By Mohamed El-Erian
FORTUNE -- Most newscasts led their Friday evening shows with the record highs for the stock market and a monthly jobs report that exceeded expectations. Both bits of good news speak to an economy that continues to heal gradually. The question now, and it is an important one, is whether positive interactions among the two will create sufficient momentum for the U.S. economy to attain escape velocity.
Let us start with what matters most to the immediate well-being of the U.S. and, indeed, the global economy -- the country's ability to create jobs and sustain satisfactory wage growth.
Friday's job report outperformed (albeit muted) expectations in three important and hopefully repeatable ways:
Of course, there is still a lot to worry about given the depth of the unemployment crisis triggered by the 2008 global financial crisis.
The sector composition of job gains is far from ideal. Earning growth is hesitant. Many people still struggle, with vulnerable segments of the population battling poverty and alienation (including among the youth, the long-term unemployed, and those lacking sufficient education and training).
Nevertheless, recent job gains are real, and they constitute a notable step in the right direction. This last observation is consequential for the linkage to the second bit of good news on Friday, the record highs for the Dow Jones, S&P 500, and even stock markets abroad.
Friday's jobs report increases, albeit just marginally right now, the possibility that improved economic fundamentals would validate today's highly-assisted financial prices -- and, with that, significantly enhance the possibility of an endogenous, self-reinforcing virtuous cycle.
We should not underestimate the potential contribution to national well-being of the interactions between an improving labor market and financial markets that are buoyant for the right reasons. Together, they provide the potential for the private sector to overcome the headwinds from dysfunctional Congressional politics and European recession.
By improving both income and wealth prospects, this combination entices healthy corporate and household balance sheets around the world (and there are quite a few of them) into win-win productive activities. In the process, the U.S. economy would transition from "assisted" to "genuine" growth; and the global economy would find better footing. The alternative is persistently high unemployment that becomes more structural in nature, and renewed risks of financial disruptions.
Remember, rather than driven primarily by fundamentals, financial markets reflect today the impact of hyper-active central banks seeking to promote growth using partial and imperfect tools. In the process, these institutions have ventured deep into experimental territory; and the longer they stay there, the higher the risk of collateral damage and unintended consequences.
While economic outcomes have repeatedly disappointed, even falling short of policymakers' own expectations, investors have nevertheless become conditioned not just to react but also to front-run any and all expected liquidity injections -- including in Europe where the President of the European Central Bank has engineered a massive broad-based market rally by simply announcing its intention to do "whatever it takes" (and asserting "believe me, it will be enough").
With such dynamics, investors end up taking more risk at ever higher prices. Some are comfortable betting more of their future well-being on the central bank liquidity wave, believing that these institutions have no choice but to increase their activism in coming months. Some doubt the longer-term robustness of the wave but are happy to ride it for now, believing that they can exit markets quickly if it starts to break. And others are simply victims of industry and media hype.
This is why more people are worrying about renewed financial bubbles that could end badly (and it has been less than five years since the global financial crisis). The best way to lower this risk is for the real economy to gain further momentum. This would enable improving fundamentals to validate current financial asset prices, encourage companies to invest more aggressively in new plant and equipment, and increase the scope for central banks to normalize their policy approach in an orderly fashion.
Friday's good news confirmed that the economy continues to heal. At the margin, it reduced the risk of financial bubbles and increased somewhat the possibility of a beneficial virtual economic and financial cycle. But critical mass is yet to be attained.
So as the endogenous improvement continues, let us hope that Congress's occasionally destabilizing behavior is kept away from the economy (meaning no more disruptive debt ceiling outcomes, fiscal cliffs, and/or sequesters) and that the recent period of European financial tranquility lasts a bit longer (no more riots in peripheral economies, excessive creditor fatigue, and/or renewed dysfunction among those charged with restoring and maintaining the financial calm).
