260. Iran War: why the poor will suffer

16:57Mohamed El-Erian:And I say this because there is optimism. There is the potential of AI to improve productivity and growth. But we've got to get rid of all these headwinds that keep on slowing us down.

17:09Robert Peston:And just on AI, I mean, obviously, you know, as you say, there is this tremendous productivity opportunity, although, you know, there's also the potential for shocks from people losing their jobs. I mean, one of the things that was striking, you know, we had sort of back to back two market jitters recently. One was the market jitters around private credit with Blue Owl telling its investors it couldn't get their money out. But almost exactly the same time, we had Anthropic announcing its new co-worker service, where that led to extraordinary neurosis and anxiety that a whole bunch of very big software companies, very famous software companies like Salesforce, their share prices plummeted because it was thought that those sorts of very big businesses would be made redundant.

18:05Robert Peston:So we are living, you know, one of the things that I've been sort of thinking about a lot, you know, in the context of this war and the shock that that has caused, we are living through a period where there are, you know, a whole series of fragilities in the system.

18:22Mohamed El-Erian:You're absolutely right. And you can add to that, there's a small U.S. payments company called Block that announced a 40 % layoff, 40 % of its labor force because of AI. AI is an amazing technology. Not only is it what's called a general purpose technology. Think of electricity. It changes everything you do. But it is also, to quote a Google colleague that I've worked with, James Minyaka, it's an inventor of inventions. So it's a very dynamic element. And there's two ways to think about it. One is it's labor displacing, meaning it will basically de-industrialize, if you like, many, many sectors.

19:09Mohamed El-Erian:The other side is labor enhancing, that if you retrain, you retool, you can actually do more, a lot more with existing or more people. And the easy thing to do, and you've seen this whenever a business reacts, is cost minimization. Let's lay off people. The harder thing to do, which pays off for the business and the country, is the labor enhancing side.

19:35Steph McGovern:We talk a lot about AI on this show about the kind of the potential wins, but also that the pressures and it could put on industry. So can I just come back to in this moment then, because we, you know, while we're waiting for AI to do its thing, we've obviously got all of this fragility, as you say, then we've got central banks trying to work out what to do. You know, they're already, particularly in the UK, wrestling with like sticky inflation, even before this conflict started. You know, Robert and I have talked on this podcast about when rates might come down a bit now that's been pushed you know further down the line and possibly if inflation becomes a bigger problem they might have to go up but what should they do now because there's a double-edged sword here isn't there of what's going on domestically and the pressure of putting rates up could mean for people here compared to

20:25Mohamed El-Erian:the problem of inflation yeah and what i'm going to say people are not going to like um there's two types of central banks. There are what's called single mandate central banks. They have one objective. That is the Bank of England. That is the European Central Bank. It is inflation control. It is price stability, inflation control. And you've seen the markets immediately change their view on what these central banks are going to do. In the case of the Bank of England, before the conflict, the market expected the next move to be a weight cut. Now the market expects the next move to be a rate hike.

21:01Mohamed El-Erian:So for those central banks, they're going to be under enormous pressure to raise interest rates. And very recently, Christine Lagarde, the president of the European Central Bank, says we will not repeat the mistake of 2021. The mistake of 2021 is the central banks took the view that inflation was transitory, meaning it's temporary, it's reversible, don't worry about it, and it proved to be a real problem. So in my mind, there's no doubt as to how those two central banks will react if the conflict continues. They will raise rates, which will make the growth side even more difficult. The Federal Reserve in the US has a dual mandate.

21:45Mohamed El-Erian:It has maximum employment and price stability. And there, the market expects them to cut rates because they're so worried about the employment side.

21:56Robert Peston:But can I just ask, do you think there is a risk that both the ECB and the Bank of England will end up, in a sense, fighting the last war? Because, you know, if there is the kind of economic shock which leads to significantly lower growth, that will turn out to be disinflationary. And all the banks would be doing if they do put up interest rates is reinforcing a slowdown that will lead to higher unemployment. Obviously, these are incredibly difficult judgments. I'm not saying, you know, essentially it's an easy job at the moment to be on the Monetary Policy Committee and decide whether to hold, you know, raise or cut.

