Mohamed El-Erian

By Mohamed El-Erian
The opinions expressed are his own.

Friday’s worldwide sell-off was a fitting end to a miserable month and a horrible quarter for equity markets.

The 14.3 percent quarterly loss in the S&P, a widely-followed index for the largest stock market in the world, was its worst performance since the fourth quarter of 2008 — a particularly bad omen given the additional market collapse that followed in the first quarter of 2009 and that brought the world to the brink of a global economic depression. Meanwhile, market and economic narratives are dominated even more now by words such as alarm, anxiety, worry and, to quote from the latest Federal Reserve statement, “significant downside risk.”

Is all this an exaggeration? Are markets stuck in an irrational cycle of self-feeding fear? Is the volatility, including eye-popping intra-day swings, just a head fake?

As much as I would like to say yes — after all, the balance sheets and income statements of multinational companies are still rock solid — the answer is no. The system is sending signals rather than making noise. It is warning about the highly uncertain and rapidly deteriorating outlook for the global economy; also, it is lamenting astonishingly inept policy-making in far too many western economies.

I know exactly how many feel. At an event last week in Washington, I was asked about my feelings about the global economy. My response was “between concerned and scared.”

I worry that, absent a dramatic change in policies in America and Europe, things will get worse before they get better. I fear that, given this possibility, it would then take years, if not decades, to repair the underlying damage done to economies, jobs and people’s lives around the globe.

We are here because of the interactions of three distinct, yet inter-related forces: poor economic growth, excessive contractual liabilities, and disappointing policy responses. The result is that western economies are getting trapped by the lethal combination of an unemployment crisis, a debt crisis, and mounting fragilities in the banking sector.

The longer this persists, the greater the risk that even the healthiest parts of the global economy, and thankfully there are still quite a few, will get dragged into a prolonged period of economic and financial stagnation. No wonder the cover of this week’s Economist magazine portrays the global economy as a black hole carrying a simple yet powerful message “Be Afraid.”

It should come as no surprise that, despite record low interest rates, companies with massive cash would rather stay on the sidelines than engage more fully in the global economy. It is also not surprising that, after showing resilience and tremendous relative strength because they sell to affluent people around the world, even high end retail stocks have been hammered recently.

If the three underlying crises — unemployment, debt and bank fragilities — continue to be left unattended by policymakers, the de-leveraging of the global economy will accelerate in the next few weeks and months. Selling will beget selling. Economic weakness will sap the willingness to spend by those with healthy wallets. And, over time, strong balance sheets will be infected by the growing economic, financial, political and social malaise.

Only policymakers, supported by more enlightened politicians, can change this outlook. Fortunately, there is now heightened awareness in American and European policy circles of the severity of the situation.

The fear of impending generalized dislocations — what the Managing Director of the IMF, Christine Lagarde, correctly labeled a “dangerous phase” — must now transition into three effective responses: immediate circuit breakers in Europe (what I call “very important and very, very urgent”); structural reforms in emerging economies, Europe and the US (“very important and very urgent”); and demand stimulus in emerging economies, Germany, and the US (“bridging mechanisms”).

The bad news is that having been “missing in action” for so long, policymakers will find it challenging to regain immediate control of a rapidly deteriorating global economy. This is particularly true for Europe where the feasible set of policy alternatives is now very far from a “first best.” Every approach that promises considerable benefits comes with substantial costs and risks as well.

Yet this is no reason to procrastinate even more. The longer policymakers wait, the smaller the room for orderly maneuver. In the meantime, dissatisfaction of electorates with the political process will continue to grow. Indeed, as this week’s Economist cover also notes, “until politicians actually do something about the global economy … be afraid.”

Markets are in the unusual and very uncomfortable position of being wholly dependent on policymakers and politicians. The investment relevance of company analysis, no matter how good, pales in comparison to the importance of getting the policy calls correct.

Faced with this, investors should also remain cautious. Yes there are already opportunities but they will be even more attractive down the road given that the world is now subject to both a synchronized slowdown and de-leveraging.

Investors should wait for stronger evidence that policymakers have the willingness, ability and effective instruments to respond properly. This is a time where cash and cash equivalents provide investors with tremendous optionality as the volatile winds of de-leveraging force far too many others into firesales. It is a time to be patient. And it is a time to strengthen firewalls that limit the further spread of economic contamination and financial contagion.

Photos, top to bottom: An artist’s impression of a growing supermassive black hole located in the early Universe is seen in this NASA handout illustration released on June 15, 2011. REUTERS/NASA/Chandra X-Ray Observatory/A.Hobart/Handout;  Anti-capitalist student protestors demonstrate outside the Bank of England in London October 10, 2008. Britain’s top share index slid 8.2 percent by midday on Friday in a global sell-off in equities as investors feared government efforts to unclog liquidity strains would not avert a global recession. REUTERS/Luke MacGregor; A reporter gestures at a board showing NASDAQ losses at midday at the NASDAQ Market site in Times Square, New York, January 22, 2008. REUTERS/Jeff Zelevansky

By Mohamed El-Erian
The opinions expressed are his own.

European officials must feel like that they were just on the receiving end of an “intervention” staged by their colleagues from other countries – a process whereby a group of people come together to “shock” a friend/family member into recognizing the depth of a personal crisis and the urgency of embarking on proper corrective actions.

The venue was this past weekend’s Annual Meetings of the IMF and World Bank. This event brings together policymakers from almost 190 countries, along with business leaders and media. It is full of formal meetings, seminars, press conferences, and bilateral discussions.

It is a well-attended gathering that serves many purposes. One of them is to enable policymakers to collectively get a feel for the state of a highly inter-connected and complex global economy. At times in the past, this has proved absolutely critical for designing policy responses that avoided terrible collective outcomes.

