willy said, is something that we're going to have to somehow find a way of doing and doing it in time.
- And then you have four other sectors, defense, healthcare, cybersecurity, and food security are going to be very deterministic as well. So you're living in a world that's being shaken from above. You are living in a world that's being shaken from below, and you've got to predict the future. That's really hard to do.
So what does the future look like for me? This is what it looks like. There's a 50% probability that we're going to soft land, meaning we sacrifice some growth. But we bring inflation down. We've only soft-landed once before, 1995. There's a 15% probability we do even better, bigger but not hotter. Why? We unleash something that Willy talked about; the supply side? We've got to unleash the supply side. And these technological revolutions can unleash the supply side in a meaningful fashion. There's a 15% probability that comes early. And then there's a 35% probability that we fall into recession. Now when people see this distribution, it brings out your biases immediately. If you're an optimist, you're going to add 50 plus 15, that's 65. 65, that's going to be okay or even better. If you're a pessimist, you're going to be obsessed with the 35% recession. That's really high. The reality is you've got to embrace a whole distribution, and that's a really uncomfortable distribution to embrace. Because you don't have a dominant outcome. We are wired for dominant outcomes. We are wired for bell-shaped distribution. Very high likelihood of something happening and very thin tails. You came to Sun Valley because you expected to have this wonderful conference. Now there was a left tail that it could have been canceled, and no one told you. That was a right tail that could have gotten a really good speaker at the 11:00 slot, but you didn't bet on the tails. You bet on the baseline. This is a very flat distribution. This is what it's called a multi-modal distribution. And this is what you have in the back of your head. You have to embrace the fact that we're looking at a multi-modal distribution. So what does it mean if you don't like distributions? This is the picture. You're on this road. It's windy. You're going to a different destination. And you've got to navigate all sorts of hazards on the road. That is what the next few years look like. The good news is that the destination is a better one. The bad news is that the journey is a bumpy one. That is what we're facing. Now, how do you do it? Let me tell you how not to do it.
We used to live in Southern California, and every six months, we would have a daughter/dad outing to Disneyland. And there would be tremendous excitement about going to Disneyland with my young daughter, who you see here. And she'd want to get to the park as it opened and stay till it shut. Now if you live in Southern California, where we were living, Disneyland is about a 30-minute drive with no traffic. But if you want to get there when the park opens you've got traffic. So this is what would happen. We would leave the house incredibly excited that we were going to Disneyland. And then we would hit traffic, and I'd be driving, and she'd be sitting in the back, and I'd hear 100 times, “Are we there yet, Dad?” And I would get irritated. Then it stop, go. And guess who would get sick in the back of the car, I would hear, “Dad, I'm going to be sick. “I say, “Open the window,” “Dad, I'm going to be sick.” And then she would be sick. So by the time we got to Disneyland, the destination didn't matter because we hadn't navigated the journey. So the sequence was we were in love with the destination. We forgot about the journey. And then we couldn't navigate the journey. We forgot about the destination. The lesson is you've got to navigate both. So we know with certain things about how you navigate both. The first thing is spare tires. Remember that image. You need some spare tires. You need resilience. Financial and human resilience are absolutely key. You need optionality. You need an open-minded approach that allows you to incorporate a lot of information as you get clarity on all these changes going on. And then you need agility, the courage, and the ability to move quickly when there's clarity. The same thing you need to understand is that the other cars on the road are very different from you. They differ in terms of their resilience. They differ in terms of the initial conditions. And if you don't understand the other cars on the road, if you're spending too much time looking in and not enough time looking out, you're either going to get hit, or you're going to miss opportunities. One of the two. So this is a world in which you've got to be really keen on what your peers and competitors are doing.
The third thing is we're going to have to reskill our employees. AI is an absolute game changer, and you're going to have a session on it. I cannot tell you how many sessions I've been on it, and everybody acknowledges it's a game changer. And then they get stuck on how to do it. The most important issue in your mind when you talk about AI is what if you grew up AI native in your business, not as an add-on, but AI native. What will that look like and how do you get that? And pretty quickly, you start discovering things like, if you don't have an AI native person in an executive team, you're not going to get there. You have to think completely differently because you're changing how we do things. And then you've got to be open about your blind spots. Blind spots and implicit biases are something that really trips you up when the world is changing. And finally, understand the destination.