22:37Robert Peston:But I am slightly anxious that in what Christine Lagarde said, there's just an element of, as I say, fighting, you know, the wrong war, the last war. and that this will turn out. I mean, you know, both the European and the UK economies are pretty soft at the moment.

22:55Mohamed El-Erian:When you have a shock like this one, and this is a stagflationary shock. Stagflation. Stag means lower growth. Stagflation means higher inflation. The inflation hits you first, and then the stag part hits you second. So if you are completely rational and have perfect foresight, you would wait. You wouldn't raise interest rates because you would know that the second leg of this shock is going to be lower growth, lower activity, and therefore lower price pressure. But there's a very important behavioral aspect here, which is while you don't want to fight the last war, you certainly don't want to repeat the last mistake.

23:36Mohamed El-Erian:And the mistakes that central banks made in 2021, 2022 was a really big mistake. and therefore from a behavioral perspective i suspect that they will be told you know what maybe robert is right maybe ultimately it will be lower growth and the price pressures will be off what if he's wrong do i really want to repeat the same mistake and it is the same central bankers if you look at who has the ecb who has the bank of england who has the federal reserve it's the same ones as 2021, 2022.

24:11Steph McGovern:So would the mistake be to not do anything?

24:14Mohamed El-Erian:The single mandate central banks are going to have to be dictated by the single mandate. And it's the government that's going to have to do the hard work here. And in a perfect world, the UK government would accelerate what you've heard me say over and over again, which is its growth strategy. We've had a lot of talk about growth, but the actual strategy, the implementation of the strategy has been partial and slow. And you hear the desire to do more and more quickly, but the reality is that every economic event in this country has now become simply a fiscal event. And it's all become about adding up the numbers on the fiscal side rather than taking a much broader perspective about economic growth.

25:04Mohamed El-Erian:because without economic growth, fiscal issues will simply get worse over time.

25:10Robert Peston:For a government that is committed to growth, they put an awful lot of grit in the wheel, whether it was putting up employers, national insurance, whether it was increasing... Obviously, there are perfectly good reasons to increase workers' rights, but there are quite a lot of people on every side of politics who just thought maybe that could have been delayed two or three years until the economy was growing a bit faster. So there's been a lot of grit in the wheel, but they've done all that. What can they do now to accelerate growth in a timely way that doesn't cost the kind of money which markets are currently, lenders to the UK are currently saying to them, do not borrow significantly more.

26:01Robert Peston:So what can they do to accelerate growth that is not in the short term going to lead to higher debt?

26:09Mohamed El-Erian:I mean, the irony for the UK is it does really well on exciting startup activities. And then they all have to migrate elsewhere in order to scale up.

26:20Steph McGovern:Yeah.

26:21Mohamed El-Erian:You need a holistic approach to growth. You need to have a better approach to innovation, a better approach to scaling up of activities that really move the needle, which we don't have right now. You also need to be...

26:37Robert Peston:But we talk about that a lot on the podcast, Maham, but we do talk a lot about this and we agree with you totally. But that's not going to move the growth rate up over the next six months to a year. I mean, we need to do it, but that is a two, three year project.

26:49Mohamed El-Erian:It is. And I always hear it's a two, three year project. So let's not do it now. And then in two or three years, I wish we had done it two or three years ago. So true. You know, it's the whole thing of you've got to walk and chew gum at the same time. And that's why the word strategy is really important. You know, I'm a great believer that you have their biases in any system. The UK has a very strong treasury bias, which is make the numbers add up on the fiscal side. And you literally need structure to do heavy lifting. You need a growth desire. You need someone there to say, but what about growth?