This was certainly the case in 2008. On that occasion, a series of consultations and discussions led policymakers from around the world to the startling conclusion that, after the disorderly collapse of Lehman Brothers, the global economy risked tipping into a great depression.

The follow-up was one of the most impressive examples of global policy coordination that culminated in the highly successful G-20 Summit in London in April 2009. The world averted an economic depression that would have spread unemployment, poverty and misery all over the world.

Unfortunately, it did not take long for such coordination to give way to competing and, at times, conflicting national agendas and narratives. This was particularly true in America and Europe where policymakers failed to understand and act on consequential global and national realignments.

Today the global economy is highly vulnerable to major dislocations on account of  three distinct but mutually reinforcing problems: a sovereign debt crisis (whose epicenter is in Europe), banking system fragilities (Europe), and an inability to grow robustly (America and Europe).

As Europe features in all three, it should come as no surprise that European officials were approached by lots of people this weekend in Washington. Many wanted to understand what the European policymakers had in mind; and they wished to ring a very loud alarm that would spur these officials into bold and decisive action.

Wherever they turned, European officials heard a consistent message which typically consisted of four specific points:

•       The bickering and dithering of European politicians and policymakers have allowed the crisis that originated in Greece to spread too far and wide;

•       The crisis is has now gotten close — far too close — to being uncontrollable;

•       Virtually no country in the world would be immune from the adverse consequences; and, therefore,

•       Europe needs to finally step up with decisive policies that are underpinned by a common political vision of what the Eurozone should look like in five years time.

Initially, the reactions of most Europeans ran the gambit: from denying the severity of the crisis to diverting the blame elsewhere. Some hit back, noting that they were neither blind nor deaf. By the end of the meeting, however, most seem to have heard the messages, taken them to heart, and indicated their intention to act on them.

Recognition and proper diagnosis are essential components of a durable solution to a problem. It is therefore good news for the global economy that, especially after this weekend, there is little doubt in the mind of Europeans about the urgency of their situation. They also know that the world is watching and hoping.

It is also good news that some key officials even went so far as to identify a timetable for action – the six-week run-up to the next G-20 meeting in France. True, it is a timetable that is excessively influenced by political considerations rather than economic and financial ones. As such, it may be challenged by markets that are unsettled by fragilities in both sovereign debt and banking systems.

So, will this Washington intervention and timetable hold? The answer depends on five key issues:

First, the Europeans must take immediate — and I stress immediate — actions to stabilize the banking system and counter more effectively the persistent recent rise in yields on government debt issued by Italy and Spain in particular. This cannot wait six weeks.

Second, they must quickly come up with operational mechanisms that build secure firewalls around at least one highly troubled country (Greece) so that it can default without triggering a tsunami for others in the Eurozone.

This will only be possible if, and this is the third point, the European Central Bank (which has been carrying most of the burden so far) receives much more support from national fiscal and regulatory authorities.

Fourth, bold structural decisions must be taken to strengthen the architecture and functioning of what, in the final analysis, is likely to be a smaller, less imperfect and stronger Eurozone.

Finally, politicians must secure the airspace for the technocrats that are waging difficult day-to-day battles through better communication, a common vision and a unified purpose.

This is quite a list, and there is very little time to waste.

By Mohamed A. El-Erian
The opinions expressed are his own.

Unlike recent G-7 meetings of finance ministers and central bankers that were essentially ignored, there was quite a bit of interest in the one held over this past weekend in Marseille. That interest turned out to be misplaced, however, as the G-7 delivered little of substance yet again.

Once more, the G-7 issued a communiqué whose disappointing lack of content contrasts sharply with the deteriorating health of the global economy, the intense risks ahead, and legitimate policy confusion. As an illustration, try reconciling the G-7′s “catch all” wording on fiscal policy — “we must all set out and implement ambitious and growth-friendly fiscal consolidation plans rooted within credible fiscal frameworks” — with the two strikingly opposing views expressed last week by Germany’s Finance Minister and the U.S. Secretary of the Treasury.

It is not just that the G-7 disagrees on policy prescriptions; the group failed again to converge to the type of common analysis that lies at the root of any coherent policy formulation.

Neither the global economy nor the financial markets can wait for the G-7 to get its act together — especially as the world’s three main economic areas each face a set of mounting challenges.

With structural impediments to both economic growth and the safe de-levering of excessive indebtedness, America’s economy is succumbing to the cumulative impact of policy shortfalls and political dysfunction. If President Obama’s speech from last Thursday fails to act as a dramatic economic and political catalyst, it is just a matter of time before America tips into another recession, unemployment rises even further, and a growing number of households and small companies are forced into bankruptcy.

On the other side of the Atlantic, Europe’s dithering policy response means that the functioning and institutional integrity of the Euro-zone are now threatened by more than just the troubled sovereign credit of peripheral economies. The European financial system is under enormous pressure as markets legitimately worry about both bank capital inadequacy and the continuous deterioration of asset quality.

All this puts the emerging economies in a tough policy position. With strong balance sheets and growing domestic resilience, they have the unusual historic ability to act counter-cyclically to stimulate internal demand and, thereby, insulate their populations from the West’s malaise while allowing for a more orderly global rebalancing.

Yet the incoherence of policies in America and Europe translates into less inclination for emerging economies to do so. Indeed, they may well opt instead for greater self insurance and, in the process, become another pro-cyclical driver for a weakening global economy.

With these issues continuing to fester, attention now shifts from this weekend’s disappointing G-7 to the IMF/World Bank meetings in Washington in two weeks and the subsequent G-20 Summit in France. The hope is that the former can lead to a common analysis of what ails the global economy, and that the latter allows for better policy formulation. In the meantime, look for markets to fret about the worrisome global economic outlook and a depressing lack of global policy coordination.