So I'm going to conclude because Willy asked me to say something about a book that three of us wrote during the pandemic. In about 2016, I was in California. I got an email from Gordon Brown, claiming to be the former Prime Minister of Great Britain, saying, “I read your article. I want to come to California to discuss it.” So I printed it out and took it to my wife and said, “Who do you think is pulling our leg here?” And she said, “I don't know, but respond to him.” So I responded and said, “I'd love to discuss it. When are you coming?” So he said, “I'm coming on so and so,” I said, “Great I will make a reservation, and we'll get together for brunch.” He said, “If you don't mind, can we meet in your house for security reasons?” So I thought this was gonna be a really good test. So he was supposed to come on a Sunday. On Saturday, the British Secret Service turned up because prime ministers have protection for the rest of their lives. And they start checking the house. And if you want something that makes you feel really insecure, it's those people in the house because they say, “That window doesn't shut properly.” Anyway, he turns up the next morning. I had not even reread the article, so I couldn't remember what I had written. And he stayed for six hours. And then we developed a friendship. Come the pandemic, he decides we should have a call every week during lockdown, and after about two calls, I realized I wasn't smart enough to deal with him. So what do you do? You bring in someone else. So I brought in another friend called Mike Spence, a Nobel Prize winner. And for a whole year, the three of us would have a call every week. And it was a really depressing call. The vaccines aren't being shared properly. The policymakers don't realize that when you shut down an economy, you can't simply turn it back on by flicking a switch. Things will be in the wrong place. Then we discovered that most of the crises going back 20-30 years had three common elements. One is the inability to grow in a durable, inclusive, and sustainable manner. And you all know, as business leaders, when you don't grow, things go wrong because you can't afford your mistakes. And if you start making mistakes, then you get into what economists call a path dependency. Where the likelihood of making another mistake gets higher and higher. The second problem is that policymakers tended to make a lot of mistakes. And this is really important because we live in a world where the Fed is likely to make another mistake. And they tend to make the same mistake over and over again. Because they lack cognitive diversity. And then the third element is there wasn't enough cooperation. I say that because your judgment on these three factors is going to be important.
And I'll leave you with the hopeful note as Willy comes back up that we have answers for all three. And all we need is political leadership. So I'm going to now sit down and get interviewed. And Willy, I must tell you, after the way Kris did his moderated panel, you are in deep trouble.
Willy Walker: I am in deep trouble. First of all, thank you, Mohamed. So I want to get a sense. You, Brown, and Spence on the phone. Like every week. How's that roll with three big brains like that?
Mohamed El-Erian: So there are two brains in me. So I don't know if you know Gordon Brown at all, but he is incredibly intense and exhausting. He'll tell you that himself. But really committed to public policy. Mike Spence is the purest economist you can find. Serious and he's the only Nobel Prize winner I know, and I know four, that assumes you're smarter than him. So if you tell him something, he'll try to understand why you're saying it. And then, my role was to circulate the Zoom link because I was the only one who knew how to do it. Laughter.
So we did that, and I have to tell you, this was incredible. Then we went on a book tour. And Gordon would start. And he feeds off the audience, so he turns into a politician. So I want you to imagine, here's a Nobel Prize winner and myself sitting like potted plants because no one is interested in us at all. Here's Gordon Brown, who starts cracking jokes. We've been with him for two-plus years. We haven't heard a single joke from him, and then suddenly he cracking jokes. My favorite one was when he told this story about Ronald Reagan. Ronald Reagan's waiting to meet a prime minister from another country. And the advisor comes in and says, “Mr. So-and-so, Prime minister of so-and-so is waiting, he's going to see you.” Ronald Reagan said, “I hate communists.” And your advisor says, “Sir, he's a social Democrat. He's an anti-communist.” And Ronald Reagan's response, “I don't care what type of communist he is, I hate them all.” So imagine Gordon and the rest of us just said that. And it was a humbling experience. But I learned a lot from these two. They really are smart.
