Mohamed El-Erian, Chief Executive Officer, PIMCO HARDtalk


Mohamed El-Erian, Chief Executive Officer, PIMCO

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Time for Hard Talk. The world's developed economies are in deep

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troubling but it could get much worse. If the euro zone in raffles

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no country be will insulate food the consequences and even if it

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does not, we may be in the middle of a decade-long contraction. My

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guess today is one of perk's most influential analysts and investors

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CEO of Pimco which manages morn $1 trillion of other people's money.

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What is the best way out of the We are in California. Welcome the

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hard talk. Thank you. You are one of the most prominent respected

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fund managers in the United States of America. Right now to you feel

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under more pressure than you have ever felt before? I feel more

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worried and scared not just as a fund manager but as a father. Every

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day when I kiss my daughter goodbye in the morning, she is eight, I

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wonder what she will inherit given the headwinds that refacing at the

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level of countries, at the level of regions and the level of the global

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economy as a whole so I would say I'm worried as a fund manager but

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more as parents. That is a fascinating answer. You have

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introduced the idea we need the talk about what is happening in the

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world at various levels from short to mid to long-term. I want to do

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that in this interview but let me start with the short-term. Right

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now it looks like nothing can be assumed to be safe - sovereign debt

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t youren situation we use t biggest banks in the world? What is safe?

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Yes, yes. I mean the global economy has lots many anchors. Not all of

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them but has lostt 78 anchors. We have lost the economic anchor, we

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have lost the financial anchor and we are losing our social anchor so

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the sense of uncertainty people are unsettled because they do not know

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what is now the parameter, something you can assume is safe

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and Constan and what are the variable, something that fluctuates

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widely so that is absolutely right, this feeling of what is safe is

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very, very broad and it speaks to why even people who can spend money

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today people with healthy balance sheets are saying "No thank you".

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They are going back the sideline and just waiting. As we bring to it

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real specifics let's to go the eurozone firstly. Right now do you

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think that we are close to the sort of fear-driven freeze of financial

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markets because of what is happening in the eurozone t fear

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that eurozone itself will unravel that we saw in the autumn of 208?

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Yes, we are. That has prompted this week's Central Banks to come in, in

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a very coordinated fashion because they are worried as well. Why do I

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say that? First we are seeing the functioning of markets starting to

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ab problem. This is like oil in your car. You do not think about

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the oil in your car often but you realise if something goes wrong

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with the oil the rest of the car will not function. What we are

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seeing is the markets themselves t pipes that connect different parts

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of the global economy are starting to get clog $. Second issue, we see

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an in ability of policy makers to catch up with the crisis let alone

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get ahead of it there it is getting worse and worse. Third, the banks

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are again fragile. And once you put the banking system in play lots of

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people will step back and stop interact tirpbgs including banks

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stopping to interact with each other. So put all these thing

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together t next few days and weeks are critical if we are to avoid a

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major economic downturn, if we are to avoid a major increase in

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unemployment and if we are to avoid a major increase in wealth and

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inequality. You say the next few days and weeks are crucial. We have

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seen the the US Federal Reserve acting with the ECB, the UK, Japan,

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Canada and the Swiss as well saying that they will do what is necessary

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to introduce new liquidity. That is going to work? It is important so

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in tree deucing liquidity buys you some time. The hope is that the

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Central Banks are moving because they feel confident this the other

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agencies which have been basically asleep at the wheel t other

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agencies are going to move and these other agencies are

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particularly in Europe and in the run-up to the December 9 summit

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where major decision haves to be taken, so the hope - an I stress it

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is a hope - the hope this is the Central Banks are providing a

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bridge to somewhere. The fear is that it will be yet another bridge

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to nowhere and that has been the story tore the last two years, lots

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of bridges by lots of Central Banks but there have been bridges to

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nowhere because other actors have not stepped up and done what they

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need to do. You and your company matter because you manage well over

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$1 trillion of other people's money. I just wonder whether right now you

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are saying to your clients that you are - you have lots fate in the

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euro and that you are moving whatever investments you had

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denominate in euros out of euros as quick as you can? What we will

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telling our client that is this is the time to be generally defensive

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and selectively offensive the reason why we are telling them that

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is because there is a lot of uncertainty out there. Therefore,

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it is better to have what we call optionality, it is better to have

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cash in order to be able to move. Your do not want to be stuck off

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siefrbgsd caught off-side when the world is complaininging so much --

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siefpltd in terms of what Europe can do, -- side. We feel Europe

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faces an engineering and a political challenge. The US faces

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mainly a political challenge. Europe has an engineering and a

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political challenge. Engineering a solution that satisfies people

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where very different initial conditions is hard and we have two

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Europes not one. We have a strong Germany that has been doing well

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and that believes that it has a right answer and we have weak

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peripherals facing enormous economic and social headwinds. That

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leads to the political prorbgs how do you get agreement again --

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problem -- on how do you debt agreement on a difficult decision

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on what the eurozone feeds the look like to be stronger. So we need to

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keep an eye on Europe. Europe is really important systemicly and

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hopefully, I say homefully the Europeans will finally get their

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act together. Yeah, but people like you in the end do not deal in hope.