27:25Mohamed El-Erian:What about growth in every economic meeting? Otherwise, you will go back to your comfort zone, which is let's make the fiscal numbers add up. There's a number of other areas. Consistency is really important. Don't underestimate what inconsistency in economic policy does to foreign investment. They just wait. They just want to know what is the consistent approach that the authorities are taking. and unfortunately the UK has been forced or has has decided on a number of u-turns that comes across as inconsistent to the rest of the world yeah and it's that issue of uncertainty

28:01Steph McGovern:we always talk about which just completely kills off investment and you know whether it's people wanting to invest into the country or just business investing themselves they're just everyone is just waiting to hear what happens next which is such a huge problem isn't it and You know, it's a disease in growth, this uncertainty.

28:20Mohamed El-Erian:It really is. I mean, you basically sideline things that can help you enormously.

28:25Robert Peston:Mohamed, there's a load more we need to discuss with you. But first, we're going to go to a quick break.

28:32Steph McGovern:This episode is brought to you by Hargreaves Lansdowne. Now, if the last four decades have shown us anything, it's that change keeps coming. There have been so many huge economic events that have shaped our thinking today. Back in the 80s, we had Margaret Thatcher's deregulation of the stock markets. Then there was the dot-com bubble of the 90s, followed by the credit crunch of the noughties and the pandemic in the decade after that. Plus lots of other significant developments too. For over 40 years, though, Hargreaves Lansdowne has helped Britain invest through it all confidently, whatever is going on in the world.

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29:57Steph McGovern:This episode is brought to you by Indeed.

30:00Mohamed El-Erian:Stop waiting around for the perfect candidate.

30:03Steph McGovern:Instead, use Indeed Sponsored Jobs to find the right people with the right skills fast. It's a simple way to make sure your listing is the first candidate C. According to Indeed data, Sponsored Jobs have four times more applicants than non-sponsored jobs. So go build your dream team today with Indeed. Get a$75 sponsored job credit at Indeed.com slash podcast. Terms and conditions apply. I mean, the other lesson, I'm afraid, of this war is how weak and under-resourced our defence is, our military is.

30:41Robert Peston:I mean, we had this sort of, I mean, you know, it was almost comic, right? We have now got one destroyer sailing to the Middle East. President Macron gets to Cyprus before our prime minister. There's a French aircraft carrier there. There are, I think, I can't remember if it's five or six destroyers, French destroyers there. It was almost as though he wanted to sort of ridicule the UK in those circumstances. But against that backdrop, there is no question that we are going to have to accelerate our defence spending. um the world is just a more dangerous place and i i guess again paying for that is um you know a big issue if they accelerate because we are talking about you know over the next 10 years you know we are talking about the requirement to find something over 40 billion additional you know you know an additional 40 billion pounds um which is i think pretty much comparable to the entire school's budget.

31:45Robert Peston:So it's a lot of money. I saw the other day from a bloke called Nick Lyons, who used to be Lord Mayor, this idea. And as somebody who knows about bond markets, I just wondered if you thought this was a runner. He said that the government should fund this to an extent with additional borrowing. But the way to do it that doesn't spook investors is to raise considerably more money from the retail market, from British people. and he basically has come up with this idea of effectively war bonds that if you bought these war bonds you know they would not incur inheritance tax when you die and he thinks that would generate really quite a lot of money um so i just wondered those that sort of you know sort of creative accounting does it make you know is is is that sort of thing a good idea yeah and gordon brown

32:37Mohamed El-Erian:has an even better idea, which is let's acknowledge that this is a Europe-wide issue. All European countries are going to increase defense. We can have a Europe common bond. And if you look at the sources of funding, the big tragedy for Europe, including the UK, is that its funding, including its pension funds, they go invest elsewhere. They go invest in the U.S. So it's not that there isn't the private funding. It is that something breaks down in connecting the private funding to genuine and productive uses. So, you know, there's several ways to approach this if you want to do it. But it requires, again, consistencies, explanation, communication.

33:35Mohamed El-Erian:And in a perfect world, you'd say, here are all these countries facing exactly the same problem. And if we solve it collectively, it's better. You know, there's something in economics called game theory. And what game theory forces you to do is to identify strategies that work and strategies that don't work. and there are certain games and i'm sorry for the word but that's how it's used certain situations where it only solves collectively cooperatively defense is one of these things you know if you if you do it cooperatively with your allies you get a lot more bang for your buck um and what game theory tells you is if you try to solve the cooperative game uncooperatively which is what we're trying to do now, it will fail.

