Bond manager Bill Gross is warning that the likelihood is low policymakers will succeed in lifting the economy out of its “new normal” debt crisis — at least in his lifetime.
Indeed, the overall sense of discouragement reflected in his December investment outlook suggests a view that the “new normal” will miff future generations who will puzzle over our current policy failures.
Gross, 70, who has been writing about the new normal since the economic crisis, when he managed portfolios at PIMCO, has argued that it is theoretically possible to “solve a debt crisis by creating more debt.”
But doing so would require that initial conditions not be so onerous, that monetary and fiscal policy be coordinated and that private investors participate constructively.
In Gross’ analysis, we have come up short in all three of these requirements.
First of all, the unattractive environment that has prevailed in recent years — particularly the prevalence of unfavorable debt-to-GDP ratios — presents a formidable barrier to economic rejuvenation.
“It is difficult, for instance, to imagine Japan getting out of its quagmire of debt by simply creating more of it and buying 100% or more of the new and current supply,” writes Gross, adding that Greece and other weaker economies in Europe also faced a level of debt from which extrication would be quite difficult.
But add to massive debt the burdens of aging populations, the challenges of technological development and other growth-stunting factors that former Treasury secretary Larry Summers referred to as “secular stagnation,” and the “old normal” looks very hard to recover.
The second problem — that of monetary and fiscal policy coordination — is everywhere evident.
“It makes little sense, for instance, for Euroland to be running a tight fiscal policy resembling the balanced budget mandate of Germany, while at the same time initiating quantitative easing and negative interest rate monetary policies,” writes Gross, adding that the same contradictory phenomenon exists in Japan:
“The same holds true for the Bank of Japan’s massive monetary stimulus on the one hand, and Japan’s raising of its consumption tax on the other.”
Gross finds fault with U.S. policy as well, noting that reducing the budget deficit from 10% to 3% over the past five years has stunted fiscal expansion while the Fed has pressed ahead with monetary stimulus:
“There has been little focus on public investment and infrastructure spending. It’s been all monetary policy, all of the time, with most of the positives flowing over to markets as opposed to the real economy.” Finally, Gross laments that the Fed has steered private investors into participating in a “pyramid scheme” under the mantra of “where else can they go?”
While acknowledging there are fringe alternatives — say, a 3-year Brazilian government bond yielding 12.5% over a 3-year German government bond yielding -0.05% — Gross says that investors have voted for the low yields but at the price of a highly distorted market.
Policymakers’ theory seems to be that low rates will boost consumption and growth, but the reality, he suggests, is that investors may actually be saving extra hard (because rates are so low) to pay for future expected liabilities such as education, health care and retirement.
For all these reasons, Gross concludes that future generations will look at today’s policymakers the way people might view the unenlightened who would smoke in public today:
“How could they?” they will say. “How could policymakers have allowed so much debt to be created in the first place, and then failed to regulate their own system accordingly? How could they have thought that money printing and debt creation could create wealth instead of just more and more debt? How could fiscal authorities have stood by and attempted to balance budgets as opposed to borrowing cheaply and investing the proceeds in infrastructure and innovation?”
In the meantime, the portfolio manager offers, with little elaboration, his current advice that “markets are reaching the point of low return and diminishing liquidity.”
He suggests taking “some chips off the table,” raising asset quality, reducing duration and preparing “for at least a halt of asset appreciation engineered upon a false central bank premise of artificial yields, QE and the trickling down of faux wealth to the working class.”
— Check out Fall of the Bond King: Gross Lost an Empire as PIMCO Cracked on ThinkAdvisor.