SPIEGEL Interview with Pimco CEO El-Erian 'Germany Finds Itself in a Very Delicate Situation'

The European Union is still struggling to find a long-term strategy to deal with the crisis that has befallen its common currency. SPIEGEL spoke to Pimco CEO Mohamed El-Erian about how Greece can get back on its feet, the fine line Germany is treading and why the US, despite high debt, is in better shape.
Pimco CEO Mohamed El-Erian says it might help if Greece took a sabbatical from the euro.

Pimco CEO Mohamed El-Erian says it might help if Greece took a sabbatical from the euro.


SPIEGEL: Mr. El-Erian, Pimco is the world's largest bond investor, with over $1 trillion in assets. A lot of that money is invested in government bonds. Are you an unflinching optimist?

El-Erian: When investors from all over the world entrust us with their savings and retirement funds, they rightly expect us to manage risk and look for opportunities all over the world. There are some very healthy countries that are running surpluses and are net creditors. But then we have certain other countries that have suffered a severe shock to their public finances and now face sovereign risk issues.

SPIEGEL: We can think of quite a few of those. The United States, for example, as well as many European countries ...

El-Erian: The US is today running a budget deficit of 10 percent of gross domestic product and has seen its debt-to-GDP ratio soar by 20 percentage points in under two years, which is unprecedented during peacetime. At the same time, the US still benefits from being the provider of the world's reserve currency and the deepest and most liquid financial markets. In Europe, some countries, such as Greece, have a public debt crisis because of fiscal imprudence. Others, like Ireland, face challenges because they used the public sector balance sheet to assume someone else's debt, namely that of the banks.

SPIEGEL: Pimco is in regular contact with governments around the world. How would you advise, for example, a Spanish finance minister?

El-Erian: I think it was my colleagues in London who met with him and his delegation, and they did so at the request of the Spanish authorities.

SPIEGEL: How many finance ministers have called you recently?

El-Erian: Some do, as do some central bankers from around the world. The typical question we get asked is this: "What does it take for Pimco to make long-term investments in our country." The answer is always the same: an outlook of high and sustainable growth.

SPIEGEL: And your people then tell the Spanish finance minister: "Sorry, but your bonds are too risky for us."

El-Erian: We are very cautious about exposures to Greece and Ireland. Spain is under more active discussion, with a lot depending on how they deal with the problem of the cajas (savings banks).

SPIEGEL: Will countries like Greece actually be able to pay back their debts?

El-Erian: Countries like Greece have to deal with their debt overhang, and they must do so in a timely manner. They face the typical debt trap: a situation where the existing stock of debt is so large that new investors are discouraged from coming into the country with new funds. It's like having a very large, dark storm cloud hanging outside your house. You will not go out; you will wait until it passes. I remember how I reacted to the announcement of Greece's rescue package almost a year ago. Having worked at the International Monetary Fund (IMF) for 15 years, I had never seen as ambitious a fiscal adjustment program as what the Greek government is trying to do. However, even if they delivered on this adjustment, their debt to GDP would go up from 114 percent of GDP to almost 150 percent. This is what a debt trap looks like. At 150 percent, the stock of debt chokes growth and employment. And if you don't have growth and employment, the population will not be able to sustain this.

SPIEGEL: Are you expecting a haircut for Greece, a forced elimination of some of its debt?

El-Erian: Right now we do not think that Greece has in place a policy approach that allows it to deliver high growth and overcome its debt overhang. What we're waiting for is a stronger response that goes from liquidity support to both liquidity and solvency support. Then there would be many possibilities.

SPIEGEL: Germany could help Greece pay down its debt.

El-Erian: One possibility is that the European Union helps with the debt overhang by refinancing existing debt with grants. That substitutes expensive funds for free money. Another possibility is to impose a haircut on creditors. There is also the approach whereby the EU helps Greece buy back its debt at a discount. The SPIEGEL reported that this was being planned in Brussels and Berlin.

SPIEGEL: Could that really work?

El-Erian: It could be a helpful solution if it can be done on a large enough scale. But, again, this substitutes private debt for public debt. At the end of the day, the question is: Can you reduce the debt stock by enough and who carries the burden?

SPIEGEL: Would a 10 percent debt reduction be enough?

El-Erian: No. At a first level of analysis, it should be targeted at a debt stock that's below 90 percent of GDP.