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You deal in what you believe to be probabilities and reallive I wonder

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we have seen Tim quite near the US Treasury Secretary and Barack Obama

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send a message to Europe for week upon week upon week of "Get your

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act together" which is a issue directed to Chancellor Angela

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Merkel t decision being it is only determine any in the end that has

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the economic power to rescue the zone don't in its current form. Do

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you believe the Germans are prepared to do what is necessary?

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First, I think it is more than the Germans. It is ironic everybody

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says it is the Germans because the Germans are the most successful,

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they are the balance sheet t wallet. If they say only they had the will.

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But there is a reason why the Germans are hesitant. I always tell

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my colleagues ask why is someone rational acting in a way that seems

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irrational to you. I think the Germans understand that you need at

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least the five elements of a solution. Five. One is the Germans

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need to decide what they want if eurozone to look like. Do they want

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it to be a full fiscal union which is another way of thinking of what

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West Germany did for East Germany which is this is a political

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decisions it is not an economic decision, this is a political

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decision but they need to do it, or does Germany want a smaller and

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less imperfect eurozone? That is Germany's desifplgts secondly, we

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need actions -- decision. Secondly, we need actions to reconcile to

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very different priorities in the privy. One is to contain that. The

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other toys grow. Remember, soften say has a numerator and denominator.

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The numerator is how much debt you have to pay, your denominator is

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your ability the pay. So far the privy has not met that balance.

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Third, we need to counter the fragile nature of the banking

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system. The banks have become a problem on a stand-alone basis.

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They are no longer just at recipient of the sovereign debt

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crisis. They are now a source of disruption that is going to get

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worse unless it is countered. Fourth, we need the ECB to be

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convinced that it can play a major role as a circuit breaker. You know

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markets tend to be self fulfilling. The more they worry, the worst

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outcome, the worst outcome the more they worry. So you need a circuit

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breaker and only the ECB can be that circuit breaker. Right, but...

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Number five... Then I have a few quick questions. You talk about the

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ECB and sick my question was simplistic -- and suggest. Issues

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about had the ECB will be unleashed to be the lender of last resort the

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Open itself up to rescue some of these countries it comes back to

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Germany does it not? In a way I want a simple emotional response

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from you, whether you think Germany acting in concert with the French

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and the other Europeans can do what is necessary. They can, if they are

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convinced that others will also do their part. I think it is important

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to ask the question why two years after the ECBtIMF and. The EU

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stepped in dramatically to save Greece every single indicator in

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Greece is worse, every single one, okay? Not jest relative to where

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they were two years ago but relative to the expectation of the

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policy makers. There is a reason for that which is the ECB, the IMF

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can only provide liquidity. Liquidity is a bridge, but if there

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is no destination on the other side of that bridge, that liquidity

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becomes wasted. I think the ECB has realised that over the last two

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years it has been doing things that has only could be Tam nighted its

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balance -- contaminated. So the ECB says "I'm willing to play, engage,

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but I need others tone gauge as well. I cannot be the only player

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in this game. Because if I'm the only player in this game, everybody

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is worse off" When you talk about the sings Greece getting worse,

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that also raises another economic philosophical question in my mind I

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mean, do you think that Europe right now is over-playing austerity,

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so preoccupied austerity it is forgetting that actually this

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crisis can only be ended when real growth is being delivered and in

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the current climate it is very hard to see where growth in Portugal,

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Greece or even it listing go to come from? Absolutely. Absolutely,

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I would say the same from other countries. We face four distinct

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problems. One is too much debt in the west. We fell in love with

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level average and this credit entitlement that you could buy

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things on credit. Now we have the pay it back. Or, we have to impose

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losses. Second, we are not growing enough. We have tremendous

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structural impediments to growth and we are not doing enough to deal

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with it. We are yet to see any serious structural reforms either

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in Europe or the US. Policy makers are stuck in a cyclical mind-set,

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what they neat they neructural and secular mind-set, this is hard work

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and they need to start. A quick- fire response on some particular

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situation. Let me start here in home in London where I speak to you

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from with the UK government which has given its latest budget

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forecast which is extraordinarily blaefpblgt it now looks like six

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years of consistent austerity coming from the British government.

