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Financial Markets Respond To Signs Of Global Economic Slowing

RACHEL MARTIN, HOST:

What in the world is going on with the world economy? An 800-point drop on Wall Street; a shrinking economy in Europe's powerhouse, Germany; and indications of recession here in the U.S. and in the United Kingdom - of course, all that news amid a trade war between the U.S. and China. To help us make sense of the instability, we have called up Mohamed El-Erian. He is chief economic adviser at Allianz. Thank you so much for being with us.

MOHAMED EL-ERIAN: Thank you, Rachel.

MARTIN: We need to say the obvious from the outset. The stock market is not the economy, but it is something people with retirement funds pay attention to. So explain the significance of the Dow's drop yesterday.

EL-ERIAN: So there's so much going on. The principal cause of the drop was concern about the global economy. We got rather disappointing numbers out of Germany - as you just said - out of China and, earlier, also disappointing indicators out of Singapore. And all point to the same thing; the global economy is slowing.

MARTIN: People keep talking about a significant indicator in the economy, the inverted yield curve. Can you explain what that is and why it matters?

EL-ERIAN: It's a big signal of what's ahead. And an inverted yield curve simply means that when you as as a lender lend your money, say, for two years, you will get more than if you lend your money for 10 years. Now, that doesn't make any sense because you're committing your money for an extra eight years if you go for the 10-year option. And yet, you get paid less.

MARTIN: Right.

EL-ERIAN: So why would a rational person do that?

MARTIN: Yes, why?

EL-ERIAN: Simply because they expect interest rates are going to come down in future. So you might as well lock in now for the higher return. And why will interest rates come down? Because the economy will slow. So an inverted yield curve traditionally signals a significant slowdown. I don't think that's the case now.

MARTIN: You don't?

EL-ERIAN: But that is why you get the concern.

MARTIN: Why aren't you worried, as others are? I mean, this measurement - this metric has predicted the last seven recessions. Right?

EL-ERIAN: It has. What's different this time around is that it's highly distorted by two things. One is what's called unconventional monetary policy. Or put another way, the European Central Bank in particular has been setting interest rates negative, which means you lend money and then you pay for the privilege of lending money - that distorts a lot of things - and has been buying a lot of bonds with no other reason than to pursue an economic outcome, not a commercial outcome. So they distort markets.

Secondly, we have this very unusual situation of divergence growth in the advanced world. The U.S. is outpacing everybody else. And yet bond markets are connected, so everybody's coming to our bond market. And these two distortions weaken the signaling of the inverted curve.

MARTIN: I mean, President Trump has made this a personal attack, as he often does, pointing the finger at Fed Chair Jay Powell. Is it his fault?

EL-ERIAN: So the vulnerability of the Fed comes from the mistake they made in the fourth quarter, which most people agree was a mistake. They shouldn't have raised interest rates then, and they shouldn't have signaled tight monetary policy. Having said that, what is harming the global economy right now, it's much - it's way beyond the Fed. It's way beyond trade. It's the fact that, since the global financial crisis, there haven't been any meaningful pro-growth measures in Europe. And now we're feeling the effects of that around the world.

MARTIN: So you're saying that it's - it would be incorrect to read too much into the effects of the Trump administration's trade war with China.

EL-ERIAN: It is a contributing factor. But even without the trade war, we would be in a similar situation. For too many years, we've relied only on central banks to promote growth. And they don't solve the underlying problem.

Think of you as having a broken bone. And you go to central banks. And they say, look. I can't really do surgery on you; I don't have the tools. But I can give you a painkiller in the hope that you'll be able to get surgery elsewhere. You go back a year later, two years later, and your pain isn't going away. And all this - all that the doctor can do is double and triple the medication. That's not going to help you.

And that's the problem. The political environment has paralyzed pro-growth policies in Europe.

MARTIN: Can you give us an example of what that would mean? What is the surgery here? What's the structural fix?

EL-ERIAN: And ironically, Rachel, the economists for once agree on that. One is more infrastructure spending. Two is more fiscal spending in countries that have the ability to do so. Think Germany, Netherlands. Three is forgiving debt in certain places where the debt is overwhelming. And finally, better regional coordination - it's not an engineering problem; it's a political problem.

MARTIN: Mohamed El-Erian, he is chief economic adviser at Allianz. We so appreciate you breaking us down - breaking us down (laughter) - breaking all this down for us. Thank you so much.

EL-ERIAN: My great pleasure. Transcript provided by NPR, Copyright NPR.