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08.15.2012 0

El-Erian’s challenge to Ryan on the ‘new normal’

By Robert Romano — The “new normal” — a Ship of State lost at sea in economically turbulent waters — will not be undone merely with a changing of the guard. So proclaims one of the principal authors of the hypothesis that after the financial crisis the economy would not recover in typical fashion.

On Aug. 14, Mohammed El-Erian, CEO and co-chief investment officer of the world’s largest bond trader, Pimco, challenged Mitt Romney’s vice-presidential nominee, Rep. Paul Ryan, over his comments that “I hear some people say that this is just ‘the new normal.’ High unemployment, declining incomes and crushing debt is not a new normal. It’s the result of misguided policies.”

El-Erian, writing for the Washington Post, says that Ryan is “both right and wrong,” and that understanding how will determine if Ryan’s prediction that “next Jan., our economy will begin a comeback” will ever materialize no matter who wins in Nov.

The Pimco head explained that the new normal “was not just a prediction that in the absence of fundamental policy adjustments the West would face an unusually sluggish recovery process,” but that with the ongoing transfer of global wealth to emerging economies like China and Brazil, “the system of global governance would join its national and regional counterparts in being operationally challenged, as well as having its legitimacy questioned and its credibility undermined.”

For El-Erian, the problem is less the proper mix of fiscal and regulatory policies, as in conventional — and usually inadequate — explanations of the current state of political and economic affairs. Instead it is “more about an economy that must find a way to safely ‘deleverage.’ We must overcome the many years during which policymakers lost sight of sustainable drivers of growth and jobs and instead ended up relying on excessive leverage, overindebtedness and an absurd sense of credit entitlement.”

Here, El-Erian is referring not just to the $15.9 trillion national debt, but to the overall debt overhang that continues to drag advanced economies down all over the world — some $54 trillion of credit outstanding nationwide and tens of trillions more overseas. Overall, these debts, both public and private, represent well over 300 percent of the combined Gross Domestic Products (GDP) of the world’s largest economies.

Such obscene levels of debt have financed everything from consumer spending to housing to education to government expenditures. But no longer. So large have those debts become, credit can no longer expand.

After doubling like clockwork for decades, since the financial crisis, gross credit outstanding has remained flat — and for a debt-addicted economy, this poses big trouble.

Since the crisis, both the Keynesian (fiscal stimulus) and monetarist (monetary expansion) prescriptions have failed to restore the prosperity Americans have grown accustomed to. After more than $3 trillion of such policies, 27 million Americans remain unable to find full-time work or have given up all together.

There is another way, and El-Erian points to it, but getting there will not be easy.

To get back on course, credit outstanding nationwide needs to be safely returned to about 150 percent or so of GDP — where it was from 1945 to 1970 before the gold standard was fully abolished in 1971 by Richard Nixon.

Of course, the role government plays in the economy should not be lightly discounted — particularly as they relate to energy, the environment, health, and labor regulations. Also, high taxes and inflation too make it costly to do business in America and favor economies overseas without such built-in costs.

But merely tinkering around the edges of tax and regulatory policy may not be enough. If this were a normal recession, the economy would have already rebounded in spite of these destructive government policies. The debt overhang problem El-Erian points to is real.

And, should Romney and Ryan prevail in Nov., they had better figure out a way to address it, or else they too may become political victims of the new normal in 2016.

Robert Romano is the Senior Editor of Americans for Limited Government.

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