El-Erian: A warning for the US, and for the global economy

Mohamed El-Erian, chief executive and co-chief investment officer at PIMCO, responds to Standard & Poor’s latest action on US debt.

S&P reaffirmed this morning the AAA rating of the US but, importantly, slapped a “negative outlook” on the rating due to concerns on how the country will address its “very large budget deficits and rising government indebtedness.” In justifying this dramatic move, it noted that “there is a material risk that US policymakers might not reach an agreement in how to address medium- and long-term budgetary challenges by 2013.”

This is a timely reminder of the seriousness of America’s fiscal issues, for the country and for the rest of the world.

The continued failure to come up with a credible medium-term fiscal reform program would increase borrowing costs for all segments of US society, thereby undermining investment, employment and growth. It would also curtail foreigners’ appetite to add to their already substantial holdings of US assets. And it would weaken the dollar.

The US also risks eroding its standing at the core of the global monetary system.

The world looks to America for a range of “global public goods” — including the reserve currency, the deepest and most liquid government debt markets, and the “risk free” standard. With no other country able and willing to step into this role, the result would be global efficiency losses and a higher risk of economic and financial fragmentation. S&P’s warning should be heard loud and clear in Washington DC, hopefully acting as a catalyst for faster convergence on a credible medium-term fiscal package. It is also a reminder of risk to the global economy, as well as the generalized deterioration in the sovereign credit quality of several advanced economies.

The time has come for the US (and other advanced economies) to take better control of its fiscal destiny—for the sake of American society and for the well being of the global economy.

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