This "freedom of action" question was addressed superbly by Bill Gross today,
Message 19340322
and this part of his remarks should be tatooed on every reader's head (at least of this thread). It's not going to be the Fed that's going to deliver the coup de grace to this bloated pig:
""One investment conclusion is this: do not expect the Fed to be the hangman by raising rates. If this were a game of Clue and we were wondering whether the killer was 1) Prof. Plum, 2) with a lead pipe, 3) in the library, you can be very confident that it won’t be 1) Chairman Greenspan, 2) with an interest rate hike, 3) at the Federal Reserve. He knows better and will only raise short-term yields if and when the U.S. economy appears to have the legs to withstand such a shock. For all of the above reasons, that day is far advanced – way out there – back, back, back, back as Vin Sculley might describe a Barry Bonds’ home run.
But there are other players in the financial arena, including PIMCO, and they make decisions too. Last month’s Outlook suggested that Clue’s economic and bond market murderer might ultimately be 1) Zhou Xiaochuan, 2) with a currency reval, 3) in Beijing OR 1) Toshihiko Fukui, 2) with a Treasury bond sales ticket, 3) in Tokyo. I described the near trillion dollars of U.S. Treasury securities held by Asian countries and posited that at some point the risk might outweigh the reward and that the ensuing sales might trigger a run on the bank, a hike in yields, and a beginning of the end for our Hummer and Hummvee prosperity. Asia, and principally China, might very well be the prospective culprit – they have a pretty big lead pipe that’s for sure and now it’s just a question of motive, not opportunity. But the fact is that for now, the status quo sort of suits them. They are sucking up a lot of Treasuries, yes, but they’re also putting a lot of their people to work and in the case of China, that means tens of millions. Why revalue their currency, why sell their surfeit of Treasuries if they can instead employ the outflow of young workers from exterior provinces into Shanghai by fixing the Yuan to the dollar? In the case of Japan, why risk renewed deflation via a stronger Yen? Some say they should buy dollars, buy Treasuries, do everything possible to keep their exports competitive and their economies above the line.
Last month’s Outlook suggested, however, that sooner, perhaps later, they would act, if only because the risk would become unbearable, but the timing was unclear. Just a week ago, though, the Yen cracked the important 115 to the dollar barrier, a sign that their appetite for dollars and U.S. Treasuries might be sated, and that the long enamored and widely held “Yen carry trade” might be on its last legs. U.S. Treasury yields have since risen.
Still, Asian countries’ apparent willingness to trade-off jobs for a bad investment begs a better question. If Asia is subsidizing its growth by purchasing dollars and Treasuries at a premium price, what about all the rest of us? What ancillary benefits do we get by purchasing a rich dollar denominated bond? Surely PIMCO and others get the same interest rate and (absent money management alchemy) we get the same return as do Asian investors. We therefore are getting the short straw, the hind teat, in short, a bad deal. We have nothing to show for our investment prowess other than an under-yielding Treasury note denominated in an overvalued currency. So when I wrote last month that China holds the keys to the Hummers, I was getting close to identifying the culprit in our ongoing game of Clue. What I didn’t suggest is that the waiting game is a dangerous one for other investors – they in fact could be the victims. There are rewards for playing of course. Instead of 3/4% money market returns there’s 5%+ for holding long Treasuries and even more if you shift sectors to corporates and mortgages. Rollers of the Clue dice rightly claim that Prof. Plum or Japan central bank boss Fukui might not be the one, or perhaps that the dirty deed of reval or Treasury sales might never happen. They have a point. Waiting for Fukui or China’s Zhou Xiaochuan could be an expensive proposition. But what oh what if it turns out to be true, or what if the PIMCOs of the world wise up to their subsidizing Chinese employment by holding an overvalued Treasury portfolio? And, lest I sound too apoplectic, the name of the next game doesn’t have to be Armageddon. A more likely course would posit reduced Asian and U.S. purchases of Treasuries, a diversification into Eurobonds, a stronger Yen and Yuan over the next few years, more expensive U.S. imports after a lag, a sapping of consumer spending power, gradually rising intermediate and long-term rates, a declining housing market and yes a near body blow to America’s financed-based economy for all the reasons outlined in previous pages. I reiterate: the stocks, bonds, and currency of a debtor nation in the process of reflating are not attractive investments. At the moment the markets are without one – but sooner or later they are bound to get – a CLUE. My vote, PIMCO’s vote, will be to play the game with eyes wide open and our wallets and purses close to the hip. Inflation and currency protection will be paramount in the initial stages of this game of Clue, and credit protection in the latter phase as the U.S. economy is mugged by a host of Prof. Plum “act-alikes” with their lead pipes.""
William H. Gross
Managing Director |
