What do sex, kittens and Victoria’s Secret have to do with the economy? For Bill Gross, they help put into perspective that clients’ toughest portfolio questions are nothing compared with difficult questions from your kids about the birds and bees.
Bill Gross, portfolio manager of the Janus Global Unconstrained Bond Fund, wrote of such a question from his then 14-year-old son in his monthly market commentary.
When his own mother asked him if he knew where kittens came from, a young Gross replied, “the pet store.” Years later, he had a similar conversation when his son discovered a Victoria’s Secret catalog and instead of explaining what the “plain and unattractive models” were selling, deflected with the kitten question, sighing with relief when he got the same answer.
Important questions about the economy are a little easier to answer, and Gross listed five that deserve consideration.
First, when might a credit-based financial system break down? “When investable assets pose too much risk for too little return,” according to Gross. That won’t happen immediately, but “at the margin, low/negative yielding credit is exchanged for figurative and sometimes literal gold or cash in a mattress. When it does, the system delevers as cash at the core, or real assets like gold at the risk exterior, become the more desirable assets.”
Central banks can maintain reserves, he explained, but they aren’t obliged to lend if it’s deemed too risky. The “secular fertilization” of credit may stop working at the zero bound, he said.
Does that mean capitalism can’t function efficiently at the zero bound?
Not well, anyway. Low interest rates can raise asset prices, but they “destroy savings and liability-based business models in the process,” Gross wrote. Banks to pension funds to small business owners lose their retirement benefits and their ability to pay future debts, he explained. “Central banks seem oblivious to this dark side of low interest rates. If maintained for too long, the real economy itself is affected as expected income fails to materialize and investment spending stagnates.”
What about central banks’ continued quantitative easing efforts? Reuters reported in July that the European Central Bank and the Bank of Japan are purchasing about $180 billion of assets every month, “with the ECB, BOJ and even Bank of England all expected to expand their QE programs soon to try and bolster fragile growth and lift stubbornly low inflation.”