The Homa Files

Punch line: Commentary from Bill Gross — one of the premier bond traders in the world:  

“The impotency of policymakers … has consequences for credit and asset markets worldwide.”

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Excerpted from PIMCO investment outlook, March 2010

Let’s get reacquainted with the fundamental economic problem of our age – lack of global aggregate demand – and how we got to where we are today:

(1) Twenty years of accelerated globalization incrementally undermined the real incomes of most developed countries’ workers/citizens …

… forcing governments to promote leverage and asset price appreciation in order to fill in what is known as an “aggregate demand” gap – making sure that consumers keep buying things.

When the private sector assumed too much debt and asset prices bubbled (think subprimes and houses, or dotcoms/NASDAQ 5000), American-style capitalism with its leverage, deregulation, and religious belief in lower and lower taxes reached a dead end.

There was a willingness to keep on consuming, there just wasn’t the wallet. Vigilantes – bond market or otherwise – took away the credit card like parents do with a mall-crazed teenager.

(2) The cancellation of credit cards led to the Great Recession and private sector deleveraging, the beginning of government policy reregulation, and gradual deglobalization – a reversal of over 20 years of trade policies and free market orthodoxy.

In order to get us out of the sinkhole and avoid another Great Depression, the visible fist of government stepped in to replace the invisible hand of Adam Smith.

Short-term interest rates headed to 0% and monetary policies of central banks incorporated new measures labeled “quantitative easing,” which essentially involved the writing of trillions of dollars of checks to replace the trillions of dollars of credit that disappeared after Lehman Brothers.

In addition, government fiscal policies, in combination with declining revenues, led to double-digit deficits as a percentage of GDP in many countries, a condition unheard of since the Great Depression.

(3) Financial crises led to sovereign defaults or at least uncomfortable economic growth environments where real GDP was subpar based on onerous debt levels – sovereign and private market alike.

Dubai, Iceland, Ireland and recently Greece pointed to a potential flaw in the model.

Now, markets are raising interest rates on sovereign debt issuance either in anticipation of higher future inflation, increased levels of credit risk, or both. This places a potential “cap” on the “debt” that supposedly can be created to get out of the “debt crisis.”

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An investor’s motto should be, “Don’t trust any government and verify before you invest.”

The potential impotency of policymakers to close the gap are evolving into a life or death outcome for the weakest sovereigns, with consequences for credit and asset markets worldwide.
 
Full article:
http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2010/Investment+Outlook+March+2010+Bill+Gross+Dont+Care.htm

This entry was posted on March 5, 2010 at 7:55 am and is filed under Financial Crisis. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.