SPIEGEL: If Europe were to reduce Greece's debts from the current level of 140 percent of GDP down to 90 percent, would that be enough to convince financial markets to start investing in Greek bonds again?

El-Erian: It would certainly help. Critically, it's going to be a judgment as to whether that's enough to allow the economy to grow again in a sustainable fashion.

SPIEGEL: Won't investors cry foul if there is a major haircut and they can't recoup their full investment?

El-Erian: It depends how it's done. You have certain countries, Uruguay, for example, where the market embraced market-based debt reduction. The critical thing is to do it in a way that promotes growth and employment, removes uncertainty and is thus a win-win situation. If, however, you do it like Argentina in 2001 in a very disorderly fashion, it's a lose-lose situation.

SPIEGEL: Some critics argue that Pimco's global influence has become too great.

El-Erian: We spend a lot of time at Pimco analyzing trends. We share our analyses with the public. We are lucky that people are interested in what we say and some give us feedback and test our ideas. This process triggers a tremendous amount of analytical and intellectual interactions that enable us to develop our thinking further. We believe strongly that sound analysis and thought leadership are key to Pimco's success.

SPIEGEL: One could also say, more bluntly, that you have the ability to direct markets in a fashion that is beneficial for you.

El-Erian: Our primary obligation is to protect and enhance the investment and retirement assets for people from around the world. And we have safeguarded our clients' investments through a variety of economic and market cycles, including the global financial crisis. However, if we had the influence to direct markets, then we wouldn't be too early in our investment calls so often. For example, in 2006 we undertook a very comprehensive US housing study and we said this housing market is very unstable and investors should reduce their exposure and manage risk better. Nothing happened in 2006, and nothing happened the first half of 2007. And there are many other examples, including our 1999-2000 acute concern about Argentina.

SPIEGEL: When the EU was trying to save Greece, Pimco publicly doubted that the plan would work. That fueled the crisis even further. Insurance for Greek debt immediately became considerably more expensive.

El-Erian: At Pimco, we call it as we see it analytically because that's what our clients expect from us. They would be asking us: If Greek bonds are paying 8, 9, 10 percent interest rates, why aren't you investing my money there? We owe it to our clients to share information and analysis that influences how we invest the savings and retirement money that have entrusted us with to manage on their behalf.

SPIEGEL: A few weeks ago you wrote that the debt crisis is a lose-lose situation for Germany. You even said that international investors should actually have sympathy for Germany.

'The Burden of Debt Reduction Has to Be Equally Shared'

El-Erian: Germany has done an enormous amount on the structural reform side and it has maintained a very prudent fiscal situation. Because of these tremendous efforts, you are starting to see a considerable payoff in terms of consumer confidence, export growth, production expansion and employment. Yet Germany is also put in a position, being at the core of the EU, of taking responsibilities for problems that it did not create at the periphery of the EU. If it continues to be the main funder of the peripheral bailouts, the problem in the periphery will start contaminating Germany's balance sheet. And if Germany decides to take a hard-line approach, it immediately gets accused of being anti-European. So Germany finds itself in this very delicate situation of having to strike an inherently delicate balance.

SPIEGEL: As one of the lessons to the crisis, Germany is calling for a European insolvency act, which would make orderly bankruptcy proceedings possible for countries that default. Does that make sense?

El-Erian: Yes. The burden of debt reduction has to be equally shared. It cannot go just to taxpayers.

SPIEGEL: We agree with that.

El-Erian: I think that what Germany has proposed starting in 2013 is a very important step in this regard. There is no reason why creditors should be immune from losses. After all, they do get paid a "risk premium" in terms of higher interest rates. They should also be exposed to the credit risk that comes with this higher compensation.

SPIEGEL: Would it be a solution if countries like Greece left the euro zone?

El-Erian: Greece needs to have an economy that is more competitive so that it can grow at a high and sustainable rate. So it has to decide if it can it do this through an internal devaluation or whether it needs an external devaluation. An internal devaluation means cutting wages and salaries, increasing the retirement age, etc. An external devaluation means delinking for a while from the euro and then coming back at a sustainable level.

SPIEGEL: If Greece left the euro, wouldn't financial markets immediately target other countries like Portugal or Spain?

El-Erian: There are no easy solutions after the global financial crisis. But you can put up a firewall to minimize the impact on countries such as Spain, Italy and Belgium.

