PIMCO's El-Erian: Debt Deal Will Only Bring Temporary Relief

(August 1, 2011) — While a potential debt ceiling deal in Washington may forestall a default and a credit downgrade, it won’t fix the root of the problem draining the US economy, according to Pacific Investment Management Co.’s (PIMCO) Mohammed El-Erian.

“The key issue…is that we simply cannot generate enough growth to get us over all these issues,” El-Erian, PIMCO’s co-CEO, said in an interview with CNBC. “Therefore, we have these structural headwinds that continue to slow us down. Until we see structural solutions we’re going to be stuck on the bumpy road to a new normal.”

El-Erian asserted that in the near-term, the deal could avert a debt downgrade threatened by ratings agencies, such as Moody’s and Standard & Poor’s. Earlier this month, Moody’s cautioned that it would slash the US’ AAA credit rating if the government misses debt payments. It noted that because lawmakers have acted to increase the debt ceiling, it had not previously considered the situation high-risk.

Meanwhile, amid growing concerns about the US sovereign credit quality, Standard & Poor’s has placed 76 fixed-income funds on credit watch as a result of their exposure to US Treasury and government agency securities. It said in a statement “there is a one-in-two chance that we would lower the ratings (on the funds) over the next 90 days by up to two notches.” The statement added: “The action on the US government’s ‘AAA’ long-term and ‘A-1+’ short-term ratings reflects our view of two issues: the failure to raise the federal debt ceiling so as to ensure that the government will be able to continue to make scheduled payments on its obligations, and our view of the likelihood that Congress and the Obama Administration will agree upon a credible, medium-term fiscal consolidation plan in the foreseeable future.”

Regarding overwhelming government debt burdens, the outspoken El-Erian wrote in an article posted on Reuters: “Other than some short bursts, Europe and America are unable to sustain the sort of economic recovery that would make a meaningful dent in their debt dynamics…If they are unable to grow out of their debt problems, countries…can default, and let restructuring lower our debt burdens, albeit in a rather disorderly fashion; or we can implement austerity, spending less in order to generate cash to pay off our debt.”

He said that America’s approach to escaping its debt problems — with the Federal Reserve maintaining low interest rates for a long period of time — will not suffice. “Look for America to intensify financial repression through regulations that forces banks and other regulated entities to hold low yielding government securities,” he cautioned. “Also, it will attempt to generate unanticipated inflation. Ultimately, it will be forced into more painful austerity involving both spending and tax measures.”

In response to US fiscal concerns, El-Erian, who popularized the phrase “new normal” to describe how growth will be depressed by consumer retrenchment and tighter financial regulation, has said the Fed’s purchase of Treasuries will lead to faster global inflation while failing to revive US economic growth. Thus, he has warned that investors should expect lower-than-average historical returns with greater regulation, lower consumption, slower growth, and a shrinking global role for the US economy.