Willy Walker: Where'd you learn your humility? You're a Cambridge undergrad, Oxford master's and PhD. You've been wildly successful in your business career. Where does humility come from?
Mohamed El-Erian: It's funny because I tell my daughters he's all the things that I didn't do. And I hope that you do things that I did not do. So I don't think of myself… I went to boarding school. I was beaten up every single day in the UK for two weeks. Why? Because I had a foreign name. And then I somehow made it to the rugby team, and that allowed me to be embraced. But only after they changed my name. And I remember how happy I was to conform and accept a name that was totally alien to me. But I just wanted to be… So I don't think of my life as success. I think my life has a number of challenges, and I'm really glad that Coach Staley said, “You learn more from your challenges than you do from your successes.”
Willy Walker: But you're born to Egyptian parents in the United States of America here as diplomats. You then moved back to Egypt until you were ten. Then you moved back to the United States. Then you went to boarding school in the UK. Where's the British accent?
Mohamed El-Erian: Okay, so we went from Egypt, the U.S., and Paris.
Willy Walker: Your dad was the Egyptian Ambassador to Paris.
Mohamed El-Erian: Correct. And then he is being moved to Switzerland. And I'm 14 years old. I go, “Dad, I can't do this anymore. I can't change friends, languages, curriculum. I just can't do it.” And he said, “Where do you want to go?” I said, “To states, because we have had a wonderful time in the States.” He said, “Too far, too expensive. What's your second choice?” And without knowing what I was saying, I said, “England.” He said, “You want to go to an English boarding school? This is the 70s, by the way.” I said, “Yes.” He said, “Is this your choice?” I said, “Yes, you said you own it completely.” I should have realized he was warning me. I said, “Yes,” he said, “No whinging, no whining. Okay, I'm not going to hear you complaining.” I said “Yes,” and I had no idea what I was saying at that time. I remember arriving at the dormitory as big as this room. There were 52 beds, no heating, the bathrooms were outside, and this was my life for four years, and it was quite an experience.
Willy Walker: So Cambridge to Oxford.
Mohamed El-Erian: For all the wrong reasons. In my final semester, I fell in love with Nikki Marbles, this wonderful girl that I thought was my future. And I was supposed to stay in Cambridge to do my doctorate and I had to organize everything. And then she was going to Oxford, and I decided to follow her, which was really hard because I had to first get acceptance at Oxford. I had to change my grant from Cambridge to Oxford. I had to find somewhere to live. And on the second day we were there, Nikki Marble dumped me.
Willy Walker: Really?
Mohamed El-Erian: Yeah. She totally dumped me.
Willy Walker: Where's Nikki Marbles today?
Mohamed El-Erian: That's what my wife keeps on asking.
Willy Walker: There are a number of people in the room who were here, Mohamed, years ago, and we had Nick Saban come speak in. Nick Saban was telling the story about how he and his wife were high school sweethearts. They broke up for a very short period of time and she went off with this one other guy who was from the local town, and they're coming back when they're going to name Nick Saban Way in their hometown in West Virginia. And they're driving by. The guy that she broke up with to date for a short period of time before they came back together had a gas station in the town. And so they're driving along, and he points out to his wife. If you ended up with that guy, you'd be still in our little old town in West Virginia, and you'd have a gas station. And she goes, “No, if I'd married him, he would have already won five national championships.” It was a good one. So you went to banking? Didn't like banking.
Mohamed El-Erian: When I was at Oxford, my father died. My mother had never worked, and I had a seven-year-old sister. So the optimization process, I'm an economist, became the highest possible pay for PhD economists with the international organization. So I decided to abandon academia. And I went to the IMF in Washington. For 15 years, I had the most amazing time learning about policy because you sat that as a junior person with the ministers of finance at Central Bank governors talking about what they intended to do and why. So I went there and then I was turning 40, and I'd never tried the private sector. And my human capital was eroding really quickly. And I decided to go from the IMF an establish bureaucracy.
Willy Walker: You were deputy director.
