Mohamed El-Erian: The U.S. Missed a Huge Opportunity to Really Fix the Debt Problem

Mohamed El-Erian spoke to Bloomberg about the debt-ceiling deal and the U.S. economy. El-Erian said that Standard & Poor’s (NYSE:MHP) “will downgrade the U.S.” if the ratings agency sticks to what it outlined last month.

El-Erian on the chances of a downgrade of U.S. credit by S&P:

[S&P] has our sovereign rating on negative watch, which is a presumption of a downgrade. We are waiting to see what they do. We suspect they’re under tremendous pressure not to downgrade. If they stick to what they told the world on July 14, they will downgrade the U.S.”

On the reason that the U.S. is worse off now than before the debt deal was passed:

“When you think of an input- output ratio, a tremendous amount of effort went into this debt-ceiling compromise and we broke a lot of things in the process. We demonstrated to the rest of the world how dysfunctional our politics are. Then you look at the output, it’s not a complete deal. Key issues have not been addressed. They have been pushed into November. The operational details are not clear. It’s not even clear that this is enough to preclude a downgrade by S&P (NYSE:MHP). At the end of the day, we created a lot of damage. We did not get what we wanted. In the process, we undermine households, business, and international confidence. That’s why this whole element is a debacle. This was manufactured and self-inflicted. We did not need to go through all of this.”

On whether the situation would have been worse if the debt deal was not passed:

“It would have been worse if we didn’t get it passed, but we had an opportunity to do something. We had an opportunity to look at public financial and fiscal reform in the context of an overall package to improve growth, to improve employment, and to put us on a better path. We missed that opportunity.”

On whether he’s seeing a double-dip recession:

Well Bloomberg is reporting today that more and more people think that risk is going up.  You have Larry Summers saying it’s 1 in 3; Martin Feldstein saying it’s 1 in 2. We think that if we can maintain this middle, it’s a 1% to 2% growth speed going forward. However, there is this fear of stall speed. The risk we face right now is the 1% to 2% may not be good enough for an economy that needs to safely delever. There are one of two outcomes. Either the Fed will be pulled in again with some pretty imperfect policy instruments or the risk of recession goes up.”

On whether he thinks the Federal Reserve will step in:

“I think it will be a really hard discussion and next week’s meetings and particularly in the run-up to Jackson Hole. On the one hand, the two mandates are not going to be met.  On the other hand, they recognize that the instruments are not as effective and involve a lot more risk and cost than they have in the past.

On the problems in Washington and beyond:

“People are trying to respond and they want something different out of Washington. The irony is this tug of war. Companies are healthy. Their balance sheets are strong. Topline revenue growth is strong. If only we could get these macro issues out of the way. It’s not just the U.S., but Europe. Europe had a golden opportunity to get ahead of the game. Surprise everybody with the summit. As you mentioned, European risk the spreads are at alarming levels again.  If only we could get the macro policy issues out of the way, the micro is still strong.”

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