It used to be radical economists like Karl Marx pointing out what they saw as the contradictions of capitalism; now it is mutual fund managers like Janus Capital’s Bill Gross.
The good news is that the bond manager thinks we can escape the fate of dustbin of history to which Soviet Communism was consigned if Fed Chairwoman Janet Yellen very gradually begins to raise interest rates, as he expects she will do.
Gross explains the importance of such a change in course through the metaphor of Monopoly, the Parker Brothers game he played as a boy, and later in life through investment in the real economy.
That game, Gross explains in his February monthly investment outlook, bears a genuine likeness to capitalist financial markets and a modern finance-based economy.
“Monopoly’s real-time bank (the Fed) distributes money to players at the beginning and then continues to create more and more credit as the economy passes go,” he writes.
Those who became good at the game version or real-life version of investing quickly understood the value of making investments (e.g. buying St. James Place) and leveraging them through cash-generating property development (e.g. hotels).
But entrepreneurs, be they Monopoly players or Lehman executives, can also lose their wealth suddenly if they lack the liquidity to pay rent or service debt when needed, leading to Gross’s observation that “early in Monopoly, property is king but later in the game, cash becomes king.”
Those facts of capitalist life have changed since 2008, thus imperiling today’s global economy. An updated version of Monopoly would have to factor in quantitative easing, involving “the outright purchase and occasional guarantee of private securities and public stocks to keep the game going,” Gross writes, adding:
“It’s as if Monopoly’s bank, which has a limited amount of 1, 5, 10 … dollar bills in each game box had ‘virtually’ added trillions of dollars more in order to keep players solvent, in the hopes that some of it would trickle out to the real economy.”
But that hope has largely failed to materialize, Gross despairs. Central banks’ zero-rate policies have distorted the real economy such that lending to Germany or Switzerland by buying their bonds actually costs the lender money through negative interest rates.
“Before 2008, economists and historians would not have believed such a condition could exist,” he laments.
The result is that those possessing capital today, instead of buying and developing New York Avenue, have little incentive to lend, borrow and invest, which involve too much risk for too little reward.
“Investors and game players do not logically give money away; a mattress ultimately becomes a more attractive haven,” Gross writes.
So in the endgame of Monopoly’s updated QE edition, “cash accumulates in corporate coffers or is used to repurchase stock in the financial economy. Investment in plant and equipment is deferred. Structural headwinds such as aging demographics and abnormally high debt/GDP ratios do not offer the player a ‘get out of jail free’ card, in fact they help keep the cell door closed. Hope is challenged.”
Gross’s fundamental point is that capitalism cannot exist without hope — hope of a return on investment.
The Janus Capital fund manager cuts through his initial gloom, however, in arguing that Fed officials now get the need to restore the Monopoly board’s normal operation by raising interest rates, which Gross expects to occur late this year.
In an interview with Bloomberg TV Thursday, the bond manager clarified and amplified the views expressed in his investment outlook, specifying that he expects an initial rate hike of 25 basis points in July or August.
Gross told Bloomberg his view of the “forward curve” suggests to him that the Fed will move very slowly over three or four years to get to a Fed funds rate of 2% at around February 2019.
The Fed’s slow pace is warranted, he argued, by the knowledge that premature or excessive moves could precipitate disorderly markets or recession.
“I think any central bank is aware that, when they raise interest rates, much like the taper tantrum several years ago, or suggesting they are going to raise interest rates, that it can have precipitous consequences in a highly levered economy, which is what we have,” he told Bloomberg.
In the meantime, as the zero rate policy slowly unwinds, Gross expects that investors will be, as he put it in his outlook, “supported.”
In his Bloomberg interview, Gross clarified that that means “the [European Central Bank] and the [Bank of Japan] have stepped in to take the place of the United States, and money and liquidity on a global basis is being provided.”
Asked whether that foretells further 11%-12% returns on the stock market, Gross said he didn’t “think so in the United States…[QE] makes stocks in their local regions attractive. But in the United States, where the dollar is appreciating and being devalued against, it’s just the reverse type of concept,” he cautioned.
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