Markets’ Federal Reserve Love Story

Mohamed A. El-Erian

MAY 21, 2014
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LAGUNA BEACHThe morning drive to my 11-year old daughter’s school is always fun, and often a source of insight. That was certainly the case last week when she pointed out something about Frozen, the hugely popular Disney film, that had totally escaped me. “It’s unusual,” she said, “to see a Disney movie in which they end up telling us not to marry someone we’ve just met.”

Quite early on in the movie, Princess Anna meets Prince Hans at her sister Princess Elsa’s coronation ball. They immediately connect on many levels and, yes, “fall in love.” He quickly proposes, and she accepts, but Elsa refuses to give her blessing.

It then takes Anna most of the movie to figure out that Hans is evil set on getting rid of both her and her older sister in order to take over the kingdom. Luckily for her, there is a wonderful commonerKristoffwhom she has gotten to know during the course of her adventures. Unlike Hans, he is genuine and dependable; they end up together.

After many decades of Disney movies, we have been conditioned to expect princesses to fall in love quickly with their charming princes and “live happily ever after.” And when there are challenges or obstacles (mostly in the more recent movies), these are quickly overcome (and with humor).

Similarly, for many years market participants have been richly rewarded for falling in lovequickly and decisively – with the new policy measures adopted by America’s Federal Reserve. Indeed, the romance has overwhelmingly followed the Disney script. Yes, there may have been some bumps along the way, but they have been overcome quickly. And the romance has resulted in both parties living happily: the Fed feels better positioned to pursue its dual mandate of high employment and stable inflation, while investors feel that they have the opportunity for sizeable financial rewards.

This relationship has been so comfortable that market participants have adopted the mantraNever fight the Fed” – and for good reason. The Fed is the world’s most powerful central bank. It owns the printing press that produces the world’s main reserve currency. It enjoys a significant amount of political independence. And it has not been shy about using its considerable operational autonomy.

Market participants also know that the Fed needs them to leverage its policy influence and deliver on its mandate, which, in recent years, has rightly been broadened in practice to incorporate the goal of financial stability. To this end, the Fed has become much moretransparent” with markets in the last few years, sharing more readily the minutes and transcripts of its policy discussions. The Chair of the Federal Reserve Board has even taken to holding periodic press conferences that are closely watched on trading floors around the world.

Since the 2008 global financial crisis, the romance has become particularly intense, especially as the Fed has been compelled to use a range of unconventional measures to overcome the capital-market disruptions that almost tipped the world economy into a deep depression. In doing so, the Fed has become more involved in how markets function, the valuation of assets, and fluctuations in their prices. And the markets have come to depend much more on the Fed, expecting more frequent attention and support from it (and throwing a short tantrum when they feel disappointed, as was the case a year ago).

Initially, central bankers were keen to cultivate this romance as a means of meeting their broader policy objectives of growth, employment, stable inflation, and financial stability. More recently, however, some have become less comfortable, warning that the codependence is encouraging excessive risk-taking and, in some cases, bubbly valuations. Some worry that it may even undermine the Fed’s political independence. And, only two weeks ago, an outgoing Fed governor, Jeremy Stein, declared that the Fed is in the middle of a policy transition that renders its guidance to marketsmore qualitative,” “less deterministic” and, therefore, less precise.

Like Princess Anna in Frozen, it will take time for markets to recognize that their relationship with the Fed is changing (and should change); and, similar to the movie, some sort of shock may be involved in socializing the new understanding. Having said that, the outcome will certainly not be as dramatic as in the movieif only because, unlike Hans, the Fed is not out to take over the markets.

So the romance will survive, but it is unlikely to be as intense, and it is unlikely to be unconditional. The hope is that, by that time, a more vibrant real economy will perform the role that Kristoff played in the movie.

The best and most sustainable love story for markets is one based on a healthy and dynamic real economy that creates jobs and opportunities for many more people. Unfortunately, on that count, it is too soon to predict whether we will live happily ever after.


Mohamed A. El-Erian, Chief Economic Adviser at Allianz and a member of its International Executive Committee, is Chairman of President Barack Obama’s Global Development Council. He previously served as CEO and co-Chief Investment Officer of PIMCO. He was named one of Foreign Policy's Top 100 Global Thinkers in 2009, 2010, 2011, and 2012. His book When Markets Collide was the Financial Times/Goldman Sachs Book of the Year and was named a best book of 2008 by The Economist.


May 20, 2014 6:54 pm


India’s election remakes our world

Modi must accelerate economic progress to benefit the vast majority, not just the elites

Ingram Pinn illustration©Ingram Pinn


Surjit Bhalla, an Indian economist, has written to me that India’s is “the most momentous election in world history”. I disagree: the elections of Abraham Lincoln and Franklin Delano Roosevelt were more significant. But the idea is not absurd
India’s population is 1.27bn. Soon it will overtake China as the most populous country. If the election of Narendra Modi were to transform India, it would transform the world.

It is already possible to identify at least three ways in which the election is remarkable.


To enlarge graph click here

Seats in Lok Sabha and the Indian economy


First, India has shown yet again the signal virtue of democracy: the peaceful transfer of legitimate power. That this is possible in such a vast, diverse and poor country is an inspiring political achievement.

