Although price pressures in the U.S. economy are currently muted, inflation could accelerate in the United States in the next three to five years, the world's biggest bond fund management company said on Thursday.
The extensive printing of money by central banks to buy securities in emergency measures, such as those the European Central Bank recently announced to stabilize euro-zone government bond markets, will ultimately stoke inflation, wrote Mohamed El-Erian, chief executive and co-chief investment officer of Pacific Investment Management Co (PIMCO) in a 3-year to 5-year Secular Outlook summary. PIMCO oversees more than $1 trillion in assets, mostly in fixed income.
This potential evolution from disinflation to inflation will likely proceed at different speeds in different parts of the globe. It is already well in train in emerging economies and will remain so, El-Erian wrote.
This week gold prices rose to a record above $1,240 an ounce on concerns about the spread of Europe's sovereign debt crisis. Flight into gold can also reflect investors' concerns about the potential for paper currencies to depreciate because of central banks' looser lending policies and worries that inflation could gain momentum.
Over the medium term, the United States will be next, with Europe and even more, Japan, lagging, he added.
In the global financial crisis too many balance sheets deleveraged simultaneously, threatening a global depression and forcing governments to step in with their own balance sheets to arrest an increasingly disorderly process, El-Erian wrote.
Last weekend's drama in Europe is yet another illustration of this phenomenon, El-Erian wrote.
Over the weekend, the European Union and the International Monetary Fund announced a $1 trillion emergency rescue package for the euro zone to halt broader repercussions from Greece's debt crisis.
Policymakers are now forcefully using the balance sheets of the EU (ultimately Germany) and ECB to compensate for the debt excesses in the periphery (particularly Greece) and the related overexposure of European banks, he said.
By Thursday yields paid on Greece's 2-year notes had plunged to 7.12 percent from 22.4 percent the week earlier, as the rescue plan reassured investors about the country's ability to service debt.
El-Erian told Reuters in a follow-up interview on Thursday that even though Greek bond prices rallied sharply, the firm avoided purchasing the deeply-battered debt and that of Spain, Portugal, Ireland and Italy. The question is whether the gains can be sustained under a solution that, until now, is incomplete as it does not address solvency issues, El-Erian said.
He added: Over history, we have seen similar market moves in other country cases that could not be sustained.
El-Erian warned against taking even bigger measures in the euro zone in the future.
An even larger-scale use of central bank balance sheets, if it were to materialize, would provide only a temporary respite, and the collateral damage and unintended consequences would be serious, including the impact on inflationary expectations.
Governments worldwide, meanwhile, are seeking central roles in economic matters after using taxpayer money to bail out their financial systems, highlighting what PIMCO characterizes as state capitalism. That translates into lower expectations for returns. For investors, this translates into a changing configuration of risks and returns -- if you like, a world with a flatter distribution of potential outcomes, fatter tails, and a baseline that is subject to the unsettling dynamics of multiple equilibriums (think path dependency).
(Editing by Chizu Nomiyama and Padraic Cassidy)