Fed chairman Ben Bernanke gave a much-anticipated speech in Jackson Hole this morning, where he basically told D.C. politicians that they need to get their house in order. In other words, this was more about fiscal policy than monetary policy.
Here is the full text of his speech:
Good morning. As always, thanks are due to the Federal Reserve Bank of Kansas City for organizing this conference. This year's topic, long-term economic MOREDan Primack - Aug 26, 2011 10:38 AM ET
What do you have to do to get slapped with the Federal Reserve's biggest-ever consumer-protection fine?
You have to rip off mortgage borrowers by the thousand. The Fed alleges Wells Fargo (WFC) did just that during the housing boom, bilking "possibly more than 10,000" out of sums reaching as high as $20,000 by slapping them with high-cost loans when they would have qualified for cheaper ones.
The Fed fined Wells $85 million MOREColin Barr - Jul 20, 2011 5:41 PM ET
Hoping Aug. 2 will come and go uneventfully? Read Wednesday's comments from Philadelphia Fed President Charles Plosser and weep.
Plosser (right) says the Federal Reserve is gearing up for a possible U.S. default should the loons in Congress fail to raise the debt ceiling. He stresses in an interview with Reuters that he isn't predicting this baleful outcome, but he doesn't underplay how quickly a default might spin out of control.
The MOREColin Barr - Jul 20, 2011 5:05 PM ET
How low would stocks have to go to bring Ben Bernanke off the sidelines?
A 17% drop in the U.S. blue chips would probably suffice, say big fund managers surveyed this month by Bank of America Merrill Lynch.
The S&P 500 would have to hit 1100 to get the Fed buying more bonds to prop up domestic demand for goods and services, according to the survey of 265 managers overseeing nearly $800 MOREColin Barr - Jul 20, 2011 9:52 AM ET
Why Greece's bailout may not prevent a Continental credit crisis and another global economic slowdown.
The Greek Parliament approved a tough austerity plan so that the country could get money from the European Union and the International Monetary Fund, including the rest of the bailout hammered out last year and a second aid package. Europe's officials have now spent nearly $270 billion to keep Greece going, signaling that they will spend whatever it MOREKatie Benner - Jun 30, 2011 1:21 PM ET
Welcome to the world of the do-nothing Fed.
After three years of frantic activity by Ben Bernanke & Co., the Federal Reserve has entered a period in which its hands are likely to be tied by a limping economy and the toxic politics of inflation. That is, unless there is another crisis. If you feel the walls closing in a bit, you're not alone.
The Federal Open Market Committee's statement Wednesday admits MOREColin Barr - Jun 22, 2011 2:00 PM ET
How lost was the past lost decade for the U.S. economy?
So lost that the United States, supposedly home of the globe's most innovative, flexible workplace, has created barely half as many jobs since 1999 as staid, hidebound Europe.
Jean-Claude Trichet, the president of the European Central Bank, notes the disparity in a speech Monday. Since the euro single currency was created a dozen years ago, Europe has created 14 million jobs MOREColin Barr - Jun 13, 2011 12:55 PM ET
How much of a mirage was the brief housing rebound?
The double dip in U.S. house prices is raising fears of another recession. But by one measure housing and consumer spending never bounced back in the first place.
The Chicago Fed's personal consumption and housing index, which tracks housing starts, building permits, retail sales and personal spending, hasn't been above zero since December 2006. That's a 52-month stretch that's unparalleled in the 34-year MOREColin Barr - Jun 13, 2011 10:45 AM ET
The race to the bottom in currencies could get more competitive.
The dollar has a nice head start, having dropped 16% over the past year against a basket of major U.S. trading partners. But the benefits of a weaker currency – cheaper exports, the ability to stick it to your creditors by repaying them with less valuable paper, abundant opportunity to blame your problems on hapless central bankers – aren't lost on people outside this country.
The euro is "objectively MOREColin Barr - Jun 7, 2011 6:40 AM ET
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