Mohamed El-Erian: I was deputy director. Where seniority could be deemed by two things in your room: how many lights you had and how many bookshelves you had. Because it was incredibly bureaucratic. There was a time in grade and everything. And I go to the Wild West of Salomon Brothers. And the shock of that transition was incredible. But once again, I adapted, and that's the advantage of being thrown into a boarding school where you learn to adapt really quickly.
Willy Walker: So you went to PIMCO and were at the beginning focused on emerging markets. How did you avoid the Argentine debt crisis of 2001?
Mohamed El-Erian: By not knowing what I was doing?
Willy Walker: No, I don't buy that.
Mohamed El-Erian: No, I'll tell you why. When you join finance late, you haven't drunk all of the Kool-Aid that you're doing growing up. So if you manage money, you don't think about it. The benchmark you manage against becomes your master. Because you are being assessed in relative terms. So when I arrived at PIMCO, remember debt indices, your weight is a function of how much debt you've issued. Argentina was issuing a hell of a lot of debt, so it was 22% of the index. The economist in me, and I wasn't the only one saying it said, “The probability of Argentina defaulting is really high.” So the economist in me says, “At the prices that Argentina is trading at. It makes no sense to own any Argentina.” So we ran an emerging market fund with 0% Argentina. When most of the other people were “On the way to Argentina.” And that's a big underweight in the fixed-income world, five percentage points which meant they had 17% in Argentina. So the fact that I had grown up in a different world, in the world of fundamentals, when I came to manage money, I wasn't captive to the index, to the benchmark. And if you're managing as a lot of people here, do single B, triple C's. If you make a mistake -- defaults are nonrecoverable mistakes. And I said I would sit in on panels, and I said, “No, Argentina.” And I would be told that's irresponsible. I'd say, “No, it's not responsible. Owning 17% of Argentina is irresponsible.” So that was a big change. Now people realize that benchmarks can be quite misleading.
Willy Walker: I'm going to come back to Argentina a bit because I want to get your take on how Milei's doing and turning that economy around. And I think one of the interesting things there is your comment about the journey and the destination. I think Milei's been spectacular as it relates to telling the people of Argentina that this is going to be a tough journey. Be ready for this. We have to do this to get to that destination. Whereas many people just say, “Let's go to the destination and forget about the journey.” Before we jump to that.
When you went to Harvard Management Company, having run emerging markets at PIMCO, you went long into emerging markets. When you first arrived at Harvard Management, you took, I think, 6% of the portfolio to 11% of the portfolio in emerging markets. Was that, if you will, a yield grab in the sense that I've heard you talk, Mohamed, about investing in emerging markets and how the developing world sits there, looks inwardly like today, where we say we can get great yield locally. And then all of a sudden, when that yield gets taken out, we push money out into the emerging markets to try and gain yield because we've taken all the yield out of our market. Talk for a moment when you got to Harvard Management about why you went so long on emerging markets.
Mohamed El-Erian: So Harvard Management for me was the ability to do both public and private markets. PIMCO, at the time, was simply a public market. When you can do private markets, you can get a much better risk reward. I'll give you an example.
At the time, if you bought a Pemex bond, the Mexican oil company, it was about 7%. Why? Because a lot of people were being pushed out of advanced economies and into emerging markets just looking for yield. Literally, they were being pushed into it. And as they were being pushed into it the price went up. Yield comes down. But if you lend on a private platform to a supplier of Pemex. With Pemex receivables as your collateral, you can get paid ten percentage points more. Why? Because very few people play in that world. So what I discovered is that combination of understanding public markets and then being able to express the view in a much better-structured way in private markets is absolutely great. And at the time we could protect the whole endowment by being willing to give up 25 basis points a year. Why? Because there were certain tranches of CDX trading at ridiculously low prices.
We remember 2006 and 2007 beginning, everybody was in love with risk. So you could have that combination whereby you stretch this way, and you protect that way. And that worked really well until I left and went back to PIMCO at the end of 2007. And then the temptation at that time, volatility had gone up. The protection we had made a lot of money. And the temptation, like any insurance you have, is to take it off when it's making money, and you forget that you put it on because it's insurance. It's like you taking off your car insurance after six months because they haven't had a crash. You wouldn't do that. But that's how people think in terms of portfolio insurance. The minute you start making money. People want to monetize it.
