Here’s why this top economist says we’re not just headed for another recession

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Investors and economists have been sounding the recession alarm. But a top economist who has seen the warning signs grow for many months says this potential downturn is different from what we’re used to.

That economist is Mohamed El-Erian, formerly chief executive of the hugely influential bond market player PIMCO. He also chaired former President Barack Obama’s Council on Global Development and has written several economic best-sellers. Simply put, he’s one of the best observers of the Fed and the markets, and he hasn’t liked what he’s seen for some time.

There is a tendency to see economic challenges as “temporary and quickly reversible,” El-Erian wrote in a comment by External relationshipsciting the Federal Reserve’s initial thinking that high inflation would be transitory or the consensus that a recession could be brief.

“The world is not just teetering on the brink of another recession,” he continued. “It is in the midst of a profound economic and financial change.”

He referenced the economic theory that a recession occurs when one business cycle reaches its natural end point and before the next cycle really takes off, but said it won’t be another turn of the “economic wheel” this time, as it sees that the world is undergoing major changes that “will outlast the current business cycle.” He highlighted three trends that suggest a transformation is underway in the global economy.

Three major trends transforming the global economy

The first transformative trend, says El-Erian, is the shift from insufficient demand to insufficient supply. The second is the end of unlimited liquidity for central banks. And the third is the growing fragility of financial markets.

These help explain “many of the unusual economic developments of recent years,” he wrote, and looking ahead, he sees even more uncertainty as economic shocks “become more frequent and more violent.” Analysts aren’t realizing this yet, she added.

The first change was driven by the effects of the pandemic, beginning with the shutdown of the entire system and government stimulus, or what El-Erian called “huge handouts,” causing “demand increases well above the offer”.

But as time passed, El-Erian said, it became apparent that the supply problem “came from more than just the pandemic.” It is linked to the Russian invasion of Ukraine that resulted in sanctions and geopolitical tensions, along with widespread labor shortages brought on by the pandemic. These disruptions in supply chains gave way to “localization near,” a more permanent shift of companies moving their production closer to home, rather than a 2019-era supply chain rebuild. This essentially reflects a change in the “nature of globalization”.

“To make matters worse, these changes to the global economic landscape come at the same time that central banks are fundamentally altering their approach,” El-Erian said. As he has for months, El-Erian criticized the Federal Reserve in particular for being too slow to recognize that inflation is taking hold in the economy, and then for its steep rate hikes to make up for lost time.

As inflation soared, the Federal Reserve resorted to aggressive rate hikes; the last four increases were all 75 basis points that raised the federal funds rate to a range of 3.75% to 4%. But this fundamental shift in focus led to the third problem, El-Erian writes. “Markets recognized that the Fed was struggling to make up for lost time and began to worry that it would keep rates higher for longer than would be good for the economy. The result was financial market volatility.”

Markets have been trained to expect easy money from central banks, he said, and the “perverse effect” of that has been that “a significant part of global financial activity” floods into asset management, private equity and hedge funds. coverage, among others less. -regulated entities. The turns in the markets since the era of easy money ended this year can be understood as that significant part that is looking for a new home, in terms of investment. It is brittle at this point.

“The fragility of the financial system also complicates the work of central banks,” he said. “Instead of facing its normal dilemma: how to reduce inflation without harming economic growth and jobs, the Fed now faces a trilemma: how to reduce inflation, protect growth and jobs, and ensure financial stability.”

El-Erian is not alone in citing multiple threats to the future of the world economy. Veteran economist Nouriel Roubini and financial historian Adam Tooze are two other leading voices warning of interrelated threats. Roubini has just written a new book called “MEGATHREATS” about no less than 10 giant economic problems facing the world, while Tooze has popularized the term “polycrisisto describe a group of related and compound problems.

Roubini himself said Fortune recently that he and Tooze are describing a similar set of phenomena, though he did not address El-Erian’s criticisms. However, like El-Erian, Roubini explained the multiple factors at play, and because they are so interconnected, they create a domino effect that contributes to a potential downturn.

“If you raise interest rates, you can also have stock markets, bond markets, credit markets and asset prices crash in general that causes more financial and economic damage,” Roubini said. Fortune. Still, he explained that raising rates helps fight inflation, though it risks a hard landing, all of which is caused by “negative shocks” in the supply chain.

Going forward, El-Erian concluded, these changes mean economic outcomes will be more difficult to predict. And it won’t necessarily mean a simple result, but rather a reflection of a “cascading effect,” where one bad event could likely lead to another.

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