Of Wall Street's major investors, few possess the background and influence of Pimco's Mohamed El-Erian. Along with Bill Gross, El-Erian runs the world's largest bond fund from Newport Beach, Calif., where he returned this year following a two-year stint managing Harvard's $35 billion endowment fund. His new book, When Markets Collide: Investment Strategies for the Age of Global Economic Change, outlines the major challenges facing the global economy. El-Erian recently chatted with U.S. News. Excerpts:
How has global economic power shifted?
It's pretty undeniable now that we are having major handoffs in the global economy. The growth handoff is the easiest to see. The rest of the world is now a more important engine of growth than the United States is. That is a major change. The global economy had relied on one engine—the U.S. consumer—for a very long time. Now it will rely on many small engines.
What fundamental economic changes are being ignored by investors?
The typical U.S. investor has 80 percent of their equity exposure in the U.S. That is risky, given the world of tomorrow. The typical U.S. investor doesn't have much inflation protection because they haven't needed it. That, again, is risky.
What does institutional investors' failure to manage risk say about the state of the global financial system?
It tells you that no matter how sophisticated the financial system looks, it can fall victim to the mistakes of innovation. That's what happened with structured finance. People fell in love with it.
What has surprised you the most about this year's financial events?
Well, I thought I was writing a forward-looking book. I talked about the possibility of an institutional failure. Did I think it could be Bear Stearns on March 16? No. It's as if a fast-forward button got pressed.
Does the speed of the unwinding leave us better or worse off now?
It's too early to tell. You can argue it's like taking off a Band-Aid and we're better off, but it caught the system by surprise. So the collateral damage element of it is very important.
Where might that damage appear?
When I started writing the book, the vulnerability was in the financial sector, where we are starting recapitalization. That leaves one sector out there still vulnerable: the U.S. consumer. It's why you see the fiscal stimulus package and talk about mortgage relief.
Are you optimistic those measures will work?
The suggestion is the U.S. will grow below capacity—around 2 percent—for a number of years. Official projections have the U.S. bouncing back in a "V"-like structure to above capacity next year. I think that's optimistic. It's going to take time for the U.S. consumer to rebuild.
Is any of this rebalancing good for the dollar?
I think you will see the dollar continue to weaken, but the subtlety is not whether the dollar weakens. It's what strengthens against the dollar. I make the distinction in the book of what should have happened and what has been allowed to happen. What was allowed to happen was the euro was allowed to strengthen against the dollar. Most other currencies weren't allowed to strengthen.
What's going to change, because it's now in the interest of these countries, is Asian, Russian, and Middle East currencies strengthening against the dollar over the next five years. Ironically, that is good for the U.S. It helps adjustment because you need domestic demand in those countries to pick up to replace the U.S. consumer.
How are these global shifts changing the way you think about investing at Pimco?
Investing is about defining the general direction in which you're going. Think of a seven-lane freeway in California. That's your framework, your big secular themes that will play out over a number of years. It doesn't tell you which lane to be in. That takes supplementing that secular view with very detailed cyclical views. Once you're driving, you have to figure out what other people are doing. You have to respect all the players.