Pimco's El-Erian: Central Banks Are Extended 'Well Beyond Their Comfort Zone'

Tuesday, 04 Jun 2013 01:01 PM

By Michael Kling

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Central banks face a dangerous threat to their "brands," warns Mohamed El-Erian, CEO and co-chief investment officer of fund giant Pimco.

Maintaining a strong brand means fulfilling promises and meeting expectations. If central banks fail to deliver, they will substantially damage their standing among the general public, in financial markets and in policy circles and they will damage their future effectiveness, El-Erian writes in an article for Project Syndicate.

Some central bankers have encouraged prices of many financial assets to rise to levels not supported by fundamentals, while some of stood by passively, El-Erian notes. They hope that hype by itself will improve economic fundamentals through the wealth effect by prompting consumers to spend.

Editor's Note:
Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

"Count me among those who worry about this situation," he says.

"From my professional vantage point, I sense a mounting risk of collateral damage and unintended consequences," El-Erian adds.

"Market signals are more distorted, fueling resource misallocations. Investors are piling on more risk at increasingly elevated prices. Fundamentals-based investing is giving way to a frantic search for relative bargains in an increasingly overpriced financial world."

Essentially representing a promise to deliver consistent quality, price or experience, strong brands offer a key tool to influence behavior. Federal Reserve Board Chairman Paul Volcker established the Fed's brand by defeating inflation in the 1980s, he explains.

"To many, central banks now stood for reliability and responsible power. Simply put, they could be trusted to do the right thing; and they delivered."

Central banks should look at Apple and Facebook for lessons on brand management, El-Erian suggests. Those companies suffered from overshooting public sentiment.

Investors thought Apple could continuously innovate and fend off all competitors, so took its stock to dizzying heights. Facebook's IPO price was hyped to inflated prices. Both stocks are trading at almost half their record prices.

"In both of these cases, and in many others, brand power did more than lead to price behavior that was disconnected from fundamentals; it also caused a dangerous overshoot, which, when subsequently reversed, damaged the brand," he maintains.

"By extending well beyond their comfort zone, today’s central banks face unusual brand-management risks," El-Erian observes. "Their prior ability to deliver on promises and expectations has made today’s financial markets take the forward pricing of the economy to levels that exceed what central bankers alone can reasonably deliver."

Central bankers should be more open about their inherent limitations and be more vocal in an attempt to pressure politicians and other policymakers, El-Erian advises.

"Otherwise, risking major brand damage, they will end up adding yet another item to an already-overloaded plate of challenges for the next generation."

Some commentators warn that stock markets are in a bubble and will soon crash.

"For some time now, I’ve been writing that the global equity markets have been inflated by central banks — and that this was a bubble that would eventually pop once people realized that monetary policy, rather than the real economy, was behind the boom," Rana Foroohar, Time magazine's assistant managing editor in charge of economics and business, writes in The Curious Capitalist column for Time.

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

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