We like to pick on Bill Gross every once in a while. He is a billionaire who loves to “talk to his book” — i.e. tout Pimco’s trading positions — so he can certainly take it.
An example from last year, “The Bond King Gets Desperate,” is newly relevant given the bond king’s latest commentary.
In last year’s write-up, we took Gross to task for saying America is like Greece. He’s saying it again – that America is comparable to Greece – and it’s still just as silly.
The latest Pimco Investment Outlook (Gross’ monthly commentary vehicle) is called “Damages.”
It is full of quotable soundbites, like ready-to-dip chicken McNuggets, such as stating Uncle Sam is addicted to ‘budgetary crystal meth.”
Here is the Greece part (which got a lot of armageddon types excited):
How can the U.S. not be considered the first destination of global capital in search of safe (although historically low) returns? Easy answer: It will not be if we continue down the current road and don’t address our “fiscal gap.” IF we continue to close our eyes to existing 8% of GDP deficits, which when including Social Security, Medicaid and Medicare liabilities compose an average estimated 11% annual “fiscal gap,” then we will begin to resemble Greece before the turn of the next decade.
No, no, no. America will NEVER resemble Greece. The situations are just too different. This isn’t apples and oranges, it’s apples and wildebeests.
Here is an excerpt of what we said more than a year ago (which still holds):
To even imply that the United States is worse off than Greece is pretty amusing — especially now that Greece is splattered all over trader’s screens like roadkill on a windshield.
So how does the United States differ from Greece in ways that materially affect the bond situation? Let us count the ways:
- The United States is a military and agrarian superpower.
- The United States accounts for roughly 25% of global GDP.
- The United States is the issuer and printer of the world’s reserve currency.
- The United States owes in its own paper.
- In the eyes of massive creditors such as China, Japan and a majority of global central banks, the United States is “too big to fail.”
Are we trying to write off America’s long-term fiscal problems? Absolutely not!
But suggesting that the U.S. is in worse fiscal shape than Greece, from a logistical / tactical perspective, is like comparing J.P. Morgan to the Bumbershoot Bank of Topeka Kansas. Greece is screwed, but the only reason we care is because of deeply embedded systemic risk. Were America to be screwed, so would the world. The comparison is more hyperbole than fact.
Further, re, “too big to fail:” As goes America, so goes the globe — still. Guess what happens in the aftermath of a true U.S. economic collapse?
The price of oil collapses, which means the Middle East goes haywire. (Saudi Arabia and other nations can no longer afford sustained pricing below $80 or $90 a barrel.)
The value of exports and world trade collapses (America is ~25% of GDP, remember, and a very important “vendor finance” customer) at a time when China is nowhere near ready to stand on its own two feet — which means Asia goes down too.
Not only is the U.S. genuinely “Too Big To Fail” in many respects — with the important advantage of a still dominant military and agrarian position — Uncle Sam also has the ability to buy bonds with dollars. This activity risks serious inflation in the long run, but as Keynes liked to say, “In the long run we are all dead.”
We have argued forcefully in the past that bad U.S. policies ultimately pose serious inflation risk, as the cost of unproductive spending is ultimately born out through inflation / reflation (distributing the hidden costs of debt).
And yet, have you seen the trajectory of the price of oil lately? It collapsed 4% in one day this week. Does the market seem genuinely worried about inflation to you?
Funny thing. Oil was dropping when we last broached this topic, and it is dropping once again.
Check out continuous contract crude oil futures as of October 2012:
Before going into his “USA as Greece / budgetary crystal meth” bit, Gross is careful to remove any semblance of timeline from his comments with the following:
Well, Armageddon is not around the corner. I don’t believe in the imminent demise of the U.S. economy and its financial markets. But I’m afraid for them.
One could perhaps rephrase that as “Look, don’t put a timeline on my prediction, because all the guys who did that with Japan are looking pretty sheepish and a lot poorer if they bet on it, but hey it makes sense to be worried in your heart of hearts and eventually I will be right!”
Yeah… okay… It is hard to see how this is helpful. Yes it is true that unrestrained spending eventually leads to severe problems. Key phrase being “eventually,” case in point Japan (an eventuality for which we still wait).
But the focus on the United States’ problems, to the exclusion of other potentially far more serious problems in the world, is so simplistic and moralistic it drives us nuts!
Consider China’s black box, for example. If estimates are correct, China could be facing a shortfall in the trillions… and don’t even get us started on Europe…
Is this a case of trying to deflect attention from one problem by pointing to others? No, not at all because the fiscal attractiveness of U.S. assets (and U.S. debt) cannot be viewed in a vacuum. Such has to be considered against the merits of other alternatives.
In that light, rather than worrying about the United States’ fiscal position at some point well off in future – on a timeline Gross refuses to even cite – it seems more sensible to us to ask the following hypotheticals:
What happens if recession in Europe – including Germany – places further pressure on China, hastening a “recession with Chinese characteristics” (growth so low it feels like collapse)?
What happens if one or more of Europe’s growing separatist movements gain traction? Or if Spain refuses a bailout?
What happens if the Federal Reserve fails in its unemployment mandate (as it almost certainly will…) and the US economy slips back into recession?