SPIEGEL: That would contain the crisis and keep it from spilling over, while at the same time keeping speculators at bay?

El-Erian: It's not about speculators. It is about the responsibility that investment managers have to protect the money that has been entrusted to them. If you entrust us with your retirement fund, you expect us to be cautious.

SPIEGEL: The US also has a huge debt problem. However, the financial markets don't seem to care much. Why?

El-Erian: Relative to other countries, the US now looks a little bit better. Think of it like a shirt. If you don't have a completely clean shirt, you will wear the cleanest dirty shirt you have.

SPIEGEL: What makes the US look better then others?

El-Erian: The US has structural advantages. It provides global public goods that others wish to use. The dollar is a reserve currency of the world. The US provides the deepest financial markets. So the market gives the US more time simply because there is no alternative. It takes time for the markets to evolve big enough alternatives to what the US provides today.

SPIEGEL: Still, the US does not have a real plan for ridding itself of its debt problem.

El-Erian: There are several ways that a country can deal with its debt issues. I suspect the US will end up with a mix of some fiscal adjustment and inflating its way out.

SPIEGEL: Washington never publicly talks about that option.

El-Erian: Europe and Germany, especially, have been very scared of hyperinflation. The US is influenced by a different historical experience, that of the fear of another Great Depression. So this country has a huge aversion to recession, huge. And if you ask a policymaker if you're going to make a mistake, which mistake would you rather make, they would say I'd rather make an inflation mistake than make a growth mistake.

SPIEGEL: But, everyone will have to suffer the consequences. The Fed is flooding the markets with another $600 billion that will impact not only the US, but the rest of the world as well.

El-Erian: It's inflating the whole world, that's absolutely right. We are concerned that QE2 ...

SPIEGEL: ... the name given to the US central bank's quantative easing program ...

El-Erian: ... will be disappointing in terms of its own objectives because it's a very imperfect instrument to deal with the headwinds to US growth. The US economy cannot productively absorb all this liquidity. So when all the liquidity is injected into the system, it also goes elsewhere. Its like pouring water on a hard surface, it splashes everywhere. That explains the large skepticism about QE2 outside the US.

SPIEGEL: Is there a better way?

El-Erian: We have said from day one that part of the problem in this country is there isn't a sufficient recognition that there are new dynamics in play. It's what we have called the bumpy journey to a new normal. Growth will be viewed as unusually sluggish. Unemployment will remain unusually high, and for an unusually long period. And we will see an accelerated realignment of the global economy.

SPIEGEL: What will that new global economy look like?

El-Erian: It is a multispeed world. While several advanced economies are dealing with debt overhangs, systemically important emerging economies will hit a development breakout phase. So our view has been if you're faced with this world, policymakers around the globe should not be using just fiscal and monetary policies. They should also be using the whole array of structural reforms. The US should be doing something about its labor market like Germany did. Many countries should be doing more to improve the functioning of the financial system, and not just pouring in liquidity.

SPIEGEL: How long do you see the dollar remaining the world's reserve currency?

El-Erian: At some point, we're going to evolve into a genuine world of multiple reserve currencies, but it cannot happen overnight because there are certain requirements.

SPIEGEL: For example?

El-Erian: Take China as an example. From the outside, we all look at China and see the second largest economy in the world. As the second largest economy in the world, we say it should have global responsibilities. The currency should be convertible and flexible. But go to China, and they will ask you what you are talking about. Look at per capita income, they will say. We're number 99 in the world, not number two. At number 99, our responsibility is domestic because we have lots of people that are poor. So we don't want our currency to appreciate and to be volatile. When we get closer to number two, we'll take on global responsibilities.

SPIEGEL: The world is changing rapidly. Pimco has been making an effort to move into equities and other assets as well.

El-Erian: If you believe in a global realignment, like we do, then you have to be able to help clients navigate this change well. Today Pimco is already more than just bonds. In the future we will be our clients' complete global investment solution.

SPIEGEL: Your father was an Egyptian diplomat and you are fluent in Arabic. What is your advice for the Egyptians?

El-Erian: To manage change well. Egypt will not go back to how it was before the street protests erupted. It's key for all policymakers to make a greater effort to get ahead of the curve and address the burdens being felt by populations due to unemployment and high food prices.

Interview conducted by Thomas Schulz and Christoph Pauly
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