In 2008, Mohamed El-Erian, CEO and co-chief investment officer of Pacific Investment Management Co., coined the term “the new normal.” El-Erian used the term to describe the post-financial crisis facing investors, predicting a world of lower investment returns and slower economic growth.

El-Erian is well respected in the academic and investment communities. In 2008, he won the Financial Times Goldman Sachs Business Book of the Year award for “When Markets Collide.” The company he heads is a leading global investment management firm with close to $1.3 trillion in assets under management as of Sept. 30. It runs the world’s biggest mutual fund.

El-Erian says his “new normal,” a term that has gained wide acceptance, will include:

Nominal Gross Domestic Product growth in America declining to 2 percent from 3 percent.

Return on assets declining to 50 percent of the performance they achieved during the previous 10 to 20 years.

The unemployment rate remaining at 8 percent, much higher than the Federal Reserve target of 4 percent.

What dampened the prospects for the U.S. economy since 2008, according to El-Erian?

During the previous quarter of a century, many companies added too much debt and speculated recklessly in order to achieve their financial goals.

With America enjoying 3 to 4 percent GDP growth and operating under regulations that allowed it, businesses accelerated their use of financial leverage and relied on toxic derivative products. Most assets — bonds, stocks, real estate and stocks — rose. This asset appreciation handsomely rewarded financial leverage, and companies borrowed heavily to expand their plants, invest in equipment and add employees to meet demand.

Has confidence in the ability of markets to regulate themselves declined?

Yes. El-Erian argues that tighter regulation of our markets is warranted. Unfettered markets led to the dot-com bubble in the beginning of the decade and to the dual housing/finance bubble that precipitated the 2008 crisis.

Why does El-Erian think investment returns will be lower?

The U.S. housing market will experience far less than the old rate of two million housing starts per year. We achieved that unsustainable level during the early years of the 1990s because of real estate speculation and financial huckstering such as subprime loans. Employment associated with housing, such as construction work and mortgage refinancing, will decline.

American consumers, who represent 70 percent of U.S. spending, recognize that they cannot continue the 0 percent saving rates of 2005-2006 to support their high consumption. U.S. saving rates are now above 5 percent, but increased saving means reduced consumption. Lower consumption reduces growth, inflation rates and investment returns.

U.S. consumption cannot remain the engine of global growth. The rest of the world, such as China, the OPEC nations and Brazil, will ratchet down their acceptance of U.S. IOUs.

The Challenge

America suffers from such a lack of demand in the private sector that we will experience higher unemployment than in almost any time since World War II. High unemployment will keep the economy sluggish for the foreseeable future.

On June 27, Nobel laureate Paul Krugman wrote in his New York Times column of a “third depression:” “We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.”

What does El-Erian think will be the long-term legacy of the 2008 financial crises — the greatest economic challenge since the Great Depression?

He argues that the 2008 recession effectively ended the old economic model. In “the new normal,” companies will be more pessimistic about growth rates when they make hiring and investment decisions, and that dour outlook will help create a self-fulfilling prophecy of lower growth.

Originally published in the Sarasota Herald-Tribune