34:24Steph McGovern:Is this one of those arguments again for us not leaving the EU and the fact we should have stuck with them?

34:29Mohamed El-Erian:You know, from an economic and financial side, you should never eliminate something if you don't know what you're going to replace it with. Because the lesson you get is you cannot replace something with nothing. And I think the strategy of the UK is that it was very keen to dismantle something in order to regain control. And I understand that. I really understand how powerful that notion is. But you need to know what are you going to put in place instead of it, especially when you are dismantling a major economic and financial relationship. So whether Britain should have done Brexit or not, that's up to the British people.

35:11Mohamed El-Erian:But there should have been a plan for what happens if we decide to exit the EU.

35:16Robert Peston:I can just ask politically, do you think it's actually realistic that, you know, I mean, even if we were in the EU, I wonder whether, you know, Britain with its 100 % debt to national income, debt to GDP ratio, you know, are the Germans really going to allow us to leverage their balance sheet to basically borrow money to fund our defence? Is that really going to happen?

35:39Mohamed El-Erian:On defence, you know, it's more likely to happen than on something else. Let me tell you my experience. I spent 15 years at the International Monetary Fund. which has 188 members and there were a few people representative of governments that you absolutely had to get on board if you wanted anything done of course you would expect the u.s but the uk was there the uk has always punched above its weight internationally is that still true mohammed is it still true do we still punch above our weight it's less true and and that's a concern it is less true and you just cited the latest illustration of that, that the whole world got to see, unfortunately.

36:18Mohamed El-Erian:It is less true, but it's not permanent. It can be reversed. But the UK has to decide what role does it have, would like to play. When it was part of the EU, it played a very important role both within the EU and for the EU relative to the US, China and Russia.

36:37Steph McGovern:With inflation, I just want to throw a scenario at you. let's say the Bank of England decides to increase rates because they're worried about inflation because of everything going on with this conflict so then mortgage costs go up rents will probably go up because of it you know cost of borrowing for business is all going up and people spend less that's the theory but people are spending less but at the same time oil energy all of those costs are still a huge problem and our inflation doesn't come down then what happens and and that's

37:13Mohamed El-Erian:the risk right um and and economists will tell you what what's the counterfactual right so so what what are you worried about the thing you're worried about is what we saw in the 70s is that costs go up and then all of us go to our employer and say wait a minute i want to protect my real wage. It was called real wage resistance. And not only that, but I no longer trust the Bank of England. So I want my wage increase to cover not just past inflation, but future expected inflation. And then you get the opposite. So those are the judgments that the central banks have to make. But if you have a single mandate central bank, if you have a single objective, and if you're the Bank of England governor, and you have to write a letter explaining why it is you don't meet that objective, you will end up raising interest rates if you think this inflation shock is of a long duration one.

38:12Steph McGovern:But surely if the majority of it is made up from the cost of energy and oil and everything that is not domestic, that's controlled internationally, no matter what you do with rates, you're not going to be able to bring down inflation if it's a price that is being built on what's going on abroad?

38:30Mohamed El-Erian:What you're not going to be able to bring down is the first price shock. But what you're hoping to minimize is what happens next. You don't want it to spread throughout the economy. I'll give you, forget the Bank of England, I'll give you a simple example. In the United States last April, when tariffs went up, businesses had to make a decision. Do they pass on the price to their consumers? So, turning a tariff increase into an inflation process and risk alienating their consumers, or instead, do they take it on their profit margins? The decision of most companies initially was, we're going to take it on a profit margin to see whether the shock persists.

39:19Mohamed El-Erian:And now you're starting to see companies raise prices and pass it on to the consumer. So, you know, these effects vary over time. But I want to stress, it's not as if the Bank of England has much choice. It's going to be expected to raise rates. And if it doesn't raise rates, the markets will punish it.