Willy Walker: What did that mistake cost Harvard?
Mohamed El-Erian: A lot.
Willy Walker: Billions.
Mohamed El-Erian: Yeah. The trouble is that you then have to liquidate things to get liquidity, whereas had you kept it that would have provided you your liquidity. But it's understandable because whoever comes in wants to do things differently. And if you have something that's made a ton of money, you are very tempted to take it off.
Willy Walker: So you think about going from PIMCO to Harvard and your point of being able to make private as well as public investments. What's the best investing seat to sit in? In other words, running Fidelity, running PIMCO, running a hedge fund, running a big family office, as you sit there as an investor, having been on the public side, the private side, and everything in between, what's the best seat to sit in as an investor?
Mohamed El-Erian: Let me tell you, the worst seat is the squeezed middle. You don't want to be in the middle. So either you are small, nimble, and have incredible expertise in a particular area, or you're very large, and you're almost like a supermarket, and you have internal diversification. It's the middle part that's getting increasingly squeezed out. I now advise “a very small $5 billion emerging market boutique.” And I'm having the time of my life because you can do a lot of stuff without moving markets. At PIMCO whenever you want to do something, there was always the risk that you were going to move the market against you. I'm trying to do it. We were $2 trillion at the time. So it wasn't easy to get things done. So, you can live in either and you just have to think differently. But you don't want to be in the middle. The middle is really getting squeezed right now.
Willy Walker: And why are you in academia now? Why did you go back to King's College and become president of King's College, Cambridge?
Mohamed El-Erian: So it's Queens.
Willy Walker: Queens. Excuse me.
Mohamed El-Erian: So I don't know if I'm going to make everybody feel really bad. Can I?
Willy Walker: Sure.
Mohamed El-Erian: 2013, it's June, I’m CEO and co-CIO of PIMCO. I asked my daughter, who was ten at the time to go brush your teeth. She doesn't do it. I say, “Go brush your teeth.” She doesn't do it. I say, “What's the matter? I'm not just your dad, I'm your friend.” She says, “Just a minute.” Goes to her room, comes back with a folder, and says, “Dad, you know that this school year, you've missed 22 of my events.” And I said, “No way.” She opens her folder. On September 7th, my first day of school, you weren’t. My first soccer game. You weren’t there. The first parent, teacher. You weren’t there, and I started defending myself. “Oh, yeah, I remember. I have to go to Japan. Oh, yes, I remember.” Then she went and got her yearbook for the previous year. She opened her yearbook on her class and there was a photo of some exhibition that I've had. And there was a picture of me sitting on a stool in the background. And I thought this was great. Here's evidence that actually turned up to something. And she said, “Look at that picture.” And I was looking at my BlackBerry at the time, my phone. And she said, “Dad, even when you're there, you're not there.” The next day, I went to see the founder of PIMCO and said, “Bill in the next 12 months. I'm going to step down. It's up to you. Do you want me to step down tomorrow? I'll step down tomorrow. Do you want me to step down in the years’ time? But I've got to step down.” He said, “Why?” I told him the story. He said, “That's bull****.” He said, “You're going to go with your competitor, aren't you?” I said, “Bill, I'm a New York Mets supporter. I'm a New York Jets supporter. Loyalty is something that I believe in. Otherwise, I would have found better teams, believe me.” And he said, “Then you're ill. Do you have cancer?” I said, “No,” and he said, “Mohamed, no one walks away from money.” And I said, “Bill, I don't know my daughter.”
So I left. And I decided at that time I wouldn't do a full-time job afterward. So I did what's called a portfolio approach, lots of things. Then comes the opportunity to go back to the college that had totally transformed me. Remember, I came out of boarding school traumatized, and I went to this university expecting that it was all going to start again. And I was transformed completely. I never once felt that I was different, and it unleashed in a really significant way my intellectual curiosity. So the notion of being able to go back and for five years runs out next year. My wife is very happy about that. But for five years, you could do your utmost to make sure that experience is available to more people is something I really wanted to do. And that's why I went back to academia.
