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Commentary

What We Learned From Mohamed El-Erian

Allianz's chief economic advisor discusses policy responses to the coronavirus and what investors can do.

Editor's note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Mohamed El-Erian--chief economic advisor at Allianz, the parent of Pimco--recently spoke to Jeff Ptak, global director of manager research at Morningstar Research Services, in a special edition of Morningstar's podcast The Long View

As the world grapples with the fallout from the coronavirus, El-Erian talked about the impact he foresees for the private and public sectors and what his views as the correct policy response for addressing each.

Here are excerpts of El-Erian's comments during the interview, which aired on March 23, 2020. 

The Correct Policy Response to Market Instability
El-Erian: Monetary policy should be focused on ensuring that market malfunctions don't reverse contaminate the real economy. Low interest rates will not do much. But fiscal policy is different. And what fiscal policy can do is help people through this economic sudden stop, so that people can manage, protect the most strategic sectors of our economy, and make sure that when we restart this economy, liquidity problems haven't turned into solvency issues. 

How Policymakers Should Deliver Stimulus to Affected Segments of the Economy
El-Erian: We're going to need principles to govern who gets and who does not get bailouts, because the line is going to be very long. Every single segment in the economy, except for a handful, will go through the demand and supply destruction that the airline industry has gone through. So, it's important that the government figures out very early on what are the technocratic principles that are going to govern why we're bailing out, who we're bailing out, when, on what terms, and what's the exit strategy. 

The Differences in Sudden Stops
El-Erian: Financial sudden stops, while they happen instantaneously and they seem catastrophic, are easy to identify and easier to address. It doesn't sneak up on you, like economic sudden stops do. A financial sudden stop basically boils down to which counterparty can you trust; in 2008, a classic financial sudden stop, banks didn't trust each other. So, the Federal Reserve could insert itself in the counterparty breakdown, fix that market failure, and then the system slowly restarts.

Economic sudden stops are very different. They sneak up on you. Dealing with the underlying source is very difficult. In this case, it's a health issue. So, stimulus policy, which is the equivalent of the central bank intervention in the case of financial sudden stops, does not work. You can help with the balance sheets; you can protect people that way. But unfortunately, you cannot reactivate economic activity until the health issue is addressed. People put health in front of everything else.

What Can Be Done to Stabilize the Market
El-Erian: The key issue is health. That is what stabilizes it in a sustainable, long-term manner. In the short term, there's potentially two stabilizers, one that is good and one that is less good. The good one is that the central banks and other financial regulators are able to pinpoint where the stress is and are able to provide ample emergency interventions. The less desirable way of stabilizing this are market overshoots, that you get very sharp reduction in market values, so sharp that people with cash available--and there are many people on the sidelines with cash available--see that the balance of risk is clearly on the upside because prices have overshoots. 

What Investors Can Do Amid the Unpredictable Circumstances of COVID-19 
El-Erian: You need a few principles to guide you. And you need to ask yourself two questions, and they are critical questions: Which mistake can I least afford to make? Which mistake can I not afford to make? That's a question that every investor should be asking themselves when they look at their asset allocation. It speaks to their tolerance for risk, their tolerance for volatility, and also, what is the time span they think of in terms of their investments. So, that's the first set of questions that each individual investor has to ask; not what will go well for me, but which mistakes can I not afford to make.

This article was adapted from an interview that aired on Morningstar's The Long View podcast. Listen to the full episode.