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Federal Reserve 'Terrified' of Deflation: El-Erian
Published:
Tuesday, 26 Oct 2010 | 2:42 PM ET
Text Size 
By: Jodi Gralnick
Economics Producer, CNBC
Economics Producer, CNBC
The
Federal Reserve will announce a new round of easing next week because
it is “terrified” of deflation, said Mohamed El-Erian, chief executive
officer of Pimco.
But
he doesn't believe a restart of the Fed's "quantitative easing" program
at its Nov. 2 and 3 meeting will be very effective in delivering high
growth or low unemployment. Quantitative easing is a term used to refer
to the Federal Reserve injecting more money into the economy.
"QE
is meant to drive down the price of safe assets so much that we are all
pushed into doing something risky," El-Erian said in an interview
Monday at a gathering of the Financial Women’s Association of New York.
Since the Fed first hinted at a new quantitative easing program in August, the dollar has weakened
and risk assets, like stocks and commodities, have raced higher.
El-Erian did not make a specific forecast on the amount of Treasurys
the Fed would purchase, but he did say he will be looking for some
"constructive ambiguity" in the Fed's statement, which would give it
options.
El-Erian said the auction Monday of 5-year Treasury Inflation Protected Securities (TIPS) at a yield of -0.55% shows the economy is not gaining traction.
“I
think it’s an indication that the unthinkable and the improbable, or at
least what used to be unthinkable and what used to be improbable, is
not only possible but is the reality,” he said.
El-Erian
also said policy makers have done a very good job winning the war
against a second depression, but pointed out that in every war,
securing the peace is complicated.
So
what would he do if he could design a policy response? El-Erian said he
would offer a plan that would include structural reforms to make the
United States more competitive and the economy more flexible. He also
said the U.S. needs a better social safety net and “a bit of QE.”
El-Erian
does not believe QE on its own will help very much, and that with QE
alone, the same issues will persist in six to nine months, while the
rest of the world will be inflated. But he points out that the market
has priced in additional asset purchases, so there is a high risk of
disappointing investors if the Fed does not act.
As far as the upcoming elections, El-Erian said he worries about gridlock.
“Anybody
who expects gridlock to be good doesn't understand that we need to
achieve escape velocity. We need to go fast enough to start overcoming
the debt overhang and we’re not gonna do that unless some pretty hard
decisions are taken,” he said.
Globally,
El-Erian reiterated that he personally believes Greece will need to
restructure its debt within three years “because the alternative is
much worse.”
But
he said Greece is luckier than Argentina, because it is “in a better
neighborhood,” and its rich neighbors will likely help mitigate some of
its problems.
If Greece does default, the impact will be containable, El-Erian, a former IMF official, noted.
El-Erian
also explained PIMCO’s significant reduction in a key fund's gold
position from 10 percent to 3 percent. He said investing the precious
metal “doesn’t make as much sense as it used to.” Because the price has
moved so much and the trade is so crowded, he sees potential for a
large technical retracement.
—CNBC Anchor Michelle Caruso-Cabrera contributed to this report.
© 2010 CNBC.com
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