The G-7 is fortunate that it is not required to justify the expenses of its meetings in terms of what is achieved. If it had to, these meetings would be more decisive and/or less frequent.

By Mohamed El-Erian
The opinions expressed are his own.

This weekend’s Labor Day celebrations in America mark a difficult time for workers. Having experienced a multi-year decline in their share of national income, they are now suffering the brunt of the current economic malaise; and there is little to suggest that the situation will improve any time soon. As a result, the country’s economic hardships risk morphing from pressuring specific segments of the population to undermining more general aspects of social justice.

The numbers are striking — and worrisome. Over the last 30 years, labor’s share of the national pie has declined to 44 percent from 52 percent, with profits growing at twice the annual rate for average wages.

This morning’s monthly employment report adds to the concerns. Unemployment remains very high, whether measured by the most-quoted unemployment rate (9.1 percent), the less partial under- and un-employment rate, (16.2 percent) or, most comprehensively, the proportion of total adults who are not working (42 percent compared to 35 percent 10 years ago).

The duration and composition of joblessness is very troubling. The average unemployed American has been without a job for 40 weeks, a record level, and 44 percent of the unemployed have been out of a job for more than 26 weeks. The incidence of joblessness is severe among those lacking a college degree (11 percent compared to 4 percent for college graduates). For 16-19 year olds the unemployment rate is a horrible 25 percent.

Whichever number you look at, America’s labor market problems constitute a full-blown crisis with far reaching economic, social and political consequences. If current trends continue, joblessness will become stubbornly embedded in the system and, distressingly, some of the unemployed will become unemployable.

We all know that such a crisis fuels rising poverty and misery. Shelter is an issue, too, as mortgage and other debt payments are harder to meet. And credit will become even scarcer for those who are already struggling.

Regrettably, there is little to suggest that, left to its own devices, the economy would improve any time soon. It is mired in low growth and insufficient job creation; and the balance of risks is increasingly tilting toward a recession.

Since economic growth will not solve the issue, what about government action? Here, initial conditions are far from ideal.

Budgets — be it state, local or federal — are generally stretched. Indeed, rather than reduce the challenges facing workers, current budgetary policies accentuate them through cuts in education, health care, emergency benefits and other social services. Meanwhile, active redistribution policies are off the table with our extremely divided Congress vehemently disagreeing on what constitutes appropriate policy responses. And the Federal Reserve is already in full policy experimentation mode, with limited durable impact on economic growth.

It is tempting to blame all this on what economists call an “exogenous factor” – a phenomenon that is outside direct societal control. The two most cited factors are globalization and technological advances.

Globalization has brought hundreds of millions of low paid workers into the global labor force, thus putting pressure on higher paid ones in advanced countries such as the US. Technological progress has allowed companies to raise productivity, helping them generate record profits with fewer employees.

Before embracing this explanation wholeheartedly, it is wise to recall Reinhold Niebuhr’s prayer asking God to grant us the serenity to accept the things that cannot be changed, the courage to change those that can and the wisdom to know the difference.

It is not feasible to reverse either of those two phenomena (globalization and technological advances). It is neither desirable to do so either given that, overall, they have beneficial impact on global welfare.

Think of the millions of people around the world who have been pulled out of absolute poverty and misery. Think also of the wider range of affordable goods available to consumers globally (the largest segment of which is in the US). And think of innovations that have saved lives and improved the quality of life.

Rather than try to unwind globalization and technological progress, the challenge for the US is to adapt its labor force and its economy to these realities.

Through better policy making at both the national and international levels, America should — and can — be a bigger beneficiary rather than a helpless victim. No wonder President Obama’s speech next week is so eagerly anticipated, and rightly so.

While we must not underestimate the significant design and implementation difficulties facing the President, many look to him for restoring America’s economic leadership. This involves three challenging and complex steps (especially given today’s economic, financial and political environment): propose a set of policies that decisively lift structural impediments to growth; mobilize sufficient political support to start the multi-year implementation process; and, as the data evolves, provide for timely mid-course corrections as appropriate.

Better off segments of the population may be tempted to dismiss all this as irrelevant to their particular reality. After all, they are doing well — in several cases, extremely well. But such an attitude is short-sighted. It is not just about fairness; the rich have genuine self-interest in reversing the country’s economic malaise and the worsening of income and wealth inequalities.

Whichever way you look at it, the outlook for the wealthier cannot be divorced from society as a whole. Such considerations have already led some American billionaires to react in dramatic fashion.

Warren Buffet and Bill Gates are among those leading the way, through both actions and words. Howard Schultz, the CEO of Starbucks, has urged companies not to wait for government policy but instead to move more aggressively to employ and produce more. Many others are doing their part, albeit in a less public fashion. They know that national prosperity cannot, and should not, be sustained without social justice.

Unlike many parts of the world, America has experienced, until now, few if any meaningful eruptions of social tensions. Yes, there have been some “flash mobs”, but they pale in comparison to what has occurred elsewhere this summer.

This is not about the comparisons out there to uprisings in Arab countries driven by a thirst for social justice. Rather, it is about what the series of unthinkables that has already occurred in several advanced countries where, facilitated by social media that lowers traditional coordination problems, more people are taking to more streets to express frustration and, in some cases, a call for greater social justice.

Britain and Greece have experienced widespread rioting. Car torching in Germany is now way too common for comfort. France, Italy and Spain have had national strikes. Israel has seen the sudden emergence of a large social movement that has taken both local politicians and worldwide observers by surprise.