Willy Walker: Where's your daughter now?
Mohamed El-Erian: So my daughter in her final year, she's a senior at the University of Pennsylvania. She's still as fiercely independent as she was at the age of ten, which I love. She's working for the summer. And she hated it because she had to take a subway to a train. She had to get up at five in the morning till the first paycheck kicked in. And then she said, “Dad, I really understand why people like this finance gig. I've gotten paid more in one paycheck than I did the whole of last year, last summer.” So she was quite happy.
Willy Walker: So I now just figured something out. When you just said that your daughter's at Penn, which is that being someone who went to Cambridge, went to Oxford, taught at Harvard, and ran Harvard Management Company yet you gave the commencement address at Wharton this past spring, and you called Wharton the best business school in the world.
Mohamed El-Erian: Correct. That's what the stats say.
Willy Walker: Actually, your friend Mike would tell you that Stanford actually, I think, is at the top of the heap right now.
Mohamed El-Erian: We can debate.
Willy Walker: It's actually funny that you say that only because the other day, my son and I got in a car. I had some people over after the Allen and Company conference, and Ted Weschler, who is Warren Buffett's right hand on Berkshire Hathaway Investments, was at my house. And I’m talking about Ted to my son Wyatt. And Wyatt says to me randomly, “We're Mr. Weschler go to college,” and I go, “I don't know Wyatt. I don’t know where he went to college.” And he goes, “I bet you went to Penn.” And he goes, and he pulls up his iPhone and he goes, he's like, “I told you he went to Penn.”
So anyway, talk for a moment as it relates you put up a lot of data on where we are from an economic standpoint. Do you think the Fed cuts in two weeks?
Mohamed El-Erian: I don't. I think they should cut in two weeks. And I've been saying that publicly over and over again, but I don't think they will. He's too data dependent. The chair doesn't have a single strategic muscle in it at all. And today's retail sales number is going to convince him not to cut, I think.
Willy Walker: Why? Because it's too high.
Mohamed El-Erian: Because it's too strong.
Willy Walker: But I hear, and I've listened to you on CNBC time and time again saying they're rearview mirrors. They're two data dependent. You actually, in that commencement address at Wharton, said to everyone in the room, don't be too data-dependent in your careers like think about things. Don't just look at the numbers. But haven't they been wildly successful? It's easy to criticize right now, but two years ago, everyone was saying, this thing's dunking into a recession we've gotten through. I put the growth numbers up on us versus the other G7. We've done famously well, don't they deserve credit for that?
Mohamed El-Erian: So they surprised them. They didn't think they had been consistently wrong on GDP growth. They've been too low all along. I go back to 2022 when he warned us of pain. What surprised us was the US economy. The US economy is incredibly resilient. It's incredibly adaptable. That is what surprised us all. He also got a positive supply shock that he never imagined. And I'm not making a political statement. I'm making an economic statement. But you've had 2 million illegal immigrants join the labor force. That's a positive supply shock that has allowed this economy to navigate a lot of the things that other countries have stumbled on. So I think we've collectively been really lucky on this, and let's hope he didn't mess it up. If I was sitting here in 2021 and told you that I've made a mistake about inflation, it's not transitory. They're going to have to hike over 500 basis points in a really concentrated amount of time. They're going to have four consecutive 75 basis point hikes. We've never seen that in the history of the Fed because they were playing massive catch-up. What do you think happens to the economy, I would have told you recession, like everybody else said, a recession. But this economy has surprised us on the upside. So I'll give them 50% credit and the economy 50% credit rather than give them 100% credit.
Willy Walker: And with that in mind, then, is the economy so damn strong that it doesn't make a difference who's running the ship?
