The financial and economic road the world ventured on is ending, soon, and it isn't clear what comes next. Therefore, investors and others involved in structured finance industry need to be careful as they make decisions about their business and strategy for the future. This was the message Allianz Chief Economic Advisor Mohamed El-Erian delivered to a standing-room-only crowd at the ABS Vegas conference today.
El-Erian cited four factors that are in flux and contributing to our slow-growth economy today, but cannot be sustained:
The West has lost the ability to grow our economy, and even though many attributed this to cyclical shock after the financial crisis, it is, According to El-Erian, a structural shock.
"We are living in the twilight zone. What does it mean in Europe to have negative interest rates? It challenges the basic concept of borrowing and lending and destroys lots of business models."
3. Political and geo-political:
The anti-establishment movements in both the U.S. and Europe don't bode well for future stability. "The minute you throw in an anti-establishment movement into the mix, establishment parties don't know how to act. We (the U.S.) have not had an active budget for six years."
El-Erian likened the central banks of the world to a doctor that doesn't have the solution for a patient (the economy), but can't refer the patient to those who could actually do something — the policy makers on Capitol Hill for instance — because they are paralyzed. So, as opposed to doing nothing, the central banks will dispense medicine that doesn't treat the problem but buys the patient some time. Hence quantitative easing in all its forms. "The patient and the central banks are rightly concerned about side effects," El-Erian said. "We have this very precarious situation that is dependent on one policy instrument and we've over-relied on it. Some central banks are prescribing more meds and some are withdrawing the meds, so we have divergency."
The result of the fluidity in all these areas is that "the system starts to crumble slowly," El-Erian said. "The system can no longer produce financial stability. There's a reason that liquidity disappears. There's a reason why a milquetoast Fed statement makes the market move. The financial, economic, political — all these are overstretched."
El-Erian hopes the result is a "small bang" response from the government that can free up the "tons of cash" that is sitting on the sidelines and take advantage of the innovations that many companies are just waiting to unleash.
El-Erian outlined what he hopes the government's response will address:
1. Structural reform, including corporate tax reform and labor retooling
2. Better matching the government's willingness to reform with their wallet
3. Deal with indebtedness and loan issues
4. Better global policy coordination
"If the market senses we are getting progress on these things, it will unleash a ton of capital," El-Erian said.
On the other hand, if the economy doesn't get this kind of political response, our current slow growth will slide into recession and financial instability, which in turn fuels political tensions and possibly more regulation, El-Erian said. He posited the future as a T intersection where either response could happen, as opposed to a more traditional bell curve where the most likely outcome is evident, and he urged the audience to understand how humans will react as they see the T divide coming.
While some companies will not even realize it is happening, others will choose to ignore it or reframe the huge changes to be more palatable. But as the direction becomes clearer, companies who want to succeed need to develop resilience, the optionality to change their mind and the agility to move quickly.
El-Erian also discussed the disruptive forces already seen in the sharing economy as another stress on the industry. "It took the Hilton Corporation 100 years to supply 700,000 hotel rooms worldwide. They had to build and maintain those. It took airbnb six years to provide 1 million rooms, with no core competency in providing."
Looking ahead, El-Erian cautioned against "falling in love with the delusion of liquidity." Factors that will assume even more importance in this environment include transparency, brand strength, contract design, and scenario analysis of both of the possible government responses at the T. "You need to know: If I end up making a mistake, which one can I afford to make?" El-Erian said.