Submitted by Taps Coogan on the 9th of September 2019 to The Sounding Line.

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Allianz Chief Economic Advisor, Mohamed El-Erian, recently spoke with CNBC and succinctly summed up exactly what’s wrong with negative interest rates, why he no longer views bonds as a core asset, and the false promise of market liquidity.

Part I

Part II

Some excerpts from Mohamed El-Erian:

“I think (central banks) are afraid of what they are going to find out. And what they are going to find out is that negative interest rates erode the integrity of a market based system and the longer you persist with negative interest rates, the higher the costs and risks.”

“I think it’s well beyond banks. If it were just banks, I would be less sympathetic honestly (to complaints about negative interest rates)… You’re seeing an increasing in cash holdings (at banks), which suggest that (negative rates) are having negative impacts in lending. But more importantly, what does it do to the provision of longer term financial protection services that are key to the household: insurance, retirement? What does it do to excessive risk taking and the treat of financial instability down the road? What does it do to resource mis-allcoation? It is a really big issue.”

“…There is too much risk taking going on outside the banks… and even more dangerous, the system as a whole has over promised liquidity to end-users. Because there has been so much liquidity and so predictable liquidity that people have forgotten what it’s like to price in liquidity risk.”

“We used to think of the bond market as a core, core allocation and we went a step further and said ‘you can outperform in bonds as opposed to equities because you have all of these structural issues.’ That’s the wrong way to think about the bond market today. The bond market today is opportunistic. it is very different from a core allocation to opportunistic. So, look for opportunistic positioning.”

“Have you ever played the game of risk…? It’s all probability driven… If you can work out probabilities, you win. Put someone on the board that doesn’t pursue the objective of the game, central banks. They are non-commercial players in the bond market. They’re not doing to make money. They’re doing to pursue other objectives. They completely distort the game. So, if you stick with the old rules, you will lose. You have to understand that we have a major player in the bond market, with a printing press in the basement, that is involved for non-commercial reasons… You have to think differently about the bond market… Long term financial protection is becoming very difficult….”

There is much more to the interview, so enjoy it above.

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