Mohamed El-Erian: You have an old saying that my friend Paul McCulley from PIMCO used to say, “If you want to go to heaven twice, you've got to have two good deeds. You can't simply use the same one over and over again.” We're not going to have the ability to run ridiculously high fiscal deficits. In fact, we're going to have a debt problem in the next 10 to 15 years if we're not careful. You're not going to have the ability to have a positive supply shock like we had on labor. So we are now reliant on these other revolutions that are going on in life sciences and technology, in sustainable energy, to bail us out. If that doesn't happen, then we have to pay for all the growth that we have borrowed from the future. I look at my girls, and I say, “My generation blew it. We are leaving you with high debt, high inequality, low growth, and a damaged planet. That is our legacy. That's our inheritance to you. I'm sorry, but the good news is you have tools that we never imagined. And your challenge is to use those tools to deal with the real problems that we live with.”
Willy Walker: So we've got $33 trillion of U.S. debt. We've got a $27 trillion economy. When do those numbers get to a point where it's super problematic?
Mohamed El-Erian: When the rest of the world does things better than us. Government bonds solve in relative space. So all you've got to do is be the cleanest dirty shirt. You don't need to be pristine and clean. You need to cleanest dirty shirt. Most of us travel with just carry-on. And we pack for the exact amount of time we anticipate to be away. And if God forbid, we have to extend a day, and we can't get to the laundry, and we will wear a clean, dirty shirt. The US is the cleanest dirty shirt in the world, and therefore we are going to attract other people's capital up until they get their act together. So we have time. We are not the UK where those of you who don't know, there's a Prime Minister that lasted 40 days because she tried to screen for growth using unfunded tax cuts. And the markets brought her to her knees and more importantly, almost demolished the pension system. So we're not there yet. We have a lot more time than others, but if others get their act together, we're going to have a lot less time.
Willy Walker: But is the act together in having a currency that becomes the fiat currency that becomes the reserve currency of the world? Chinas clearly had growth, but we're not sitting around buying their bonds or investing in their currency. Doesn't it have to be that something has to take over the dollar? And if you look at the strength of the dollar. The euro was headed towards that obviously faltered. As long as we are the reserve currency of the world, we're okay or no.
Mohamed El-Erian: So we are okay, but we're not as okay as we used to be. For a long time, the argument was you cannot replace something with nothing. And as long as you cannot identify a currency that replaces a dollar, then we're safe. But what we've discovered is China, in particular, says, “I'm not interested in replacing the dollar. I'm interested in building pipes around the dollar.” That's a very different approach. And they're fragmenting the system. They now have payment agreements with 50 countries that never deal with the dollar. They have created institutions to compete with the institutions in which the US dominates. So the Asian Infrastructure Bank, the US, is not a member of that. And yet it's growing. And then the biggest shock to me personally, but to lots of us, is when we kicked Russia out of the Swift system when we told Russia that you could not settle in dollars anywhere in the world. We thought that this would bring the Russian economy to its knees. It did not. Because between China, India, Turkey, and the UAE they've created a whole new system. It's very inefficient, but it has allowed Russia to continue functioning without having to deal with the dollar. And there are a lot of countries that are suddenly interested in how you have a competing system to the dollar. It doesn't have to dominate like the dollar, but it has to help them in case they are on the receiving end of sanctions. So Willy, what you're seeing is not something to replace the dollar, but little pipes being built all around the dollar that reduce the dominance of the dollar. And that's the world we're living in right now.
Willy Walker: Is watching, if you will, fund flows. I mean, so the Chinese have lowered, I believe, their holdings of U.S. treasuries from like a trillion two down to $800 billion. Something like that is, if you will, a false narrative in the sense that that's not where the real action is, and it's actually where you just pointed out.
Mohamed El-Erian: Some of it's there. But the trouble is you can't, they're buying a lot of gold, they're trying to divert, but there isn't something to replace the dollar. But it is a completely different architecture that they're building. That is the concern for the US in terms of its dominant role.
Willy Walker: And you still sound very bullish on the core U.S. economy.
Mohamed El-Erian: I am. I think there's no other economy that I'd rather be in than the US. We have the ability to adapt. We have incredible resources. We have people who react to incentives. Look at this AI. The AI equation is 80/20. Go to Europe. They're obsessed with the 20. The bad things that can happen, totally obsessed. So what do they want to do? They want to regulate it. And they're going to kill the 80. In the US, we are obsessed with the 80. We forget about the 20. We are just obsessed with the 80. And we're going to make the 80 become 90. And we just have to manage the ten. I just love the attitude that we have.
