Bartiromo one on one with Mohamed El-Erian

Russia is considering steeper counter sanctions against the West after the European Union instituted new sanctions against it. This as voters in Scotland go to the polls and vote this Thursday on whether to separate from the United Kingdom. That referendum has sent the British pound plummeting as investors bet on negative implications of an independent Scotland. Many people worry about a contagion if the Scots are successful, with protests breaking out elsewhere in Europe with calls of their own to break away. Meanwhile, despite scary global headlines, the U.S. market is not far from all-time highs. I caught up with one of the most plugged in investors around — Mohamed El-Erian, formerly CEO of bond powerhouse Pimco — to find out how he sees this disconnect. Our interview follows, edited for clarity and length.

Q: Let me begin with the markets. Terrorism, beheadings, threats to oil facilities, the Ukraine. And yet stocks continue to soar despite all of this. Why?

A: First let me add to your "despite list" — despite the disappointing global economic environment and a less-than-comprehensive policy response. And don't forget the notion that Brazil, Russia, India and China are not what they used to be. That means that the stabilizing wall on the global economy is not as good as it used to be. And yet the market is doing really well.

The first reason is the market is convinced central banks remain their best friends and that it is in the interest of central banks to boost financial prices and to repress volatility. And because of that, investors feel comfortable taking on a lot of risk.

The second reason is a lot of corporate cash is entering the market. It used to be held on balance sheets after the near-death experience of the global financial crisis. But recently we see a step-up in share buybacks, a step-up in dividends, and a boom in merger and acquisitions. So cash that was previously held on the balance sheet of companies is coming into the marketplace and is supporting it.

Q: What do you see as the biggest risks in the world today?

A: The first risk is that the major economies are not able to generate enough economic growth, and that matters for companies' earnings. The U.S. is doing better, but still nowhere near liftoff. Europe is stagnating again. Japan has just re-recorded a significant decline in GDP. Even the emerging countries, which we once looked to be the local motivate of growth, are struggling.

The second is that the West has relied on a very unbalanced policy response. In particular, it has been the central banks that have been doing all the heavy lifting, not because they want to, but because they feel obliged to do so given the political dysfunction elsewhere that undermines a comprehensive policy response. There's concern that the central banks are buying short-term economic calm at the cost of longer-term financial stability.

The third factor is a set of geopolitical tensions, which in the case of Russia could spill over in the economic field. If the West and Russia fail to deescalate the geopolitical tensions over Ukraine, we will get another round of sanctions and counter-sanctions. If Russia feels really hurt, it will likely counter by disrupting the flow of energy supplies to Eastern, Central and Western Europe, and that would definitely push Europe into recession. It's a a 50-50 chance right now because of the role of non-state actors, in particular the separatists on the ground in Ukraine. It is not clear that Russia controls them completely.

Q: Meanwhile, the dollar has been soaring.

A: This is an issue that's completely off the radar screen that should be of interest to all investors. I warned about this much earlier that at some point volatility will return to the currency markets. And it's returning for three very valid reasons.

First, the U.S. is on a different economic track than Europe and Japan. The U.S. isn't growing as much as we'd like it, but it's growing and continues to heal. Japan and Europe are going the other way.

Second, policy is starting to diverge. The ECB is stepping harder on the stimulus accelerator while the Fed is slowly easing off the accelerator.

Third, the geopolitical tensions affect Europe a lot more than the U.S. So what we have seen is a major move in the dollar versus both the yen and the euro. This is key because it means the return of volatility in the foreign exchange market can undermine central banks' effectiveness in limiting volatility elsewhere, which is one of their objectives.

Q: Meanwhile, we have not had a double-digit correction in the stock market in several years. Does this surprise and worry you?

A: I do worry that things are overvalued because there is now a significant wedge between financial asset prices, which are high, and fundamentals which remain sluggish. So I do worry. Do I understand why it has happened? Yes. Because the Federal Reserve has given comfort to a lot of investors. And secondly because so much cash is coming out of corporate balance sheets and being put back into the marketplace.

Q: The Scottish people will vote Thursday on whether Scotland will become independent from the U.K. What are the implications of Scotland being separated? We have already seen the British currency plummet on the notion that the U.K. will lose Scotland and its businesses and its tax revenue.

A: If it is independent it should not keep the British pound as its currency. It should learn from the history of Europe that you cannot have currency union without also having some sort of fiscal integration. If the Scottish people decide to opt for independence, it would not be a good idea for Scotland to maintain a very rigid link to the pound. It would be better off adopting its own currency, but that of course is very unsettling for the Scottish people because they don't know what this new currency would look like.

There are two consequences that people are trying to understand. The first is how will the U.K., minus Scotland, be seen on the international economic playing field? How much weaker will it be? We know it's gonna be a weaker entity. We don't know how much. The second element is the extent to which a Scottish vote for independence will encourage other parts of Europe, starting with Catalonia in Spain, to also opt for separation. And that is why the market is suddenly paying attention because there are broader consequences of a "yes" vote on Sept. 18.

Bartiromo is anchor and global markets editor at the Fox Business Network. Her daily show 'Opening Bell' can be seen M-F from 9-11 a.m. ET on the FBN and her weekend show, Sunday Morning Futures can be seen Sundays at 10 a.m. ET on The Fox News Channel.Follow her at @mariabartiromo or @sundayfutures.