Bill Gross outlook. Has some real thoughts that are reality based, amazing.
Subject: Pimco's Gross January Outlook
Investment Outlook
Bill Gross | January 2010
Let's Get Fisical
Quixotic journeys often make for great literature, but by definition are
rarely productive. I am, after all, referring to windmills here - not
their 21st century creation, but their 17th century chasing. Futility,
not productivity, was the ultimate fate of Cervantes' man from La
Mancha. So it is with hesitation, although quixotic obsession, that I
plunge headlong into a discussion of American politics, healthcare
legislation, resultant budget deficits and - finally - their potential
effect on financial markets. There will be windmills aplenty in the next
few pages and not much good can come of these opinions or my tilting in
their direction. Still, I mount my steed, lance in hand, and ride
forward.
Question: What has become of the American nation? Conceived with the
vision of liberty and justice for all, we have descended in the clutches
of corporate and other special interests to a second world state defined
by K Street instead of Independence Square. Our government doesn't work
anymore, or perhaps more accurately, when it does, it works for special
interests and not the American people. Washington consistently stoops to
legislate 10,000-page perversions of healthcare, regulatory reform,
defense, and budgetary mandates overflowing with earmarks that serve a
monied minority as opposed to an all-too-silent majority. You don't have
to be Don Quixote to believe that legislators - and Presidents - often
do not work for the benefit of their constituents: A recent NBC
News/Wall Street Journal poll reported that over 65% of Americans trust
their government to do the right thing "only some of the time" and a
stunning 19% said "never." What most politicians apparently are working
for is to perpetuate their power - first via district gerrymandering,
and then second by around-the-clock campaigning financed by special
interest groups. If, by chance, they're ever voted out of office, they
have a home just down the street - at K Street - with six-figure incomes
as a starting wage.
What amazes me most of all is that politicians can be bought so cheaply.
Public records show that combined labor, insurance, big pharma and
related corporate interests spent just under $500 million last year on
healthcare lobbying (not much of which went to politicians) for what is
likely to be a $50-100 billion annual return. The fact is that American
citizens have never been as divorced from their representatives - and if
that description fits the Democratic Congress now in control - then it
applies to Republicans as well - past and present. So you watch Fox, or
is it MSNBC? O'Reilly or Olbermann? It doesn't matter. You're just being
conned into rooting for a team that basically runs the same plays called
by lookalike coaches on different sidelines. A "ballot box" pox on all
their houses - Senators, Representatives and Presidents alike. There has
been no change, there will be no change, until we the American people
decide to publicly finance all national and local elections and ban the
writing of even a $1 check for our favorite candidates. Undemocratic?
Hardly. Get on the internet, use Facebook, YouTube, or Twitter to
campaign for your choice. That's the new democracy. When special
interests, even singular citizens write a check, it represents a
perversion of democracy not the exercise of the First Amendment. Any
chance that any of this will happen? Not one ghost of a chance. Forward
Don Quixote, the windmills are in sight.
Distressed as I am about the state of American democracy, a rational
money manager cannot afford to get mad or "just get even" when it comes
to investing clients' money. Still, like pilots politely advertise at
the end of most flights, "We know you have a choice of airlines and we
thank you for flying 'United'." Global investment managers likewise have
a choice of sovereign credits and risk assets where stable inflation and
fiscal conservatism are available. If 2008 was the year of financial
crisis and 2009 the year of healing via monetary and fiscal stimulus
packages, then 2010 appears likely to be the year of "exit strategies,"
during which investors should consider economic fundamentals and asset
markets that will soon be priced in a world less dominated by the
government sector. If, in 2009, PIMCO recommended shaking hands with the
government, we now ponder "which" government, and caution that the days
of carefree check writing leading to debt issuance without limit or
interest rate consequences may be numbered for all countries.
Explaining the current state of global fiscal affairs is often confusing
- it's much like Robert Palmer's 1980s classic song where he laments
that "She's so fine, there's no telling where the money went!" Where
government spending has gone is not always clear, but one thing is
certain: public debt is soaring and most of it has come from G7
countries intent on stimulating their respective economies. Over the
past two years their sovereign debt has climbed by roughly 20% of
respective GDPs, yet that is not the full story. Some of governments'
mystery money showed up in sovereign budgets funded by debt sold to
investors, but more of it showed up on central bank balance sheets as a
result of check writing that required no money at all. The latter was
2009's global innovation known as "quantitative easing," where central
banks and fiscal agents bought Treasuries, Gilts, and Euroland corporate
"covered" bonds approaching two trillion dollars. It was the least
understood, most surreptitious government bailout of all, far exceeding
the U.S. TARP in magnitude. In the process, as shown in Chart 1, the Fed
and the Bank of England (BOE) alone expanded their balance sheets
(bought and guaranteed bonds) up to depressionary 1930s levels of nearly
20% of GDP. Theoretically, this could go on for some time, but the check
writing is ultimately inflationary and central bankers don't like to get
saddled with collateral such as 30-year mortgages that reduce their
maneuverability and represent potential maturity mismatches if interest
rates go up. So if something can't keep going, it stops - to paraphrase
Herbert Stein - and 2010 will likely witness an attempted exit by the
Fed at the end of March, and perhaps even the BOE later in the year.
Here's the problem that the U.S. Fed's "exit" poses in simple English:
Our fiscal 2009 deficit totaled nearly 12% of GDP and required over $1.5
trillion of new debt to finance it. The Chinese bought a little ($100
billion) of that, other sovereign wealth funds bought some more, but as
shown in Chart 2, foreign investors as a group bought only 20% of the
total - perhaps $300 billion or so. The balance over the past 12 months
was substantially purchased by the Federal Reserve. Of course they
purchased more 30-year Agency mortgages than Treasuries, but PIMCO and
others sold them those mortgages and bought - you guessed it -
Treasuries with the proceeds. The conclusion of this fairytale is that
the government got to run up a 1.5 trillion dollar deficit, didn't have
to sell much of it to private investors, and lived happily ever - ever -
well, not ever after, but certainly in 2009. Now, however, the Fed tells
us that they're "fed up," or that they think the economy is strong
enough for them to gracefully "exit," or that they're confident that
private investors are capable of absorbing the balance. Not likely.
Various studies by the IMF, the Fed itself, and one in particular by
Thomas Laubach, a former Fed economist, suggest that increases in budget
deficits ultimately have interest rate consequences and that those
countries with the highest current and projected deficits as a
percentage of GDP will suffer the highest increases - perhaps as much as
25 basis points per 1% increase in projected deficits five years
forward. If that calculation is anywhere close to reality, investors can
guesstimate the potential consequences by using impartial IMF
projections for major G7 country deficits as shown in Chart 3. |