This weekend, American workers will understandably temper their celebrations. Their malaise is about more than the challenging economic headwinds. It is about fundamental social issues.

America is now on the growing list of advanced countries where social cohesion is coming under increasing pressure. If left to fester through inadequate public and private sector responses, this phenomenon will damage the welfare of current and future generations. Loud alarm bells should be ringing everywhere.

Are you tired of all the stories on Europe’s financial crisis and American politicians’ endless bickering about debt and deficits? Are you tired of weekends of hectic negotiations as policymakers rush to cobble together some agreement before markets open? If you are, you are not the only one.

Millions of people, including stressed-out policymakers on both sides of the Atlantic, wish to put these issues behind them. Unfortunately, despite many announcements, they are unable to do so decisively, and for good reason.

So we better understand why, if we want to minimize the risk of collateral damage and unintended consequences.

To do so, you need only remember one rather clumsy phrase: “safe de-levering” (also known to some as “safe de-leveraging”), or the lack thereof. Consider please each word, starting with the second one.

De-levering refers to the rehabilitation of balance sheets that have gotten over-indebted to such an extent that they are unsustainable going forward. The contributing causes are usually numerous and many years in the making.

In Europe, three peripheral countries face immediate and significant de-levering pressures. Greece and Portugal are two of them. They had too many years of irresponsible government spending, inadequate taxation, weak public administration, and insufficient economic growth. The third, Ireland, was fiscally responsible but made the big mistake of using what was a relatively healthy public balance sheet to assume the massive losses of its irresponsible banks.

These three countries now face a buyers’ strike. Lenders have been resisting the renewal of their credit lines and, needless to say, have no appetite whatsoever to provide incremental funding. No wonder interest rates have soared and financing has dried up, other than official bailouts from neighboring countries, the European Central Banks and the International Monetary Fund.

The result is not just a liquidity crisis; but also a solvency one. With government gross debt burdens ranging from 100 percent of GDP in Portugal to 156 percent in Greece, these countries are now embarked on an unpleasant, forced de-levering process.

America’s case is different. Yes, it has a high budget deficit (over 10 percent of GDP) and has experienced a dramatic increase in its debt-to-GDP ratio since the global financial crisis. Yes, the fiscal outlook gets cloudier as a result of a structurally weak budget. But unlike peripheral Europe, it is nowhere near an immediate liquidity crisis.

America’s creditors are more than willing to fund the country at historically low interest rates. Rather, it is political squabbles that have dramatically brought forward medium-term fiscal challenges, and have done so through the use and misuse of the debt ceiling, an arcane but, as we have all found out, a rather lethal legislative weapon.

We should all accept that Europe and America — the former for fundamental reasons and the latter for self-inflicted ones — are now in a de-levering cycle whose consequences will be with us for many years.

The actual process of de-levering can play out rather quickly. Indeed, too fast a de-levering can be catastrophic in terms of its impact on growth, employment and poverty. So you can be sure that policymakers will do their utmost to deliver a safe, gradual process.

The best way to do so is through high economic growth. This maintains living standards and generates incremental income to pay off debt, thus providing an orderly path to medium-term debt sustainability. Unfortunately, this option is not available today to either Europe or the US as both are stuck in what PIMCO has been describing for over two years now as the bumpy journey to a new normal.

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. They will remain in this regrettable situation until policymakers become more serious about a comprehensive and coordinated set of measures to remove structural impediments to sustained economic activity — including steps to improve the functioning of the housing and labor markets, better worker retooling and retraining, enhanced education systems, even more bank lending, improved productive infrastructure, etc.

If they are unable to grow out of their debt problems, countries have four other options. Two of these are also available to us as individuals: we 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.

Because countries control the printing presses and write regulations — things that the rest of us do not have or cannot do — they have two additional alternatives. They can try to inflate their way out of the debt, or they can reduce it through years of “financial repression,” that is, paying millions of depositors and creditors much less than they deserve in order to divert funding to debt payments.

Judging from what we have seen so far, governments are opting for different mixes.

The three peripheral European governments are imposing harsh austerity on their populations — remember the riots in Greece? — and also benefiting from the willingness of their European neighbors to financially repress their citizens in order to provide additional official funding. At least one (Greece) is having to go further by also partially restructuring its debt.

America is talking about austerity, including this past weekend’s compromise fiscal framework, but using financial repression. So far, this has taken the form of the Federal Reserve maintaining interest rates at extremely low levels for an exceptionally long period of time — so much so that savers and creditors are paid interest rates that are below inflation, and in some cases, well below inflation.

This 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. Also, it will attempt to generate unanticipated inflation. Ultimately, it will be forced into more painful austerity involving both spending and tax measures.

The de-levering pressures will be with us for years, and governments will mix and match from the menu of options. Accordingly, periodic debt dramas and crises will not go away any time soon. Debt is simply too high and there isn’t enough economic growth to painlessly de-lever.  Each response that governments decide to adopt has different implications for us, as savers, investors, debtors, home owners, and business people (the topic of a future piece).

Unfortunately, none of us have the ability to fully insulate ourselves from the collateral damage and unintended consequences. The best we can do is to understand the process, including what governments will do. In this way, we can try to minimize, though never eliminate, the adverse impact of de-levering.

By Mohamed A. El-Erian
The opinions expressed are his own.

Friday’s stunning and very public quarrel between the president and the Speaker of the House of Representatives was the catalyst for a weekend of frantic negotiations on how to increase America’s debt ceiling, maintain the country’s sacred AAA rating, and avoid a near-term default. Meanwhile, administration officials and members of Congress took to the airwaves on Sunday trying, but largely failing, to strike the balance between statesmanship and another round of the Washington blame game.

