Über die Autorin bzw. den Autor

Mohamed A. El-Erian is co-CEO and co-CIO of PIMCO, one of the largest investment management companies in the world. He formerly served as president and CEO of Harvard Management Company, the firm that manages the university's $35 billion endowment. He spent 15 years at the International Money Fund, working on policy, capital market, and multilateral economics issues. El-Erian has been featured by Bloomberg, Forbes, Financial Times, Latin Finance, CNBC, The New York Times, and The Wall Street Journal. In 2004, Fortune named him a member of its eight-person "Mutual Fund Dream Team."

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The #1 New York Times and #1 Wall Street Journal Bestseller

“Mohamed A. El-Erian is one of the most gifted and successful riskmanagement practitioners in the world. In this book he combines anacademic’s insight into advanced risk analysis with a portfolio manager’sgrasp of real world economics. This book is an essential read for those whowish to understand the modern world of investing.”
—Alan Greenspan

"Few people are as well positioned to understand markets as Mohamed El-Erian. He is almost unique in being able to attack the credit crisis from the perspectives of academic economist, policy official, investment banker and fund manager...Mr. El-Erian's insights are as valuable as ever."
--Financial Times

"El-Erian is a doer and a thinker and someone who understands the risks of rare events. [Never before, have] I seen such a combination. Read this book."
—Nassim Nicholas Taleb, author The Black Swan

“This extraordinary book portrays the future with a powerful andtrail-blazing illumination of the past.”
—Peter L. Bernstein, author Capital Ideas Evolving

“Brilliantly written, easy to understand—a forceful explanationof our changing global economy.”
—Bill Gross, Managing Director, Founder and CIO, PIMCO

“Mohamed El-Erian, with his deep grounding in economics and his profoundknowledge of financial markets, has written a book that no one else could write.”
—Seth A. Klarman

“I can think of no better guide to the terrifying yet exhilaratingnew world of global finance….”
—Niall Ferguson, William Ziegler Professor at Harvard Business School

“Mohamed El-Erian is a deep thinker of the global financial and economic scene.”
—Arminio Fraga, Founding Partner, Gavea Investimentos and Former President, Central Bank of Brazil

“Mohamed El-Erian is that rare creature: a skillful participantin financial markets who is also a brilliant analyst of them. He has writtena book that is important and urgent.”
—Fareed Zakaria, editor, Newsweek International

"Mr. El-Erian . . . offers extremely detailed advice.”
--Paul B. Brown, The New York Times

“El-Erian...specializes in spotting trends amid the blur and clanging noise of markets in motion. He steps back to consider the big picture and offer tips on how to allocate your assets in his new book, When Markets Collide: Investment Strategies for the Age of Global Economic Change. El-Erian does offer something valuable for investors seeking to benefit from the global economic realignment: a road map. In a chapter on asset allocation, he provides an illustrative mix for a long-term U.S.-based investor.”
--Bloomberg News

“The recent turmoil in financial markets is a symptom of realigning economic power around the world, promising investors more rough times ahead, prominent fund manager Mohamed El-Erian writes in a new book.”
--Reuters

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WHEN MARKETS COLLIDE

The McGraw-Hill Companies, Inc.

Contents

Chapter One

In the Introduction, I noted that over the last few years, economic and financial issues have arisen that could not be explained using existing models, mindsets, or prior experiences. As a result, they came to be called "aberrations," "conundrums," and "puzzles," and many in the marketplace dismissed them as being just "noise" and, as such, devoid of meaningful information. But these issues were, in fact, signals of underlying shifts or transformations that have proven to be of great consequence—in particular, as illustrated in the crisis that shook the foundation of the international financial system starting in the summer of 2007. These signals remain significant to investors now and will continue to be so in the future.

Perhaps the most famous reaction to the phenomena of anomalies and inconsistencies was contained in then Fed chairman Alan Greenspan's semiannual monetary report to the Senate. In the February 2005 report, he noted that "for the moment, the broadly unanticipated behavior of world bond markets remains a conundrum." I still remember the reaction on PIMCO's trade floor when Greenspan used the word "conundrum." Many were struck by how the most-respected, well-read, and influential policy maker of the day did not have an explanation for something as basic as the shape of the U.S. interest rate curve (that is, the "yield curve").

