Will Greece default? Will Portugal, Italy, Spain and other nations fall like dominoes if Greece does? Does it matter? And how about the United States? We don't really risk default, do we?
I talked to a man who should know: Mohamed El-Erian, the CEO of PIMCO, the world's biggest bond trader. He's also written a superb book called When Markets Collide. Here's a transcript of our conversation from Sunday.
Fareed Zakaria: For a long time, the Europeans have tried to find some way that they could kick the can down the road, that they could provide some kind of assistance because I think they fear a Lehman-like event where if Greece falls, it causes a kind of shock to the markets? Is it inevitable that Greece will default?
Mohamed El-Erian: It is inevitable that Greece would have to restructure its debt. And you're absolutely right. Europe has been kicking the can down the road treating Greek's problem not as a solvency issue but as a liquidity problem.
I don't like the analogy of kicking the can down the road. I prefer a better one, Fareed. Think of rolling a snowball down a hill. Two things happen when you do that. First, the snowball - or in this case the problem - gets bigger. And secondly, the dynamics start accelerating and becoming more disorderly. And that's exactly what's happening in Greece.
Greece has two problems. It has too much debt and it cannot grow. And until these problems are solved, more and more of Europe is going to be contaminated. We had a massive bailout a year ago in Greece - massive. A year later, every single indicator in Greece is worse off.
A substantial part of that reason, is that it has had to adopt policies of austerity. Cutting spending, raising taxes, and that when you do it in a fragile economy, of course, you're taking money out of the economy. The government isn't spending on all the things it used to; it's firing people rather than hiring people; all that has a downward spiral effect on demand and the economy.
Does that mean in the U.S. as we think about these issues of should we have another stimulus, should we start cutting the budget - is the lesson that while the U.S. economy is fragile, don't cut budgets substantially?
The United States is fundamentally different from Greece in a number of respects. First, it has a lot more time. Because the U.S. supplies the global public goods. It supplies the dollar as a reserve currency. It supplies the deepest markets, financial markets, which means that other countries are willing to outsource the savings. This gives the U.S. much more time to deal with its fiscal policy issues.
The second issue is that the U.S. actually is a much more vibrant economy. The problems facing the U.S. are not an engineering issue as much as a political issue.
You need political will - you need the Democrats and the Republicans to come together to deal with four structural impediments - and they should be able to do that over time.
So when we look at the U.S., yes, there was a public finance issue, but it's certainly nothing like Greece.
So when PIMCO looks at this situation, do you - are you short of U.S. treasuries? Are you selling U.S. treasuries because you worry that the U.S. does not have the political will?
As you say, in our case, there are many solutions. I mean Greece's case, there really isn't a solution - there isn't a good solution. We have many solutions, just no political will, at least, nor apparent political will to deal with it.
Does that make you despair enough that you guys are selling U.S treasuries?
We find better value in government bonds outside the U.S. right now, so it's an issue of valuation. You should buy or sell based on price. U.S. bonds have benefited enormously from the Federal Reserve buying them under the QE-2 program, which ends at the end of June.
Put another way, the Fed has been buying about 70 percent of how much of treasury issues. A basic rule as an investor is don't buy something unless you know who else is going to be buying. So when we look at treasuries, we see the big buyer stepping away from the market for certain. And we ask the question who else is going to be buying at these levels and we can't identify another buyer of the size of the Fed.
How much time do you think the U.S. has to put its house in order?
I think the U.S. - in terms of immediate valuations - I think the end of the QE-2 program is a major event that the market is underestimating. Longer term, I think we have two to three years.
Fareed, as an investor, it's very important to recognize what your alarm clock is.
You know, all of us would like to wake up just as the alarm clock is going off, but a lot of us cannot. A lot of us have type one and type two errors.
Type one is you wake up before your alarm clock and you just sit there and you're early, but at least you don't miss the alarm clock.
The other alternative is you oversleep and you sleep through your alarm clock. Our preference has always been wake up earlier than later.
Do you think that a default, even if it is temporary and does a six-month extension, but an actual default on the debt limit would be a big event for the markets?
It would be and simply because of the technical linkages. So if the U.S. would not only fail to get agreement on the debt ceiling, but end up cutting more than just expenditures on transfers and expenditures on federal workers, but actually not meet a debt payment, then we would be in the land of the unpredictable.
So your advice to the American political system would be, "Do not play with this issue"?
My advice is please try and get together and solve this issue in the context of a medium term reform package.