It was hoped that all this would serve as a prelude to a political compromise announced just before the opening of Asian markets. This did not materialize. But while another self-imposed deadline has been missed, it is likely that the nation’s leadership will stumble into a short-term compromise over the next few days — one that raises the debt ceiling and avoids a debt default but, importantly, leaves the AAA rating extremely vulnerable and does little to lift the damaging clouds hanging over the US economy.

It will come down to the wire; and when the stopgap compromise is reached, many in Washington will declare victory and, in the process, claim credit for averting a national disaster. Yet the resolution will likely be temporary, and the damage will be real and long-lasting — both of which render an already worrisome situation even more difficult going forward. Indeed, by illustrating so vividly to the whole world what is ailing America, the weekend’s political theatrics should make us all worry even more about the world’s largest economy.

First, consider the context. America’s already-fragile economic psyche and its global standing have taken a material hit. Forget about “animal spirits” for now. Instead, worry even more about an economy that is already having tremendous difficulty sustaining an acceptable growth momentum, and that already suffers from an unemployment crisis that is increasingly protracted in nature. Analysts will now scramble to again revise down their projections for growth, and up those for unemployment.

Second, remember the content. The debt and deficit issues that are at the root of the debt ceiling drama are, unfortunately, a small part of a much larger set of structural impediments to employment, investment and wealth creation. The housing sector is still languishing, credit intermediation is uneven, infrastructure investment is lagging, job skill mismatches are increasing, and income and wealth inequalities are worsening.

Third, lament the process. Virtually all Americans worry about these problems and too many feel them acutely on a daily basis. Astonishingly, however, our elected representatives and their appointees are just bickering and, distressingly, failing miserably to communicate a vision that provides for even the smallest amount of medium-term optimism. The endless political squabbles compel all to question whether politicians are aware of Main Street’s realities, let alone up to the task of making things better.

Finally, don’t forget the international angle. Anyone who travels will tell you that America’s friends and allies are bewildered at what is going on here (and its enemies rejoicing). This comes at a time when the country can ill-afford to lose the confidence of large foreign holders of US Treasury bonds, overseas manufacturers with factories here, those that use the dollar as the reserve currency, and the many who have outsourced to here the intermediation of their hard-earned savings and pensions.

Yes, after taking it to the edge, it is still highly probable that Washington will manage to step back from defaulting on the national debt. But no one will, or should, feel good about how this happens.

It is highly likely that the solution will be a band aid that has to be replaced in the coming months. In the meantime, America’s structural injuries will deepen and, to an extent that was unthinkable, America’s economic future will become even cloudier.

This country’s turnaround is less of an economic engineering predicament and more of a political fix. But if Washington continues to squabble and if acrimony intensifies further, it will quickly become both.

This piece originally appeared on the Huffington Post.

By Mohamed A. El-Erian
The opinions expressed are his own.

With its high unemployment and stretched balance sheets, today’s US economy can ill-afford a negative shock from abroad. Yet, this is what it is experiencing. And it explains why markets go through bouts of nervousness about the debt crisis in Europe, and why American policymakers are worried about a foreign financial situation that is getting worse by the day.

Europe’s debt problem is indeed a headwind for what remains a disappointing US economic recovery. It dampens America’s export prospects, can raise the cost of borrowing for some American companies and diminishes an already low enthusiasm among banks to lend to households and small companies.

Having said that, it is unlikely, though not inconceivable, that Europe’s debt crisis would constitute a “Lehman Moment” — a situation that totally paralyzes American economic activity, puts the country on the verge of a depression and triggers yet another round of extreme crisis management measures.

There is now broad-based recognition of America’s persistent economic weakness. Most recently, the Federal Reserve has been forced again to revise downwards its growth projections for both 2011 and 2012. Moreover, with refreshing candor that speaks well to the uncertainties felt by the average American, Fed Chairman Ben Bernanke acknowledged in his second ever press conference on June 22 that only part of the economic weakness is due to transitory factors such as higher oil prices and supply disruptions associated with the Japanese tragedies.

As Bernanke hinted, and as PIMCO’s analyses have demonstrated for a while, the US unfortunately faces four structural headwinds that are yet to be addressed properly by policymakers.

First, and nearly three years after the global financial crisis, the US housing market is still unable to find a firm enough footing. This undermines confidence and limits labor mobility.

Second, joblessness remains worrisomely high, and to make things even worse, is increasingly structural in nature. Witness the 9% unemployment rate, declining labor participation and an alarming 24% unemployment rate among 16-19 year-olds and a 40% rate for African-Americans.

Third, credit is yet to flow properly in the economy. With bank lending still hampered, it is small companies and poorer households that suffer the most.

Fourth, there is a problem of debt and leverage. Coming off a “great age” of debt and credit-entitlement that went way too far, balance sheet rehabilitation has been uneven and generally insufficient. Yes, some sectors, led by multinational companies, have recovered strongly. But far too many in the private sector are still over-indebted. Meanwhile, public balance sheets, be they of the Federal Reserve or the fiscal agencies, are contaminated to such an extent that they now constitute a source of medium-term uncertainty.

Policy responses have been too timid in the face of the economic challenges, and for too long, lacking a central vision. Instead, they have been ad hoc, too reactive and lacking sufficient structural underpinnings.

In the absence of a credible alternative, the role of the country’s main economic spokesperson has fallen to President Obama who, understandably and correctly, is extremely busy with many other national and international priorities. Meanwhile, the other arms of government — Congress in particular — are hostage to extreme political polarization, posturing and bickering. And the recurrent drama associated with budgetary legislation discussions — including the continuing budgetary resolution of a few months ago or today’s debt ceiling debate — adds to the uncertainties facing the nation.