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Do you think they have the calibration of economic policy

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wrong? -- bleak. I think on the whole they got it almost right. I

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would like to see more structural reforms and the Chancellor's speech

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this week went a little bit towards that but he could do more. But I

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think they understand thank a small country looking at storms, as it

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was called - storms coming from Europe and another storm that will

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come if the US at some point, that they understand that they do not

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have the luxury of the US, they do not have the luxury of being a

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large economy with a reserve economy so I think what brings is

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doing is understandable, it is not pleasant but understandable. A

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final thought on the European situation S I was taken with with

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words from the French economist former head of European bank for

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reconstruction an development who said he believed there was a 50/0

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chance the euro could break down, unravel by Christmas. How would you

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charge rise the chances of that happening? Think he is right to be

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worried. I think if we do not see some meaningful action in the run-

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up and at the December 9 European summit, the transis his citing is

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correct but Europe still controls its destiny but it will have to

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make one of two difficult choices, either opt for the full fiscal

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union or smaller an less in perfect eurozone it needs to make that die

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If the crisis deepens, should the US government stepped in at some

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point and use its enormous economic power to do what is necessary to

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shore up this massive sovereign debt crisis in Europe? That is a

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great question. The US is playing a supportive role. It could play an

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even more supportive role by co- ordinating this orchestra that has

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no conductor. The European crisis is happening partly because there

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is no global conductor. Everybody is stepping back rather than

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engaging. But I think the solution is in the hands of the Europeans.

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The US can support a solution and help ward maid, but it cannot

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impose a solution. But on the other hand, Obama knows that if Europe

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does go belly-up, they will be a massive consequence for the United

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States. You'll go back into recession if not depression.

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Michael Bloomberg described the situation in the US, you call them

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political problems, over the budget, he said, cowardice and partisanship

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in what cent -- Washington is right now really hurting our country.

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Would you agree? I absolutely agree. First, I say that you cannot be a

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good house and a bad neighbourhood. If Europe goes down, if the global

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economy goes into recession, everybody will feel it. The US is

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political -- politically dysfunctional. That is why we

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cannot agree. We cannot come to the centre. Not only are the Democrats

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and the Republicans far apart, but the populist movements are pulling

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them further apart. The Tea Party is pulling the Republicans further

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to the right, the Occupy movement is pulling the Democrats further to

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the left. What we need in the US is what we call a Sputnik moment. A

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realisation that unless we come together with a common vision and

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common purpose, things are going to get a lot worse. Let's put your

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cards on the table. The specifics that the two parties are arguing

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over when it comes to the Budget and dealing with the deficit are

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whether it is right to extend the push tax cuts. As part of any

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deficit-cutting programme, Republicans insist there has to be

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an extension of the tax breaks for the richest Americans. Obama says

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that is not acceptable in this hour of need. Where do you sit on that

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debate? I think Presidink Presidis right. Everybody has to contribute.

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This is a shared responsibility with shared sacrifices. The rich

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have been doing extremely well and the United States over the last

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number of years. I would not extend the tax breaks. Some more quick-

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fire things. Take us around the world a little bit more. It strikes

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me that when you and I talk about the state of the world economy, I

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in London, you in California, with both talk about a sort of doomsday

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scenario. Perhaps we are missing a particular point, that is, if we

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were watching this in China, India, or other cities in the emerging

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economies, we would say that we are way too pessimistic, because

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overall growth around the world this year will be between 3-4 %,

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growth, not a contraction. Cannot continue if we are right about what

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is happening in the industrialised world? First, we live in a multi-

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speed growth world, where the emerging markets, because of their

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own efforts, are doing much better. But if we were sitting in these

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countries, we would say, yes, yes look at us, we are doing fine, we

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have lots of growth, we have a middle class that is getting richer,

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we have production and employment, but also, we live at a global

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system, and at the core of the global system is the US and Europe.