Second, Indians have rejected the dynastic politics of the Congress party, which, alas, brought to a sad end the distinguished public service of Manmohan Singh, a man I have known and admired for four decades. The most important Congress-led government since the days of Jawaharlal Nehru was that of Narasimha Rao in the early 1990s, under whom Mr Singh served as reforming finance minister. If Mr Modi succeeds, it will be because he builds on that foundation. Congress still has the best chance of being the strong secular party India needs, but only if it liberates itself from its dependence on the Gandhi family.

Third, Mr Modi truly is a self-made man. Even though his party won just 31 per cent of the vote, he has gained an overwhelming majority in the lower house. He has done so by promising to spread the perceived successes of Gujarat to the rest of the country. There is debate in India over whether Gujarat is the model it is alleged to be. Yet that is not the main point. What matters more is that Indians have chosen a man who promises to improve their lives. He is not chosen for his origins. That is testimony to India’s transformation over the past quarter of a century.

The outgoing government is condemned as a failure. Yet, as Shankar Acharya, former chief economic adviser to the Indian government in the 1990s, points out, “economic growth has averaged 7.5 per cent a year, the fastest in any decade in Indian history. This rapid growth in gross domestic product has raised average income . . . by nearly 75 per cent in real, inflation-adjusted rupees.” This sounds good. But, he adds, it also hides the truth.

Growth slowed sharply over the past three yearsbecause of the cumulation of bad economic policies”, while consumer price inflation has risen to between 9 and 11 per cent over the past five years. At the same time, Mr Acharya says, the government’s policies became steadily worse. He points to exorbitant spending on subsidies for oil, food and fertilisers, wasteful entitlement programmes, exorbitant pay settlements and huge fiscal deficits. Other failures include the refusal to lift disincentives to employment, crony capitalism, capricious regulation, retrospective taxation, excessive jumps in food procurement prices and corruption.

Mr Acharya argues that all this has contributed to a daunting legacy: a failure to create jobs for the 10m young people entering the job market each year; stagnation in manufacturing; inadequate infrastructure; huge overhangs of incomplete projects; vulnerability of agriculture due to water stress; badly run entitlement programmes; the weakening of the country’s external finances; and further deterioration in the quality of governance itself.

Mr Acharya is a sober analyst of Indian economic realities, who worked closely with Mr Singh in the 1990s. His damning assessment is persuasive. Yet India can surely do better. The latest estimates suggest that GDP per head is just a tenth that of the US, and half that of China. It must be possible for this country to catch up even faster.

Mr Modi has above all been elected to accelerate development. But if one recalls the failure of his Bharatiya Janata party’s India shining campaign of a decade ago, he must do so in ways seen to benefit the vast majority of the population, not just its elites.

It is not clear whether Mr Modi can rise to such big challenges in this vast and complex country. His motto – “less government and more governance” – has caught the public mood. Yet it is not clear what this will mean in practice.

An analysis by JPMorgan suggests that in factthere is a remarkable convergence of broad economic thinking” between the two main parties. The difference, if so, might be more in implementation, an area Mr Modi’s supporters also stress. This suggests that the goods and services tax (a national value added tax) might be put into effect, investment projects might be accelerated, energy prices might be liberalised, shares in public enterprises might be soldalbeit without full privatisation – and fiscal consolidation might be accelerated.

This would be to the good, but probably not enough to bring about the needed acceleration of growth and jobs generation. Vital further reforms would be in employment regulation, education and infrastructure, with a view to making India a base for labour-intensive manufacturing. With Chinese wages rising, this is a plausible ambition. Improvement in the administration of law is crucial. Agriculture needs big advances, including a more modern supply chain. The states need to be forced to compete with one another for people, capital and technology.

This election might prove to be a big step towards the economic modernisation of India that was relaunched in 1991. But this round of reforms will also be far harder than those were. It is not now just a matter of pulling the state out of the way. It is more about making the government an effective and honest servant of the Indian people. This challenge is possibly an order of magnitude more daunting than those Mr Modi once overcame in Gujarat.

Mr Modi remains an enigma. He is a man of action, a nationalist and a committed member of the Hindutva movement. It is hard to believe he would match Mr Singh’s emollient reaction to Pakistan’s promotion of terrorism. It is impossible to know what he might mean for India’s communal relations. Nobody knows either how far he feels obliged to the business people who funded his campaign. But one thing is sure: India has a new game. Pay attention.


Copyright The Financial Times Limited 2014


Why Jeffrey Sachs Matters

Bill Gates

MAY 21, 2014
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Newsart for Why Jeffrey Sachs Matters

SEATTLEBono calls the economist Jeffrey Sachs “the squeaky wheel that roars.” To me, Sachs is the Bono of economics – a guy with impressive intelligence, passion, and powers of persuasion who is devoting his gifts to speaking up for the poorest people on the planet. So I was not surprised that a journalist would find Sachs to be a compelling central character for a book – and a good way to draw readers into the potentially dry subject of international development.

