PIMCO's El-Erian Says the Fed Must Exit QE2

(March 1, 2011) -- Pacific Investment Management Co.'s Mohamed El-Erian said today that the cost of the Federal Reserve's actions is starting to outweigh the benefits.

In an interview with CNBC, El-Erian said the central bank should calculate how it can exit from its multi-trillion dollar quantitative easing program, often called QE2. Federal Reserve Bank of St. Louis President James Bullard has said the central bank is "determined" to get monetary policy back to normal, confirming that policymakers could subtly adjust its plan by backing off early from QE2, the Wall Street Journal reported.

El-Erian used an automotive analogy to explain the costs and risks associated with extending the Fed's easy-money policies. "Think of your car having stalled and someone comes along with jumper cables and starts it. At some point, you have to take the cables off and see whether the car will drive," he told CNBC. "The reality is if we go to QE3 we're going to find very quickly that the costs and risks of these unconventional policies are going to offset what the benefits are." He said the stimulus cannot last forever.

Last week, responding to conflict in the Middle East, El-Erian asserted that global markets paid minimal attention to the Egyptian and Tunisian revolutions, as they were viewed as lacking both "systematic and financial significance." Yet, he claimed that mounting protests have the potential to be the tipping point to trigger shock in the Middle East.

In an article featured in the Financial Times, El-Erian wrote that while both Egypt and Tunisia are by no means economic powers, they are both catalysts for global demand and price dynamics. He wrote: "In the short run, regional developments will be stagflationary for the global economy due to three main factors - First, higher oil prices will increase production costs and act as a tax on consumers. Second, greater precautionary stockpiling around the world will intensify pressures on commodities as a whole, aggravating the impact of demand-supply imbalances and large injections of liquidity. Third, the region will be a smaller market for other countries’ exports."

Thus, he warned that "there is little that western countries can do to offset short-term stagflationary winds." Over time, he says, market apprehension is likely to give way as the impact of greater long-term stability becomes stronger.

The upside to higher oil prices, he told CNBC, are investment opportunities for in oil-producing countries not affected by the turmoil in the Middle East, with Russia, Canada and Indonesia being primary places investors should look to for protection.