In sum, this is not an economy that is well positioned to deal with a shock from abroad, let alone a major one. Its ability to absorb a systemic shock has been worn down by persistent internal economic weaknesses and the agility needed to sidestep, or at least minimize the impact of the shock, has been eroded by slow economic policy responses and stretched balance sheets.

All this helps to explain America’s concern about Europe’s debt crisis, which has led to periodic selloffs in capital markets and warnings from policymakers. It also speaks to why some commentators have gone as far to suggest that the country faces another “Lehman Moment” — a devastating shock that totally paralyzes the economy, disrupts the functioning of the financial system and pushes the country to the verge of a great depression.

This situation was last faced in the fourth quarter of 2008 following the disorderly collapse of Lehman Brothers, the investment bank. As illustrated by various recounts of those nervous months, policymakers came very close to losing complete control of the situation, despite all the firepower at their disposals.

Indeed, if it weren’t for the aggressive use of what was at that time a relatively healthy public sector balance sheet (especially that of the central bank’s), the US would have been forced into temporarily shutting down its financial system (including by declaring a “bank holiday”) and experiencing an economic depression which, according to some, would have been worse than that of the 1930s.

The question of the “Lehman Moment” becomes even more important now that policymakers have less firepower at their disposal to counter a huge shock. So what should we expect in the months ahead?

To be sure, the European debt crisis is a serious political, economic and financial engineering predicament that is hard to solve. As such, it will likely get worse before it gets better. In the process, it will slow global economic growth, increase risk premiums and darken the cloud over the health of the financial sector in Europe.

None of this is welcome news to an American economy that urgently needs to create jobs. But it need not result in a repeat of the total Lehman paralysis provided three conditions are met: a banking system that remains robust, no disruptions to money market funds and limited blockage to the plumbing of the country’s payments and settlement system.

Chairman Bernanke has spoken publicly to all three. Noting the Fed’s focus on these issues, he has indicated that the US does not face a new Lehman Moment.

Published data, to the extent that they are comprehensive and accurate, support his view; as do the actions taken by certain institutions. But risks remain, particularly within a money market complex starved for yield, and where certain firms appear to have stretched far and wide for extra returns.

A small risk of a catastrophic event should never be ignored. Accordingly, there is no room here for any complacency among policymakers whose economic management to date has fallen far short of what is needed to create jobs and put the country back on the path of high and sustained economic growth. Indeed, Europe serves to amplify warning sirens that have been ringing for a while.

Let us all hope that the increasing volume of the alarm will finally push America to design and implement the type of holistic measures that are desperately needed and long overdue. In the meantime, risk-averse companies, households and investors are justified in taking some extra precautionary steps.

Note: Mohamed El-Erian will be doing a live Q&A on Reuters.com on Thursday, July 7 at 9 a.m. ET. He will be answering your questions and responding to your comments about this piece along with his other previous pieces.

On Thursday, July 7 at 9am ET, CEO of PIMCO Mohamed El-Erian will be taking your questions live and answering them here. Please join us and leave your comments and questions for him below.

El-Erian’s previous columns have talked about the European debt crisis, how to make Egypt’s revolution successful, the IMF, Dominique Strauss-Kahn and Christine Lagarde and what he learned from his recent visit to Tokyo, Japan.

You can also post your questions on the Reuters Facebook page or send them over Twitter using the hashtag #askmohamed or @kherrup.

It is a great pleasure to be with you today. I would like to express my deep appreciation to the Board of Trustees of the American University in Cairo … and extend my immense congratulations to AUC’s graduating class of 2011.

At this time, and more than ever, AUC and other centers of learning in Egypt occupy a very important position in a country that is in the midst of historic transformations. In today’s Egypt, universities are — and should be — much more than centers of learning. They are critical facilitators of beneficial change for millions of Egyptians; for current and for future generations; and for the well-being of a country, a region, and a global system.

People look to our centers of learning for education and thought leadership. They look to them for guidance in navigating complex economic, institutional, political, and social transformations. And they look for them to develop the future leaders of society at every level.

All this gives our centers of learning a critical role in Egypt’s already rich and inspiring history. It is a privilege for AUC and other universities in Egypt. It is also a huge responsibility.

I have no doubt that, with sustained effort and steadfast commitment, you will deliver; and do with pride and excellence.

Speaking today at an academic institution, I could — and should — support this assertion with a well-formulated theoretical foundation, empirical evidence, and peer analysis. I should, but I will not.

Instead, I will illustrate it with two very down-to-earth analogies that reflect the importance of never forgetting the insights of simplicity.

The first comes from the 1980s. I was traveling from Cairo to New York on the direct, non-stop EgyptAir flight. We left Cairo 5 hours late, had an uneventful flight, and experienced the perfect landing that Egyptian pilots are internationally renowned for. Sitting next to an American, we did not exchange a single word during the 10-hour-plus flight — that is, until we landed.

Just after the wheels touched down incredibly smoothly, this gentleman turned to me and said “typical Egypt.” “Excuse me?” I responded. He repeated “typical Egypt.” And then went on to share with me an explanation along the following lines: “Leave Egyptians to do things on their own, and they will deliver a world class outcome. That is why we had such a perfect landing. But place them in an inefficient system, and the outcome is far from world class; and that is why we are five hours late.”

This EgyptAir story is illustrative of the fact that there are many examples of Egyptians shining in the toughest of worldwide competitions. It is about a Naguib Mahfouz and an Ahmed Zewail winning Nobel Prizes. It is about Egyptian doctors that are among the very best healers in the most respected hospitals around the world. It is about Egyptian professors that are first-class educators and researchers. It is about Egyptian artists who bring music, movies and art to millions. And it is about Egyptian football stars helping their teams win league championships in tough national and regional competitions.