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They are having difficulties. So we would also be worried, not because

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our internals are problematic, but because we are part of a system

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where the core is contaminated. Therefore, we worry about how does

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that system operate. In 2008 we had that massive sense of crisis in the

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We Wethin a year, we saw China restored the growth of almost

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10%, India, 8-9 %, why are you so insistent that they cannot insulate

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themselves from what is happening now? De buoy reasons. First, in

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2008, everything stopped. There was a sudden stop. That brought in a

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lot of fiscal stimulus. Today, we do not have the scope for fiscal

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stimulus. We have a sovereign debt crisis that has been the impact,

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the outcome, of what we did in 2008. The first thing is that we have a

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lot less physical firepower. The second thing is we have a lot less

:19:58.:20:02.

minatory firepower. Interest rates are almost at 0%. Central banks

:20:02.:20:06.

have been doing unconventional things with no assurance that it

:20:06.:20:11.

will work. We have fewer spare tyres, if you like, on this car,

:20:11.:20:16.

that is on a bumpy journey to an uncertain destination. It caused a

:20:16.:20:20.

real stir recently by saying, unlike most big financiers and Wall

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Street players in the United States, saying that actually the message

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coming from Occupy Wall Street, the fundamental rejection of many of

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the values of aggressive capitalism that we have seen, you said that

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was a message that everybody in the United States needed to listen to

:20:35.:20:40.

and think carefully about. Why did you say that? Because whenever I

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look around the world, there are social movements. It is not just in

:20:44.:20:49.

the US. It is in Britain, Spain, Italy, the Arab world. It is all

:20:49.:20:53.

over. The reason why is because we have had an incredible increase in

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income and wealth inequality. No system can operate well when there

:20:59.:21:03.

is a sense that it is not fair. And right now, the perception of the

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system is that it is not fair. In particular, the system privatised

:21:10.:21:14.

massive gains in the run-up to the 2008 crisis, and then socialised

:21:14.:21:20.

massive losses. These losses were socialised on the premise that this

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was needed for growth and employment, and neither have

:21:23.:21:28.

materialised at any scale that is sufficient. So we have a perception

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that the system is unfair, and we have to deal with that perception

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rather than ignore it, because the more we ignore it, the more that

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social discontent will increase. you are saying that you now have

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concluded that capitalism in its current guise in the United States

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and Western Europe is unfair and unsustainable? Is that what you are

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saying? Yes. I think we were on a motorway, if you like, where we

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live to the speed limits without realising that the vehicles that

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are on this motorway cannot drive at that speed. And therefore we

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have to be calibrate the whole motorway if we are to avoid

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accidents. I think that is a recognition that we went too far,

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we went to mac far in this great age -- too far in this great age of

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credit, of debt, and of Credit entitlement. And now we have to

:22:24.:22:28.

deal with the consequences. I can't help wondering what your clients

:22:28.:22:31.

make of this new message from you! The deal with some of the richest

:22:31.:22:34.

individuals and corporate clients in the world, they pay you to look

:22:35.:22:41.

after their money and maximise their returns, you say your total

:22:41.:22:45.

return fund can deliver profits for your clients in good times and bad.

:22:45.:22:48.

Are you suggesting that you are part of a fundamentally flawed

:22:48.:22:51.

system? Will you stop doing what you have been doing for the past

:22:51.:22:56.

few years? Nw years? Nate in the system, so we say, given the system,

:22:56.:23:02.

we operate, and what we aim to do is deliver returns and manage risk.

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We do this because people trust us with their pensions, their

:23:06.:23:10.

retirement funds, with their investments. Now, in doing so, we

:23:10.:23:16.

take a view on what is likely to happen. And we invest on the basis

:23:16.:23:21.

of what is likely to happen. We also discuss what should happen. We

:23:21.:23:25.

don't invest on the basis of what should happen, because we don't

:23:25.:23:27.

control out comes, we are part of this global system, so you have

:23:27.:23:31.

been asking me about what should happen, and we invest on the basis

:23:31.:23:35.

of what is likely to happen. In a perfect world, the two converge,

:23:35.:23:40.

but we don't kid ourselves that we have that power. That power lies

:23:40.:23:44.

and has a policy makers, and we operate, like everybody else, in a

:23:44.:23:47.

world that we must understand in order to navigate well for our

:23:47.:23:51.

clients. A final thought. I began by asking you about pressure. Let

:23:51.:23:55.

me end by asking you about control. Do you feel more helpless today

:23:55.:24:02.

doing your job than you have ever felt before? I feel that every

:24:02.:24:05.

morning, something will happen that will disrupt markets, and we are

:24:05.:24:09.

going to have to react to. I feel we are living in a world that is

:24:09.:24:13.

incredibly volatile, a world full of unthinkables. We used to keep a

:24:13.:24:17.

list of unthinkables. Now we just do it every quarter, because they

:24:17.:24:24.

have been so many unthinkables. We live in a very uncertain world, but

:24:24.:24:28.

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