Greenspan was far from alone. Later in 2005, The Economist ran a cover story about the puzzling global economy. A few months later, Larry Summers, the Harvard professor and former secretary of the U.S. Treasury, referred to "an irony of our time" when reflecting on the configuration of global payments imbalances. He was commenting on the large flow of capital from developing to industrial countries, or from the poor to the rich—a flow that runs completely counter not only to what is predicted in economic textbooks but also the logic of rich-poor relationships. Summers observed: "To my knowledge it was neither predictable nor predicted and the implications are large and have not yet fully been thought through." The finance minister of New Zealand was similarly perplexed when asked to comment about the actions of investors in his country. In a September 2006 interview with the Financial Times, he described these investors as "irrational," noting that their investment behavior was consistent with "someone [who] would have to be slightly strange."

For me, the biggest puzzle of all centered on the reaction of investors—particularly the ability and willingness of the financial system to overconsume and overproduce risky products in the context of such large systemic uncertainty. Like others, I was struck by how two phenomena that you would expect to be negatively correlated ended up being positively correlated for so long—namely, on the one hand, the significant fall in the premiums that investors were paid to assume risk and, on the other hand, the investors' desire to assume even more of this mispriced risk.

The dynamics behind this positive correlation, which I will discuss in greater detail in Chapter 2, went something like this: Some investors were hesitant to accept the lower expected returns associated with the generalized decline in risk premiums. Accordingly, they tried hard to squeeze out additional returns. Leverage served as the best way to do so: By borrowing, they could put more money to work in their best investment idea; and this seemingly made sense as long as the expected return was higher than the cost of borrowing. In turn, the leveraged positions pushed risk premiums even lower, encouraging another round of leverage.

That cycle is just one illustration of the amazing sense of calm and self-confidence that prevailed despite the abundance of things that could not be explained. Rather than stay on the sideline until proper explanations emerged, many investors rushed into ever riskier trades and even higher leverage. Wall Street responded by putting the production of ever- more-complex products into overdrive. Many of these products offered investors "embedded leverage," playing directly into the hands of those looking to magnify what would otherwise be for them, low expected returns. And while national and multilateral policy makers expressed a mix of concerns and bewilderment, no meaningful actions were taken to "take the punch bowl away."

A few months later, the world economy found itself in the grip of significant market turmoil. Unlike the majority of the global financial crises of the preceding 25 years, this one was triggered by events in the world's most sophisticated economy, the United States. It impacted segments closest to the monetary authorities—namely, the interactions among banks. The results were bizarre to say the least.

Consider the highly unusual intraday swing in interest rates of over 100 basis points that occurred in the U.S. Treasury bill market, that on at least one occasion, was associated with highly unusual erosions in liquidity and market flows. You would expect such a systemwide event to cause collateral damage or be contagious, perhaps even envisioning people lining up outside banks to pull their money out. Based on recent history, you might also expect the casualties to be in an emerging economy with a weak banking system and not in another industrial country with a sophisticated financial system.

There was indeed a bank run, but it came from the United Kingdom. The event panicked the government into guaranteeing all bank deposits and triggered an amazing turnaround in the publicly stated policy of a highly respected central bank—the Bank of England. And there was collateral damage to an extent that in years past would have resulted in job losses on the part of ministers of finance and central bankers in emerging economies and in some cases, prime ministers and presidents. But this time, the high- profile casualties were the CEOs of some of the most influential banks in the world and other senior corporate officials.

The list of aberrations goes on. Interestingly, the numerous instances did not involve just one market, one country, or one set of actors. They pertained to several. Also notable was that the more usual tendency of inconsistencies occurring sequentially gave way to the emergence of inconsistencies occurring simultaneously.

It is therefore no surprise that, in the presence of so many anomalies, some conventional approaches to making investments have become less effective. Conventional strategies and business models are no longer adequately capturing the real dynamics that exist in the global economy; and the dominant industry players are being challenged by competitors who once seemed to be undertaken only lower-value-added activities and, as such, were not viewed as influential market participants. At the same time, policy measures and coordination mechanisms increasingly lack relevance and effectiveness.

In the following sections, I will discuss the nature of the aberrations, conundrums, and puzzles that have recently emerged. By focusing on topics that relate to market and policy issues, it will be clear that these inconsistencies contained important signals about underlying global transformations. In the process, I will shed light on...