Speaking of football, allow me to share the second simple analogy. This one comes from my childhood.

Growing up in Egypt, I was always among the very last kids to be picked for a soccer team at primary school. And sometimes, I would not be picked at all. Instead, I would be asked to stand behind the goal to retrieve the balls rather than play on the field.

Well, as a 10-year-old, I followed my father to New York as he assumed his post at the Egyptian Mission to the UN. I joined a school there and, quickly, I became the captain of the class soccer team.

Now it could be that I experienced some remarkable transformation during the trip to New York. I did not. The reality is that, back then, Egyptians were simply better at the sport.

I share with you these simple stories because I believe that Egypt, led by Egyptians, is today at a very special juncture.

Egyptians have a remarkable opportunity to shape a new and better destiny for their country. And the rare combination of both willingness and ability comes wrapped in a new sense of purpose, energy and engagement on the direction of the country.

Owing to the tremendous sacrifices of its many heroes, Egypt is in the midst of a revolution — a truly transformational moment in a history that goes back over seven millennia. We thank all those that bravely took to the street, forming a movement that helped all Egyptians overcome decades of fear. In the process, they united Egyptians of all ages, social classes, and religions around a simple aspiration of a better tomorrow.

To use a song that I came across when watching a wonderful American television (“60 Minutes”) interview with Wael Ghonim, and one that has been played many times in our home and at presentations that I have made in the U.S. on the Egyptian revolution-Sout el Horreya, or the Voice of Freedom sung by Hany Adel and Amir Eid: “Our dreams were our weapon…[and] all barriers have been shattered.” And to use New York Times columnist Tom Friedman’s characterization, what was delivered was a revolution “made in Egypt, by Egypt, for Egypt.”

But most revolutions are not discrete events; they are transformational processes. They are seldom easy; they can take many months and years; and the first, most visible part of a successful revolution — that of overthrowing a regime — is often a necessary condition for a successful revolution; but this huge and courageous step alone is not sufficient. It improves the probability of achieving the objective of the revolution — that of a better society for all of Egypt — but it does not guarantee success.

In today’s Egypt, the required transformations involve challenges that cut across politics, economics and finance. They have important social and geo-political dimensions. And they operate in fluid regional and global contexts. And they will not happen without continued steadfast commitment. Each of these realities is extremely complex.

Think about the challenges inherent in altering the structure of an economy so that it can deliver in a decisive and lasting manner the combination of more inclusive economic growth, greater poverty alleviation, improved international competitiveness, and low inflation.

Think of the importance of reaching the most vulnerable segments of the population in a timely manner — providing better access to education, health, nutrition and other essential social services.

Think of the challenges of keeping the country’s finances in order at a time of reduced tourist receipts, lower remittances from workers in Libya and elsewhere, and high food and commodity prices in international markets.

Think of the challenges of constructing an open and transparent political process after many decades of repression, suppression, and too much control by too few.

And think of the importance of institutions. As Jean Monnet, the famous French father of European unity, observed: “Nothing is possible without men and women, but nothing is lasting without institutions.” Egypt today faces the complex challenges of quickly adapting and building institutions that are credible and efficient.

None of these are easy; and the significant degree of difficulty compounds quickly when the challenges interact, as is the case in Egypt today.

It is tempting for a nation and for a society to feel overwhelmed by all this. Today’s Egypt should not. These are all surmountable challenges, especially if the country retains its unity, commonality of purpose, and purity of aspiration.

It may also be tempting for some of you here to feel powerless, believing that your own potential contributions pale in comparison to these significant societal challenges. You should not.

Every single one of you has the ability to make a difference in today’s Egypt. Indeed, many of you already do so, day in and day out.

You maintain the momentum for positive change. You work hard to counter the huge disparities in income and wealth, and the extremes in access to education, health and other basic social needs. And you are unwilling — and rightly so — to see millions of your countrymen and countrywomen condemned to a life of poverty, human degradation and despair.

All of you are facilitators of a better tomorrow for Egypt, of the “new Egypt.”

Indeed, nothing gives me greater joy than to hear all the stories of Egyptians volunteering to make a difference in a village, in a slum, in a school that has insufficient books, and in a hospital overwhelmed by patients.

Just a few months into Egypt’s revolution, we see concrete changes on the ground. And it is not just about new political parties, broad-based national debates, and a more generalized sense of empowerment to influence the country’s outlook. It is also about multiple daily wins.

It is about young volunteers adopting villages and neighborhoods to help make a difference on the ground. It is about individual Egyptians, like Wael Ghonim, setting up NGOs to improve the future of other Egyptian families. And it is about true visionaries, such as Ahmed Zewail, who is inspiring and leading a national project to help Egyptian society attain the scientific and technological advancements that are so essential to sustain growth, poverty alleviation and employment creation in today’s rapidly changing global economy.

AUC has also been at the forefront of change. New courses have been created to put the revolution in context, both historical and forward looking. New initiatives, such as the Tahrir Dialogues, are part of an effort to help “build a better Egypt.” Public seminars are being held to encourage debate among the many and facilitate civic and political participation. And web-based approaches are being used to facilitate volunteerism and community service.

A lot is already being done; and a lot, lot more will need to be done.

To be associated with a university in Egypt today is to occupy a very special and important place. Whether you are members of the student body, educators or administrators, you should always remember that privilege comes with enormous responsibility.

As John F. Kennedy once said, “To those whom much is given, much is expected.” And Egyptians living outside Egypt, like me, are committed to help you and others in whatever way we can to ensure a truly successful revolution and a better Egypt for current and future generations.

This is adapted from a commencement speech delivered at the American University in Cairo on June 16, 2011.

