Pimco's El-Erian: US Will Inflate Its Way Out of Debt

Mohamed El-Erian, CEO and co-chief investment officer of bond giant Pimco, says that the U.S. Federal Reserve will at least partially inflate its way out of the debt crisis.
“There are several ways that a country can deal with its debt issues. I suspect the U.S. will end up with a mix of some fiscal adjustment and inflating its way out,” El-Erian said.

That’s because U.S. policymakers have an innate fear of recession thanks to U.S. history, more than of inflation, which is more relevant to the financial history of Europe, El-Erian told Der Spiegel, the German newsweekly.
“This country has a huge aversion to recession, huge. And if you ask a policymaker if you're going to make a mistake, which mistake would you rather make, they would say I'd rather make an inflation mistake than make a growth mistake,” he said.
The United States has several advantages other countries don't, such as being the global reserve currency and having deep financial markets. There are few reasonable alternatives for investors, so the United States tends to benefit disproportionately, El-Erian said.
The Fed’s decision to dump another $600 billion into economy, known in the press as QE2, is “inflating the whole world,” El-Erian said, but the policy might ultimately disappoint the United States in terms of its own objective — growth at home.

“The U.S. economy cannot productively absorb all this liquidity. So when all the liquidity is injected into the system, it also goes elsewhere,” El-Erian said. “It’s like pouring water on a hard surface, it splashes everywhere. That explains the large skepticism about QE2 outside the U.S.”
El-Erian repeated Pimco’s assertion that a “new normal” of slow growth and weak job creation will reign for quite a long period.
“Growth will be viewed as unusually sluggish. Unemployment will remain unusually high, and for an unusually long period,” he said. “And we will see an accelerated realignment of the global economy.”
He also said that it’s unlikely that the Chinese currency, the yuan, could soon displace the dollar the world’s reserve currency. Such a move would require the yuan to appreciate too quickly for comfort in China itself.
The currency should be convertible and flexible. But go to China, and they will ask you what you are talking about,” El-Erian said.
“Look at per capita income, they will say. We're number 99 in the world, not number two. At number 99, our responsibility is domestic because we have lots of people that are poor. So we don't want our currency to appreciate and to be volatile. When we get closer to number two, we'll take on global responsibilities.”
Speaking to journalists recently, Federal Reserve Chairman Ben Bernanke laid the responsibility for inflation squarely on other countries, not the Fed.
"I think it's entirely unfair to attribute excess demand pressures in emerging markets to U.S. monetary policy, because emerging markets have all the tools they need to address excess demand in those countries," Bernanke said, answering a question.
"It's really up to emerging markets to find appropriate tools to balance their own growth."