Pimco’s El-Erian Revisits The New Normal

August 29, 2013

An analysis of what investors should expect in the future.

[This article originally appeared in the September/October Journal of Indexes.]


In four quick years, the concept of the "new normal" has gone from being viewed as unlikely by most analysts and policymakers to becoming consensus. The popular application of the phrase now extends well beyond its original conceptualization that simply encompassed economic and financial prospects. It has also been used to describe medical procedures, unusual weather patterns and geopolitical shifts. It even gave rise to a television series.

Yet all is not well for the concept of the new normal. Yes, its popularity has expanded. Yes, it has become conventional wisdom in most policy and market circles. And yes, the concept has proven consequential for evaluating the effectiveness of policies and the potency of traditional investment approaches. But there is also an important qualification: The concept itself is morphing, evolving to describe a contextual configuration that is less stable and more unpredictable.

The purpose of this paper is to analyze what lies ahead for the new normal, and why.

After summarizing how the new-normal concept emerged at Pimco and eventually became consensus view, this paper explains why it is likely to morph in the years ahead. Specifically, it argues that, within the next five years, the popular characterization of the phrase will evolve—away from the notion of an equilibrium, as unsatisfactory as its economic components have been for the West, to the neck of a what the British call a "T-junction." And the consequences are material for policies, investing and the well-being of current and future generations.

Allow me to take you back to the beginning of 2009. Severe disruptions from the global financial crisis still dominated financial markets. Economic damage was substantial and spreading. Governments and central banks were throwing in all they had to counter and overcome this costly storm. And institutional investors and professional money managers were trying to both navigate the dislocations and position their clients' resources for what would follow.

Having understood relatively early on the nature of the "sudden stops" and what they entailed, including the early 2008 notion that "unthinkables were thinkable," Pimco was spending many long hours detailing the different ways this global storm could evolve.

Would the storm eventually exhaust itself, or would policy measures change its course and limit further damage? Would it analytically prove the equivalent of a severe cyclical shock, or would it involve material structural and secular shifts? And how would the institutional underpinning withstand its direct and collateral damage?

These were just some of the questions that we discussed. As we debated the various related scenarios, we came across an important finding that would shape much of our subsequent analysis: The eventual recovery that Western countries would follow would be far from a traditional one (and particularly so for the highly finance-dependent economies such as Ireland, the United Kingdom and the United States).1

We concluded that the global economy was experiencing much, much more than a traditional cyclical downturn. It was in the midst of a paradigm change that was also secular and structural in nature. And most policymakers and market participants, understandably consumed by severe crisis management, were yet to comprehend the world's new reality, let alone formulate the type of responses required.



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