39:39Steph McGovern:And either way, it's going to be terrible for people, like normal people in the short term.

39:42Mohamed El-Erian:I'm really worried, and I'm worried in particular about low-income households. because this shock, the three elements of it, will hit disproportionately hard low-income households.

39:56Robert Peston:Yeah, you're absolutely right, and it is a big problem. There was just one other aspect of this I wouldn't mind exploring with you. We talked a bit about the Liberation Day widespread tariff increases imposed by Trump and then the initial shock to the market. And in that initial shock to the market, it, one of the things that was striking was despite the global uncertainty, the dollar and dollar assets actually fell. Normally, at a time of global uncertainty, investors buy dollars. It's part of this privilege, the exorbitant privilege of the US that investors in both sunshine and rain tend to favour the dollar and dollar assets.

40:45Robert Peston:So it was quite striking that against almost all recent precedent, the dollar fell and dollar assets fell. Now, in this crisis, it's been quite interesting to see the dollar strengthening quite significantly at a time when other assets are falling. Is that simply because it is basically oil and gas self-sufficient? Or was that idea that Trump is undermining confidence in America and the dollar, has that gone away?

41:21Mohamed El-Erian:So I don't think the concern is gone. And what I point to is the move in the dollar was much less than what you would have expected otherwise. There's a dollar index that captures its value relative to many other currencies. It's called the DXY. It moved from just under 97 to 99. That's not a big move at all. What's different this time around is that the bond market has behaved better in the US than it has in the UK, for example. And that reflects what you were saying, Robert, which is the notion that the US is the cleanest dirty shirt. it is impacted what a phrase

42:05Steph McGovern:I like that

42:06Mohamed El-Erian:and it comes from this notion that a lot of the time markets solve in relative space not absolute space so they compare different jurisdictions and the US is self-sufficient in energy has a more dynamic economy and therefore while it's going to get dirty to be clear it's going to get dirty from this higher inflation it will be the cleanest dirty shirt compared to other countries we've talked on this podcast

42:34Steph McGovern:before about the you know the fact that the the a lot of the safe assets are dollar backed and that's part of the reason you know why um why the dollar manages to stay strong in all of this but we were talking i think it was about this time last year about how um you know is that going to change because people are because is because at the minute it feels like trump can do anything and it'll kind of be all right. I know, okay, we've got midterms coming up and he might lose them if people feel like their lives are a lot worse. But from a dollar perspective, because of the fact, as you say, it's the cleanest dirty shirt, that kind of saves him a bit.

43:10Steph McGovern:But could we see that change? Like, does there need to be, it not be all about the dollar anymore? And are we seeing any more signs of that? Because it felt like last year we were a little bit.

43:20Mohamed El-Erian:So in my conversations with a lot of people around the world, there is still the recognition, as in last year, that they are, quote, overweight the dollar. There's still the recognition that they would like to reduce it. And there's still the dilemma of there is no single currency that can replace the dollar. So it's a very gradual process. You go into many things, including gold. But then when the gold price goes zooming up to$5 ,000, you slow it down a bit. So the U.S. has a much longer runway to misbehave. than other countries because there's no other runway. Countries can't go elsewhere immediately.

44:01Mohamed El-Erian:It's very dissimilar to what happened to the UK when it lost its status as a reserve currency. The US was ready to step in. Here, there was nobody ready to step in. So it takes time, Steph, it takes time for all this diversification to take hold.

44:20Robert Peston:I'm struck that although we have this huge surge in the price of gold before the war, actually, the price of gold has gone almost nowhere since the war started. It rose a bit and then fell. And the other bit of it that I think is quite interesting, the sort of bulls, the fans of crypto kept saying it's a store of value. Well, quite interesting that actually, again, there was actually quite a sharp sell. Right at the start of the war, the price of Bitcoin fell very sharply. So the idea that it's a store of value in uncertain times is just rubbish, isn't it?

