Oct. 12 (Bloomberg) -- Mohamed El-Erian, co-head of the world’s biggest bond fund, says the U.S. economy is in for a sustained period of below-normal growth. Lawrence Summers, President Barack Obama’s top economic adviser, disagrees.
Economic reports this week may support El-Erian, who manages $842 billion together with Bill Gross at Pacific Investment Management Co. Retail sales probably fell in September and industrial production slowed after the government’s cash-for-clunkers auto-rebate program expired, economists forecast, indicating the economy remains dependent on government aid.
Summers “needs to get out of Washington some,” said Mark Vitner, a senior economist at Wells Fargo Securities LLC in Charlotte, North Carolina. “We have got a huge hole to come out of. Individuals’ forecasts of how much income they will earn over their lives and how much wealth they will build up has been reduced. That’s the new normal.’”
El-Erian, chief executive of Newport Beach, California- based Pimco, says the economy is likely to expand at a 2 percent annual pace in coming years, compared with a 2.8 percent average rate in the five years before the recession started in December 2007.
Summers, in an Oct. 8 interview with Bloomberg News, rejected that notion. “I would be very reluctant to accept the idea that the American economy no longer has the potential to grow rapidly,” Summers said.
Earth’s Gravity
El-Erian, 51, compared Summers’ view of the U.S. economy to a three-stage rocket ship attempting to escape the pull of Earth’s gravity. The first stage is government spending, followed by inventory reductions and consumer demand.
Summers “has this concept of escape velocity,” El-Erian said Oct. 9 at a meeting of financial-market professionals in Toronto. “We don’t have enough to achieve escape velocity.”
Retail sales in the U.S. dropped 2.1 percent in September, the biggest decrease this year, after rising 2.7 percent in August, according to the median forecast of 56 economists surveyed by Bloomberg News ahead of Commerce Department figures due Oct. 14.
Excluding automobiles, sales probably rose 0.2 percent after a 1.1 percent increase the prior month, according to the Bloomberg survey. The government’s program allowing consumers to trade in older models for new, more fuel-efficient ones ended in late August, translating into a 35 percent drop in auto sales last month. Industry data showed declines at General Motors Co., Toyota Motor Corp. and Ford Motor Co.
Industrial Production
Industrial production expanded by 0.1 percent in September after increasing 0.8 percent the month before, reflecting the end of the clunkers program, according to the survey. The proportion of plant capacity in use, meanwhile, was probably little changed. The Federal Reserve figures are due Oct. 16.
Summers, 54, says the deepest recession since the Great Depression hasn’t changed the growth potential of the U.S. economy.
“The American people have not become less capable of entrepreneurship,” Summers, who heads Obama’s National Economic Council, said in last week’s interview. “They have not become less dedicated to hard work, and the productive potential of this economy has not declined.”
The government’s $787 billion stimulus program has helped put the economy on the path to recovery, he said. While “we’ve got a substantial period ahead of us until we get back to a fully satisfactory state for the American economy,” Summers said, “we’re looking at a very different economic situation.”
Stock Surge
Stock investors are supporting Summers’s view. The Standard & Poor’s 500 Index has jumped 58 percent since its low for the year on March 9. Last week, the index rose 4.5 percent, the best weekly performance since July, after Alcoa Inc.’s first profitable quarter in a year boosted investor optimism about the economic recovery.
The Chicago Board Options Exchange Volatility Index, the VIX, tumbled 19 percent to 23.12 for the steepest weekly decline since November. The index measures the cost of using options as insurance against declines in the S&P 500 Index.
El-Erian said household spending won’t be sustained without government incentives as long as unemployment remains high.
The jobless rate rose to 9.8 percent last month, the highest since 1983, and it is forecast by economists to reach 10.1 percent by the second quarter of 2010. Since the start of the recession, the economy has lost 7.2 million jobs.
James Bullard, president of the Federal Reserve Bank of St. Louis, said the jobless rate may rise beyond 10 percent.
‘Weak’ Labor Markets
“Unemployment is leveling off but we still may be headed toward double digits,” Bullard told reporters yesterday after a speech in St. Louis at a meeting of the National Association for Business Economics. “Labor markets are very weak.”
The rebound in U.S. consumer spending will wane as the unemployment rate surpasses 10 percent, a survey of economists showed last week.
Purchases will grow at a 1 percent annual rate this quarter after rising at a 2.4 percent pace in the previous three months, according to the median forecast of 57 economists surveyed by Bloomberg News from Oct. 1 to Oct. 8. Analysts also marked down spending estimates for the first quarter of 2010.
The economy will probably grow at a 2.4 percent rate this quarter after expanding at a 3.2 percent pace from July through September, according to the survey. Gross domestic product will increase 2.4 percent next year and 2.8 percent in 2011, the survey showed, compared with the 3.4 percent average over the past six decades.
Fed Policy
Federal Reserve policy makers lowered their benchmark interest rate almost to zero in December 2008 and switched to asset purchases as their main policy tool. The Fed last month reiterated its pledge to keep the rate low “for an extended period.”
Obama and his advisers are considering a mix of spending programs and tax cuts to provide some additional stimulus to the economy, Summers said, although he declined to specify which measures are on the table.
“There are a whole set of mechanisms that are normally in place in a well-functioning economy that were knocked out” in the financial crisis, Summers said. “The challenge is to get the mechanisms for economic growth back to being engaged.”
That’s the problem, El-Erian said. In 2010, inventory rebuilding will end as consumer spending flags, leaving government programs as the major growth engine.
The “new normal” includes a higher level of government intervention in the economy, El-Erian said. “The potential growth rate of the U.S. is going to come down.”