By Mohamed El-Erian
The opinions expressed are his own.

Very few of us like to be confronted with unpleasant choices. If we are, we will tend to delay a decision. And if forced to make one, we will likely opt for the choice that, in our minds at least, seems less disruptive upfront — even if we know it is likely to involve discomfort down the road.

This simple human analogy is critical in understanding why Europe’s increasingly ugly debt crisis refuses to go away. It sheds light on the choices made up to now; and it speaks to why an increasingly incoherent policy response will likely end up in tears for Greece and potentially other European economies and institutions.

Let us wind the clock back to just over a year ago when Europe first bailed out Greece, a country no longer able to pay its bills. Together with two monetary institutions — the European Central Bank and the International Monetary Fund — European politicians faced unpleasant choices and had to respond. But rather than decisively addressing the problem, they essentially opted to kick the can down the road.

There were, and still are two main reasons for Greece’s predicament: The country borrowed way too much; and it failed to grow its economy on a sustained basis. This lethal combination was amplified by weak public administration.

Yet the rescue of Greece involved making new loans to the country and was asking for a very ambitious fiscal adjustment effort. Neither the size of the debt nor growth reinvigoration were properly addressed.

I suspect this choice was not driven by a strong conviction that the approach would work. Rather, decision makers feared the complexity of the alternative which involved opting for a pre-emptive, and hopefully orderly debt restructuring, and placing much greater emphasis on structural reforms.

A year later, Greece is still in the financial intensive care unit, and needs renewed urgent attention by the “troika” of doctors — from the European Commission, ECB and the IMF.

Regrettably, the country’s condition is even more serious now, with every single one of its vitals worse than projected by these same doctors a year ago.

The economy has contracted by more than programmed: unemployment is higher, debt and deficit dynamics are worse and, with market risks measures of spreads at even more alarming levels, the country is further away from restoring access to normal capital market financing.

Understandably, the Greek government is under intense pressure at home from a population that is being asked to sacrifice tremendously but sees virtually no improvements on the horizon. Coordination among lenders is becoming more difficult as two related concerns fuel ever-growing bickering: what has happened to all the money that has already been disbursed? And, why are so many dubious liabilities being transferred to taxpayers from private creditors, who were paid an interest rate premium to take an informed risk?

No wonder Europe’s approach to its debt crisis is losing credibility. In the process, the institutional integrity of some key institutions is being undermined.

This is particularly true for the ECB which now finds its balance sheet saddled with billions of Euros of Greek bonds. Some were purchased in a failed attempt to counter the surge in Greece’s risk spreads; others are related to repo operations that have kept afloat an essentially bankrupt Greek banking system.

When you think of it, none of this should really come as a surprise to Europe’s decision makers. At its root, the approach to solving Greece’s excessive debt problem was to pile new debt on top of old debt; and the accompanying medication served more to reduce growth than improve the structural drivers of a sustained economy expansion.

Despite this obvious diagnosis, the doctors are essentially at it again; and the patient, already weakened, is forced to commit to yet greater sacrifices. Thus, Greece will get more debt-creating financing in exchange for even larger fiscal austerity.

However, it is not entirely all déjà vu. It seems that there will be two tweaks in the days ahead.

The first, involving a more structured privatization initiative, will look good on paper but is unlikely to deliver much. The second is more promising, if pursued properly. It entails “convincing” private creditors to renew their maturing loans to Greece rather than exit completely.

Notwithstanding these modifications, I fear that this new rescue of Greece will, again, only kick the can down the road. It will not materially improve Greece’s solvency outlook; nor will it do much to promote growth and employment. What it will do is fuel more social unrest in Greece and intensify tensions within the official creditor community.

There is one silver lining here. In again opting for the seemingly easier but ultimately unsustainable choice, the troika is giving other potentially vulnerable parts of Europe more time to get their house in order — thereby reducing contagion risk.

Some countries, like Spain, are taking advantage of this window. Under the guidance of the central bank, the savings banks (“cajas”) are getting serious about strengthening their capital buffers. Such capital raising should be pursued aggressively by more banks across the Euro-zone. And, hopefully, the ECB is discussing how to navigate its weakened balance sheet through the minefield of an inevitable Greek debt restructuring.

So is this tradeoff — persisting with a costly approach for Greece in order to buy time for the rest of Europe — worth it? As much as I would like to say yes, I worry that the answer is likely to be no.

First, Greece is not the only country in this highly unfortunate situation. Ireland and Portugal face similar debt and growth challenges, though somewhat less severe. Given that the troika is applying the same remedy there too, the overall cost of this unsustainable approach is even larger.

Second, the money being transferred to private creditors could be used more efficiently in safeguarding the European system directly, thus reducing vulnerability to contagion risk.

Finally, the viability of simply kicking the can down the road is undermined by growing cooperation challenges — between Greece and the troika, and within each group in this tragedy.

As Europe finalizes its new bailout of Greece over the next few days, it would be well advised to keep these considerations in mind. It is not too late to correct the course, and opt for a choice that is unpleasant upfront but offers a greater chance of success over the longer term.

Photos, top to bottom: Protesters raise arms in front of the Greek parliament during a rally against austerity economic measures and corruption in Athens’ Constitution (Syntagma) square June 5, 2011. The protest, on its twelfth day, was organized through a Facebook group called “The Indignant”. REUTERS/Pascal Rossignol; Employees of the Hellenic Postbank push a mock money box during a rally against government’s privatisation plans in Athens June 2, 2011. Greece wants to sell its entire 34 percent stake in the lender by the end of the year as part of a goal to raise 50 billion euros by 2015 to pay down its debt mountain. REUTERS/Yiorgos Karahalis