44:56Mohamed El-Erian:Yeah, I mean, Bitcoin has still a lot to prove to become a safe haven asset because it hasn't behaved like one, as you said. And Bitcoin had a lot of speculators. So when you start shaking speculators out, they shake each other out as well. Gold is an interesting one. It had moved a lot. So we got to 5 ,000 really quickly. And, you know, we've stuck around 5 ,000. We haven't sold off in a meaningful way. So, you know, relative to other safe haven assets, it has behaved better than other safe haven assets. But like you, I would have thought it would have gone higher.

45:36Robert Peston:I mean, so the other, I think, if you just look at the big economies in the world, China, you know, before the outbreak of war, downgraded its growth prospects. There is still quite a lot of debt overhang in China. They are massively dependent on oil and gas coming out of the Straits of Hormuz, which obviously that tap has been turned off. Two questions, really. Is this going to be very damaging for the Chinese economy? And how will China attempt to influence events, in your view?

46:09Mohamed El-Erian:So first, China is losing its second supplier of discounted oil. It lost Venezuela, and now it's losing Iran. And it only has one source of discounted oil left, which is Russia. So it's now lost two out of three sources. And that's not good news because, as you say, they're highly dependent. Now, they had built up a lot of strategic reserves. So it's not an immediate shock. But it is in the context of lower growth. The only thing going well for China, which is a problem mainly for Europe, is its exports. We just got the numbers for January, February, and yet another record surplus. And just to show you how much they're doing, the market expectation was that their exports would grow by 7%.

46:58Mohamed El-Erian:The export grew by over 20%.

47:02Steph McGovern:And that's when the exports to the US are falling.

47:06Mohamed El-Erian:And at some point, Europe is going to say, enough, we can't absorb all that. As to what is its role in this, it has been surprisingly quiet. People expected it to say something. After all, it is a major, Iran was a major Chinese ally. It's been extremely quiet. And there's a lot of speculation as to why it has been so quiet. I'm not a specialist to say it, but I can tell you on the economic front, they're not going to be able to repeat month after month, grow by dumping the exports into Europe. At some point, Europe is going to say, enough, we can't take this anymore.

47:47Robert Peston:And I suppose, I mean, some of it may be related to the relationship that it wants to maintain with other Gulf and Middle Eastern countries. But just on them, how much damage has been done to their attempt to diversify away from total reliance on energy? Obviously, they're going to struggle to get the taps back on, but they were supposed to be basically a safe haven for tax exiles. They were trying to basically attract both talent and capital. They've been hugely damaged by this, haven't they?

48:20Mohamed El-Erian:Yeah, a lot depends on what happens to Iran. I mean, there's two scenarios. One is that Iran was a threat and Iran will come out of this weakened and will no longer be a threat. And therefore, those countries, especially the UAE, Bahrain, can really position themselves even more as what they've positioned. And I think that's the central view. And that's the most likely view. The other view is Iran fragments. You know, people forget that the Persians are only 60 % of the Iranian population. and if you're not careful you could have domestic fragmentation of iran that is problematic for for the neighborhood you know again you know these these are issues that we're going to see play out it's a very uncertain time um for the whole neighborhood right now and we're going to need

49:14Steph McGovern:you to come back quite regularly just to talk us through it or muhammad if you don't mind i love

49:19Mohamed El-Erian:I love the conversation with you. Thank you for having me, always.

49:22Robert Peston:Before we go, I just need to say one thing. You raised the need for the prime minister to appoint a growth czar. I'm sure he's listening to this podcast. So if you're listening, you know, I vote for Mohammed as your growth czar prime minister.

49:39Steph McGovern:Seconded.

49:40Mohamed El-Erian:You're very kind. I just think it's really important to let structure do the heavy lifting. This issue has came up with employment a long time ago. the biases in a system are so deep that unless you look for a way structurally to fight it, you will go back to doing exactly what you've been doing and you will not evolve. And that's true for businesses as well.

50:03Steph McGovern:Yeah, it's so true. We need growth and that needs to be the priority. Mohamed, thank you very much for your time. As ever, we will see you again soon when we can call you. But thank you very much. And that's it from us on The Rest is Money. Bye-bye.

50:15Robert Peston:Goodbye.

50:19you