October 31, 2011

PIMCO’s Bill Gross: Can More Debt Solve Debt Crisis?

The bond king says stimulus policies are stifling growth; on same day, OECD pleads for structural reform

PIMCO's Bill Gross PIMCO's Bill Gross

PIMCO bond manager Bill Gross is warning that U.S. and European economic policies are stifling portfolio returns with policies that fail to deliver growth.

His comments, in his November letter to PIMCO clients, comes as the OECD projected weak to negative growth in the U.S. and Europe, with the OECD calling on leaders to “promptly and forcefully” implement last week’s Euro summit agreement and warning of a “gloomier” outlook if that were not to occur.

Gross, who runs the world’s largest bond fund, says the “the investment question du jour should be ‘can you solve a debt crisis with more debt?…’ Policymakers have been striving to answer it in the affirmative ever since Lehman 2008 with an assorted array of bazookas and popguns: 0% interest rates, sequential QEs with a twist, and of course now the EU grand plan with its various initiatives involving debt write-offs for Greece, bank recapitalizations for Euroland depositories and the leveraging of their rather unique ‘EFSF’ which requires 17 separate votes each and every time an amendment is required.”

Gross’ answer is that none of this can work absent economic growth, which has gone missing for structural rather than economic reasons. This is a problem that is “relatively immune to interest rate or consumption stimulative fiscal policies. Citing economic research by Ken Rogoff and Carmen Reinhart, Gross says high debt levels and government spending, which used to restart a stalled capitalism, now act as a barrier to growth, leading to a vicious cycle akin to “Japan’s  lost decades.”

Gross offers three structural reasons blocking businesses from responding to stimulative monetary and fiscal policies:

“If (1) globalization is precluding the hiring of domestic labor due to cheaper alternatives in developing countries, then rock-bottom yields can do little to change the minds of corporate decision makers. If (2) technological innovation is destroying retail book and record stores, as well as theaters and retail shopping centers nationwide due to online retailers, then what do low cap rates matter to Macy’s or Walmart in terms of future store expansion? If (3) U.S. and Euroland boomers are beginning to retire or at least plan more seriously for retirement, why will lower interest rates cause them to spend more?”

While developed world economic  policy is not generating real growth, Gross say it has “managed to produce disproportionately large inflation. The fund manager thus warns bond investors to “avoid longer dated issues,” sticking with one-10 year maturities instead. He says “both earnings and bond yields near historic lows as a result of a lack of real growth in developed economies” and doesn’t expect returns “above 5% in bonds or equities.”

The OECD, the rich nations' economic think tank, offered a parallel plea for growth ahead of the G-20 summit to be held in Cannes, France, on Thursday and Friday. In a special briefing note ahead of the summit,

OECD Secretary-General Angel Gurria lowered its forecast for developed world economies to 0.3% for the eurozone in 2012–down from 1.6% this year. U.S. growth was expected to remain little changed for its anemic 1.7% rate of growth this year, inching up to 1.8% in 2012.

Gurria wrote in his report that “strong, credible medium-term frameworks for fiscal consolidation and durable growth are needed to restore confidence in the longer-term sustainability of the public finances and to build budgetary space to deal with short-term economic weakness. He called for structural reforms, and specified that the weak growth outlook for developed economies “will likely be better than anticipated here if comprehensive action is taken, including the commitments made at the 26 October Euro Summit, to address the euro-area sovereign debt and banking crises.”

More than usual for an economic think-tank policy paper, Gurria conveyed a sense of urgency though language calling for “decisive” action and “swift” implementation of his pro-growth and structural-reform recommendations.

Read about Bill Gross and others appearing at Schwab Impact 2011.

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