Willy Walker: And you put up seven sectors that are going through transformations. If you sat there and said, “I'm going to leave academia. I'm going to go be an investor.” I'm going to focus on one place to do what you did in emerging market debt, for instance, when you went to PIMCO. What of those seven sectors do you focus on right now?
Mohamed El-Erian: That's a really tough question. The one that I've spent most time on is what's happening in technology. And when you sit… I just came from a conference where you mentioned OpenAI. There were two people and they showed us what ChatGPT 5.0 looks like. And it's incredible. It's absolutely incredible. And then the most scary thing was when I asked them. I was chairing the meeting, “What does it look like in 12 months' time?” And their response is, “We have no idea.” Because the four things that you need are totally abundant.
- You need money. You said it, “Money's being thrown at them.” Literally thrown at them.
- You need data. There's so much data yet that we haven't yet totally captured. Y
- You need expertise. That's actually quite a few smart people around.
- And you need energy. And so far, they haven't hit that constraint. They will, but they haven't hit it yet.
So this thing is building momentum at an incredible rate. I see what it does to education. It turns education completely upside down. And the places that cannot adjust are going to become irrelevant pretty quickly.
Willy Walker: So we're almost out of time. What are your final thoughts as you look at the outlook for ‘25-’26, rough GDP growth, where rates are two years from now – the ten year?
Mohamed El-Erian: So rates, I completely agree with what you said, which is that the curve will disinvert, the front end will come down. But don't expect the long end to come down below 3.5, 4%. That's the natural rate. We're living in a different world right now. And growth is a big question. That's why I go back to a combination of resilience, agility, and optionality. And if you are to remember anything as the heavyweight fluff fight of the 70s to rumble in the jungle, do you remember that or not? You're too young.
Willy Walker: I'm not too young. I was around.
Mohamed El-Erian: Okay, so for those of you who are young. Mohamed Ali, an old, exhausted boxer who once floated like a butterfly and stung like a bee, was facing George Foreman, the strongest, most powerful boxer that the world had ever seen. And everybody bet on Foreman. And Ali beat him by knockout in the eighth round. So there's been a ton of academic studies of how that happened. And the bottom line is that the Ali camp realized early on that they were facing a really bad distribution of outcomes. The least likely outcome was that he would win. The second least likely outcome was that he would survive to 12 rounds, and the most likely outcome was that he would be knocked out and injured really badly. So what did they do? They worked on changing that distribution. They did two things.
The training involved hiring a former convict who spent three hours every single day beating up on Ali. And they were building his resilience. And then when the fight started and you can see it on YouTube, everybody expected Ali to stay in the middle of the ring and not get trapped. Instead, Ali goes to the ropes and bends back. And what they had invented was the rope a dope? The notion of using the ropes, the flexibility of the ropes to dissipate the blows. For seven rounds, he relied on the resilience that they had built up. In the eighth round, Foreman got tired, and Ali had the optionality and the agility to knock him out. And that is the one story that you should take away that if you're going to navigate this you've got to get control of your distributions because these are not good distributions to operate to, because they're multimodal. And that is the one thing that, when it comes to growth, I don't know what it's going to look like. I know it can be really good. And I also know that if we make a policy mistake, we're going to slip into recession pretty quickly. And then we're not going to be worried about interest rate risk, which is what we're worried about right now. Are we going to be worried about credit risk? And that is not something we want to worry about.
Willy Walker: I'm trying to figure out now whether you're on the 65% or on the 35%.
Mohamed El-Erian: I embrace the whole distribution.
Willy Walker: You can't say that.
Mohamed El-Erian: No, I think you've got to embrace the whole distribution because if you focus too much on one end or the other, you're going to be laser-focused so much that you're going to forget that things can change. I go again. If I had told you that we're going to hike by over 500 basis points, would you have bet on a recession? I would have.
Willy Walker: I'll tell you one thing. A lot of people bet on my 11:00 discussion being a great one. And we got just that. Ladies and gentlemen, Mohamed El-Erian.
