PIMCO examines the role of finance in the New Economy

David Nicola is a Capital Institute Fellow and former portfolio manager at a credit hedge fund.

The following is an excerpt from Mohamed El-Erian’s article on the outlook for the global banking system which appears in The Economist’s 25-year Special Edition “The World in 2011.”

“Rich-world governments will use 2011 to put in place detailed measures that de-risk and slim down the banking system…

The phenomenon will be most visible in Britain and America, the two economies that aided and most strongly abetted the expansion of finance. Indeed, too many people in these countries incorrectly viewed finance as the next stage in the natural maturation of an advanced economy—from agriculture, to industry, to services and to finance. This bet went disastrously wrong in 2008, with governments (and their electorates) being painfully reminded of a truth which thoughtful people have known for a long time: finance is not an end in itself; rather, it is a means of servicing the economy as a whole. Finance cannot expand well ahead of economic realities without getting itself into significant trouble.”

 http://www.economist.com/node/17493486

As Mr. El-Erian so elegantly points out, we have lost our way by focusing on the misguided principal that an economic system, which over-emphasizes finance and ignores limits to leverage, can produce economic benefits indefinitely.  In society’s reevaluation of future economic policy and practice, the US must lead not only in reconsidering defunct economic “science”, (see work of the Institute for New Economic Thinking - http://ineteconomics.org/) but also in redefining the role of finance, particularly as it ranks in the economic pecking order.  In doing so, the US can facilitate a truly robust and resilient model that supports a broad spectrum of industries, innovations, and stakeholders.

As a former portfolio manager at a credit hedge fund, I know from first hand experience the influence that PIMCO and financial leaders such as Mohammed El-Erian can have on both markets and society.  Markets move when Bill Gross and Mohammed El-Erian so much as reach for the phone.  We also hope that the collective psyche of the United States and global financial industry can shift as a result of Mr. El-Erian’s thought leadership on the role of finance.

By no means is this entry an attempt to undermine the importance of finance in the global economic system.  We would be unable to fully harness the power of innovation and entrepreneurship without this crucial industry.  As Mr. El-Erian points out, however, we cannot rely solely on the financial industry at the expense of important industrial, agricultural, social, and environmental innovations.  In order to achieve a resilient system that adequately supports all stakeholders, society must redefine the role of finance.  We will achieve nothing from financial reform if the bankers and alternative asset managers refuse to change their practices or de-lever the system.  Similarly, we will accomplish little if the public over-zealously vilifies bankers (although anger is by no means unwarranted…up to a point).  We can only get to the right economic focal point, what we at the Capital Institute refer to as a “New Economy,” by working together to produce a more robust, resilient, and just system.  Redefining the role of finance, as Mr. El-Erian points out, is one of the first steps we can take.

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