財經觀察 1365 --- The Storm Clouds Spread

October 2008

The Storm Clouds Spread
The economic crisis will produce a system with greater stability, at the cost of productivity and flexibility.

This article was originally published in Newsweek.com on October 11, 2008 and will appear in the October 20, 2008 issue.

By Mohamed El-Erian
October 11, 2008
It was déjà vu all over again for officials from more than 180 countries gathering last weekend in Washington, D.C., for the annual meetings of the IMF and World Bank: frantic emergency policy discussions held in the context of highly volatile stock markets, wild fluctuations in exchange rates, a generalized loss of confidence and trust and a cascading paralysis of markets. All this comes despite the fact that a series of dramatic, and previously unimaginable, policy steps have already been taken by the U.S. and other industrial countries—massive injections of liquidity, coordinated interest-rate cuts and partial nationalization of some financial institutions.

This is an eerily familiar combination for developing-country officials in particular. Yet it should be noted that this crisis is different from past situations in three key respects.

First is the transfer of problems from Wall Street to Main Street. Most now understand that, regardless of who is to blame (and the list is long), the global prosperity of societies around the world is being fundamentally threatened. That's because the epicenter of the crisis is not an emerging market, but the U.S., which, in addition to being the largest economy on the planet, also provides the world's reserve currency and the deepest and most liquid financial market for government and corporate paper. As a result, the crisis has destroyed trust between buyers and sellers in a cascading number of markets.

Second, the policy response to date has been bold—indeed, unprecedented—and yet insufficient. A large part of this reflects the time it has taken the U.S. to make the three transitions that proved key to successful stabilization efforts in Asia and Latin America: on the design front, moving from individual actions to a comprehensive package of self-reinforcing measures; and on the implementation side, shifting from a sequential approach to a simultaneous one, and from an inward focus to a globally coordinated one.

Third, the crisis has altered the financial landscape in a profound way, and shifted power away from unfettered markets to greater government interference. The result will be a significantly more regulated global financial system that will gain greater short-term stability at the cost of long-term productivity and flexibility.

That stability will not come immediately. After all, too many things are still in flux: institutions, policies and, most fundamentally, market rules. With the enormous shifts still taking place in the U.S., which possesses by far the biggest and most influential markets, the global system lacks any meaningful anchors. We should therefore expect additional market accidents, institutional failures and policy mistakes in the weeks ahead.

Many developing countries were fortunate to enter this crisis in relatively strong shape. They had large holdings of international reserves, limited leverage and relatively low indebtedness. Policy flexibility was also considerable, as reflected in the ability to prudently use monetary and fiscal policy in a countercyclical manner. And internal consumption was picking up momentum.

The robust initial conditions have served to partially insulate the developing world from the effects of the global financial crisis that most observers rightly classify as the worst since the 1930s. Contrary to what would be expected on the basis of the experience of the past 30 years, there has been no dramatic collapse in growth and consumption; widespread defaults have not materialized; and many governments retain their core policy credibility.

Developing-country governments should, in general, feel good, given the ongoing turns in policy reactions in the U.S. and other industrial countries. Yet there is no room for relaxation and complacency.

The short-term outlook remains treacherous, as a good chunk of the strong capital position of these markets is now being eroded by the crisis. Accordingly, governments should not relax their cautious stance, lest they fall victim to the vagaries of what still is an unpredictable and fast-moving global crisis. In today's world, you certainly do not want to come anywhere near running out of cash at a time when virtually no one is lending.

What's more, the favorable initial conditions will provide little comfort for emerging-market equity investors. The long-term story in these markets may still look good, but investors are sitting on large losses now. Why? In major global dislocations like the one we are experiencing, fundamental drivers of value get totally overwhelmed by "technicals." Foreign investors, facing large losses at home, all scramble to repatriate their funds at the same time. The emerging-market equity door is simply not big enough to accommodate them all without a large and disorderly decline in prices.

Provided they are sufficiently liquid and that their portfolios are not overly concentrated, investors should think twice before joining this stampede. As a rule, long-term value investors should not become distressed sellers on account of technical factors alone. They should be guided primarily by their views on fundamentals, which will once again assert themselves over time. Moreover, help is on the way. Emerging markets will be aided, albeit neither immediately nor smoothly, by the aggressive policy decisions now being taken in industrial countries.

El-Erian is co-chief executive officer and co-chief investment officer of PIMCO and author of “When Markets Collide: Investment Strategies for an Era of Global Economic Change” (McGraw Hill).