In The Idealist, Vanity Fair writer Nina Munk draws a nuanced portrait of Sachs and his Millennium Villages Project (MVP) – a $120 million demonstration project intended to show the world that it’s possible to lift African villages out of poverty through a massive infusion of targeted assistance. It would have been easy, and perhaps more marketable, for Munk to draw a caricature, overly accentuating Sachs’s negative qualities at the expense of his great gifts. But she doesn’t.

Munk spent six years researching for the book, getting to know Sachs well and living for extended periods in two of the 15 Millennium Villages. She clearly appreciates the importance and difficulty of what Sachs and his team are attempting to do.

Unlike most books about international development, Munk’s book is very readable and not long (260 pages). I’ve told everyone at our foundation that I think it is worth taking the time to read it. It’s a valuable – and, at times, heartbreakingcautionary tale. While some of the Millennium Villages succeeded in helping families improve their health and incomes, the two villages that Munk spent the most time studyingDertu, Kenya and Ruhiira, Ugandadid not come close to realizing Sachs’s vision.

When Sachs first started planning the project, he came to the foundation for support. We were already a big supporter of his efforts at Columbia University’s Earth Institute and felt it was invaluable to have him focused on the needs of poor countries.

His pitch was intriguing. He was picking a handful of villages to be the focus of intense interventions in health, education, and agriculture all at once. His hypothesis was that these interventions would be so synergistic that they would start a virtuous upward cycle and lift the villages out of poverty for good. He felt that if you focus just on fertilizer without also addressing health, or if you just go in and provide vaccinations without doing anything to help improve education, progress won’t be sustained without an endless supply of aid.

My colleagues and I had a number of concerns about Sachs’s approach. We questioned his assumptions about how quickly the gains would materialize, what would happen when the MVP funding was phased out, how much governments would contribute to offset the high per-person costs, and how feasible it was to measure progress (given the likelihood that people from the surrounding area would stream into their villages once the MVP aid started flowing). So we decided not to invest in the MVP directly, although we were happy to keep supporting his other work.

Now that the project has not gone as planned, I’m not about to throw stones. We have many projects of our own that have come up short. It’s hard to deliver effective solutions, even when you plan for every potential contingency and unintended consequence. There is a natural tendency in almost any kind of investment business, philanthropic, or otherwise – to double down in the face of difficulty and failure. I’ve done it, and I think that most other people have, too.

So what went wrong? For one thing, the villages that Sachs picked experienced all kinds of problems – from drought to political unrest. For another, the MVP took an idealisticField of Dreamsapproach. MVP leaders encouraged farmers to switch to a series of new crops that were in demand in richer countries, and experts on the ground did a good job of helping farmers to produce good crop yields by using fertilizer, irrigation, and better seeds.

But the MVP didn’t simultaneously invest in developing markets for these crops. According to Munk, “Pineapple couldn’t be exported after all, because the cost of transport was far too high. There was no market for ginger, apparently. And, despite some early interest from buyers in Japan, no one wanted banana flour.” The farmers grew the crops, but the buyers didn’t come.

Of course, Sachs knows that it’s critical to understand market dynamics; he’s one of the world’s smartest economists. But in the villages Munk profiled, Sachs seems to be wearing blinders.

Warren Buffett likes to say, “The rearview mirror is always clearer than the windshield.” Through that rearview mirror, we can see that the project never had an economic model that could sustain successes once the MVP dollars ran out.

All of the interventions involvedhealth, agriculture, infrastructure, education, and business seed moneymake sense if carried out carefully, over time. But I am surprised by how little Sachs dug into country budgets, and that he didn’t work to convince governments to commit to additional taxation to fund more of these interventions domestically.

Through the rearview mirror, we can also see that many of Sachs’s ideas have proved to be exactly right. Munk details his 2007 fight with international aid donors who were refusing to distribute insecticide-treated bed nets for free because they favored a market-based approach whereby people would pay a small amount for each net. To put it mildly, Sachs didn’t make any friends in the process of advancing his case for free bed nets.

Through increasingly ruthless tirades, he wound up alienating potential allies who want to defeat malaria just as badly as he does. But history will show that Sachs was absolutely right. We have since seen that the free model has allowed for much broader distribution of bed nets – and much greater reductions in malaria – than market models.

In the end, I hope poverty fighters will not let the MVP experience stop them from investing and taking risks. In the world of venture capital, a 70% or 80% failure rate is considered a great track record. In the world of international development, critics hold up every failure as proof that aid is like throwing money down a rat hole. When you’re trying to do something as hard as fighting poverty and disease, you will never achieve anything meaningful if you’re afraid to fail.

I greatly admire Sachs for putting his ideas and reputation on the line. After all, he could have a good life doing nothing more than teaching two classes a semester and pumping out armchair advice in academic journals. But that’s not his style. He rolls up his sleeves. He puts his theories into action. He drives himself as hard as anyone I know.

I suspect that Sachs, like all relentless thinkers and doers, will learn from his missteps and come back with stronger ideas and approaches. Sachs will always be a squeaky wheel that roars – and the world will be a better place for it.


Bill Gates is Co-Chair of the Bill & Melinda Gates Foundation.