How We Got Here

• Author: Manmohan S. Kumar
• Position: Assistant Director IMF Fiscal Affairs Department
• Pages: 55

Page 55

When Markets Collide

Investment Strategies for the Age of Global Economic Change

McGraw-Hill, New York, 2008, 304 pp., $27.95 (cloth).

Timely, informative, and readable, this book combines a multifaceted analysis of structural transformation in the global economy and financial markets with an action plan for market participants, as well as policymakers. The approach reflects the extensive experience of the author, cochairman of PIMCO, which runs the largest bond fund in the world, and formerly president of the Harvard Management Company and a senior official at the IMF.

The book first summarizes elegantly anomalies and puzzles, giving a snapshot of the symptoms of the transformation, including the famous interest rate conundrum: falling long-term interest rates in the United States even as monetary policy was being tightened. It explores these symptoms' underlying causes- dramatic change in the magnitude and channels of interaction among industrial and emerging market countries, and enormous expansion in the operations of the financial markets. These in turn have a significant bearing on how we should assess market developments, investment decisions, and policy responses.

The author argues convincingly that we should not ignore the anomalies and the information they contain, because they highlight underlying changes in risk and return patterns. The book offers a systematic framework for recognizing and understanding anomalies and turning points, and explains why it is difficult to look for signals within the noise. The author draws on behavioral science disciplines and neuroscience to explain our general inability to internalize rare events, despite their extreme impact. This analysis illustrates well the basis for the Keynesian dictum that "the difficulty lies not so much in developing new ideas as in escaping from old ones." The book identifies a number of specific steps to separate the signal from the noise.

El-Erian uses this framework to explore the general realignment of the global system: it is no longer enough to assess developments in the major industrial economies; the role of emerging markets is also crucial. Moreover, the fundamentals are affected by unprecedented cross-border capital flows, and proliferation of new products and instruments, new financial market participants, and new pools of capital such as sovereign wealth funds. In short, there are more diversified sources of global...