[Velshi:] Back with a special live edition of YOUR MONEY, covering the S&P; downgrade of U.S. sovereign debt. Ken Rogoff is back with me again. He's a professor at Harvard University and former chief economist for the International Monetary Fund. On the phone is Mohamed El-Erian, he is the CEO of PIMCO, one of the biggest bond dealers in the entire world. They run the biggest bond fund in the entire world. Mohamed, thanks for being with us. I just spoke to David Beers of S&P.; I want to get a sense from you, because it is a question a lot of our viewers who may not be involved in the world of bonds and bond ratings, ask me, after what happened in the financial crisis in 2008 and the errors that the major bond rating agencies made, do serious bond buyers and sellers and traders listen to what S&P; says? Does this matter?
[Mohamed El-erian, Ceo, Pimco:] It does matter, Ali, but not because we invest on the basis of what the rating agencies say. Here at PIMCO, we have our own sovereign credit assessment. We have our own internal ratings. And we make investment decisions based on our own work. However, the rating agencies, who are a record ratings monopoly, are wired into the system. And they are wired into such a way as it gives them enormous influence. So they are reflected in investment guidelines. They are reflected in the way certain people think about risk. And, therefore, we have to pay attention to what other people are going to do based on this downgrade. So strictly speaking, it will not impact how we invest our money, but it does impact how the system responds.
[Velshi:] It may impact how other people invest. And that will be important to you. Let's take a look. I want to put up a list on our screen of the 15 countries used to be 16 by the way, until yesterday the 15 countries that enjoy a AAA credit rating from both Moody's and S&P.; The United States is no longer on that list. But Australia is, Canada is. Mohamed, these countries pay better yields. Is there some reason why they wouldn't benefit dramatically from this downgrade in U.S. bonds?
[El-erian:] They will benefit. But it's not going to be dramatic. The U.S. had two thing going for it in addition to being the AAA. It is the reserve currency, so other countries use the dollar. And secondly, it has the deepest and most liquid financial markets, which means other countries outsource their hard-earned savings to be intermediated through the U.S. system. Now none of these other countries on your list is either able or willing to step in for the U.S. They can do something at the margin, but they cannot replace the U.S. That's both the good news and the bad news. It is the good news which means the system will not change radically overnight. Because you cannot replace something with nothing. But it is also bad news because there is an uncertain element to how a global system operates with the AA as a score.
[Velshi:] So given how plugged in you are to the system, and I just want to remind our viewers who may not be familiar with this, but the international bond market is substantially bigger than the capitalization of the value of the international stock markets. After being whip-sawed this week, Mohamed, many of our viewers were wondering, oh, my god, what happens next week? In the broadest economic sense-I know you are not a stock market prognosticator-but in the broader economic sense, will we wake up Monday with some massive response and reaction to what S&P; did on Friday? Or was this, in some quarters, expected enough that the response will be muted?
[El-erian:] It was expected in some quarters, but it will also come as a shock in others. We're looking at an uncertain and volatile outlook. Certain things I think we know. We know that this is bad news for the U.S. economy. It is a further headwind to growth and job creation. We know that this is going to accelerate lots of questions about the rating agencies themselves. You'll hear the question, who rates the rating agencies? We know that it will put a question mark on other AAA countries, which means there will be concern about Europe. So which ever way you look it a, the risk premium in the market is going to go up. And this was unthinkable, Ali, not so long ago.
[Velshi:] David Beers said it could take-if everything is done the right way and in fact if these budget discussions get a little more aggressive about either raising revenue, raising taxes or cutting spending, the U.S. could regain its AAA credit rating in about two years. You know, the credit rating is not the same as lowering or raising interest rates themselves, Mohamed. And what we saw is that U.S. bonds got more expensive and their yields got lower. Their return got lower. That's counter intuitive to some people. You could expect that this kind of thing would cause U.S. bonds to-would cause the U.S. to have to pay more interest to borrow money. Why is that not happening?
[El-erian:] Two issues: First on the S&P;, they added insult to injury because they didn't just downgrade the U.S. from AAA to AA plus. They put the new rating on negative outlook, which means they're still worried about the possibility, not the probability, but the possibility of a further downgrade. In terms of the impact on U.S. Treasuries, remember U.S. Treasuries reflect a whole host of factors. What has dominated in recent times are two things. First, a recognition that the U.S. and the global economy are slowing down significantly. And that tends to push bond prices up, yields down. And second, we've had a fight to quality out of Europe because of the crisis there. And out of the stock market because of nine sharp days of decline. So the bond market is trying to reflect so many moving pieces. And net-net these two that I've just cited have dominated over the credit risk which was associated with the AAA downgrade.
[Velshi:] And Mohamed, finally, I want to ask you, do you think there is going to be, maybe not on Monday, maybe not in the short term, but what's the overall effect, both psychologically and financially on the delicate economy here in the U.S. of not only this, which happened on Friday, but of the things we've seen unfold over the course of the last nine days. The debt deal, the new numbers on GDP which shows our growth is slower than expected, that manufacturing is slowing a little bit. That demand, the consumer demand had slowed a little bit and our job growth is actually a little better than we expected. When you put all of this into a bowl, what kind of bake do you bake out this?
[El-erian:] Let me tell you my expectation and then my hope. My expectation is when you put thought in a bowl, the analysts will be revising down again the growth estimates for the U.S. and for the rest of the world. And that is not good news for a country that already has an unemployment crisis, and has a housing market that is not functioning properly. This is bad news for Americans, because it means lower growth and fewer jobs. My hope, Ali, and it is a hope, is that this will be a wake-up call for the politicians and the policy makers. This could be our Sputnik moment. The moment in which our psyche, as a country, is shaken so much, that we recognize collectively the need for common vision and common purpose to put this country back on the road to faster growth and more jobs.
[Velshi:] Mohamed El-Erian, very clear, I appreciate you coming here and making some sense for us. Mohamed El-Erian is the CEO and co- chief investment officer at PIMCO. I'm standing by with Ken Rogoff, he is the former chief economist of the International Monetary Fund. He is a Harvard professor and one of the smartest guys I know. He will help make sense of this, right after our commercial break. You're watching a live special edition of YOUR MONEY. Stay with us.