What happens if a chain reaction of events tying together Iran, Israel, Syria, Saudi Arabia etc. causes the Middle East to implode, sending oil prices rocketing higher and delivering the equivalent of a massive economic coronary via deflationary (not inflationary) shock?
Rather than worry about what could happen “some day” with the U.S. — sorta like the constant worry over what will happen “some day” with Japan — it seems far more sensible to pay attention to here-and-now developments like this:
CATALONIA may be the catalyst for a renewed wave of separatism in the European Union, with Scotland and Flanders not far behind. The great paradox of the European Union, which is built on the concept of shared sovereignty, is that it lowers the stakes for regions to push for independence.While a post-national European Union may be emerging out of the euro zone crisis, with a drive for more fiscal union and more centralized control over national budgets and banks, the crisis has accelerated calls for independence from member countries’ richer regions, angry at having to finance poorer neighbors.
Anyone sweating a breakup of the 50 states? Didn’t think so…
Or how about this, via the American Security Council, which reputedly has crude spiking nearly 4% as we write:
In a report issued Monday, the Institute for Science and International Security (ISIS) said Iran has the capacity to produce 25 kilograms of highly enriched uranium needed for the core of a nuclear warhead in two to four months. Iran has thousands of centrifuges enriching uranium at its main plant in Natanz and hundreds of other centrifuges operating at its Fordo facility, located under a mountain to shield it from air attacks.
Considering Iran’s currency is collapsing, that sounds pretty timely.
Or this, which is our candidate for “low level diplomatic conflict most likely to develop into full-blown Smoot Hawley style protectionist trade war” – via Reuters:
U.S. telecommunications operators should not do business with China’s top network equipment makers because potential Chinese state influence on the companies poses a security threat, the U.S. House of Representatives Intelligence Committee said in a report on Monday.
The report follows an 11-month investigation by the committee into Huawei Technologies Co Ltd and its smaller rival, ZTE Corp.The companies have been fighting an uphill battle to overcome U.S. lawmakers’ suspicions and expand in the United States after becoming key players in the worldwide market.
The House Intelligence Committee’s bipartisan concerns are bound to set back the companies’ U.S. prospects and may also lead to new strains in trade ties between the United States and China, the world’s two biggest economies…
Here is another distinct irony in respect to the whole bond vigilante stance:
Picture the global economy as a jumbo jet powered by four engines — the United States, Europe, China, and Japan.
Right now the United States is the main engine… sputtering a bit, but the only one not shooting out smoke and flames (Europe, China, Japan in seriously bad shape).
Were the price of treasury bonds to fall sharply, then, U.S. interest rates would rise sharply.
Were interest rates to rise sharply, any semblance of U.S. economic recovery would be stopped in its tracks.
Were U.S. recovery stopped in its tracks, the rest of the world would nosedive as well (the plane already flirting with ‘stall speed’).
Such an environment would be extremely deflationary…
And thus supportive of US treasuries…
Causing long bond prices to rise again (and interest rates to fall).
This feedback loop scenario is not original to our thinking. It was laid out by Andres Drobny some years ago in Invisible Hands.
But it makes sense. To assess the credit quality of the United States in a vacuum is to think myopically and to erringly exclude multiple key variables. As a primary driver of the global economy, a military and agrarian superpower, a key trading partner, and so on, with many trillions of dollars in embedded intellectual property, real estate, and hydrocarbon assets on the balance sheet (think fracking revolution), the United States is a country that will virtually always have preferable lending status in situations of last resort… and any situation in which the global economy is in danger of collapse, which is exactly what we would have were U.S. rates to spike and threaten to kill off U.S. recovery, is by definition “last resort.”
No, not at all. Instead it is a recognition of the fact that
- The global economy has many moving parts
- The fiscal attractiveness of US obligations cannot be determined in a vacuum, and
- Indulging in U.S.-centric doom and gloom predictions is inaccurate and irresponsible.
There is something to be seriously concerned about regarding the US fiscal situation, in our opinion… but it isn’t an eventual bond market collapse, or any “armageddon” prediction relating to the U.S. fiscal situation per se.
(For the love of Pete, have you SEEN the state of the competition?)
The real threat instead — in our humble view — is a persistently weak and degraded economic state — a sort of hellish purgatory — that lasts for many years, because toxic fiscal policy is never addressed, leading to rapid societal decay at the margins as more Americans grow destitute and the middle class vanishes.
And as long as congress and all the other idiots in Washington, regardless of political affiliation, continue to believe that monetary policy, i.e. Federal Reserve action, is the main driver of economic recovery, real and meaningful changes to fiscal policy will be lost to porkbarrel gridlock.
And by the way, the potential worst economic situation of all — a Smoot-Hawley style downward spiral into protectionist trade war — is one that could be created by congress… possibly even in the name of deficit reduction… and such would cause U.S. treasury values to go up, not down, as the global economy goes down in Molotov Cocktail flames.
Irony of ironies, you would want to be long treasuries out the yin-yang if such happened…
But nobody is pounding the table saying “HEY IDIOTS, GET OUT OF THE WAY OF DOMESTIC JOB CREATION” or “HEY IDIOTS, DON’T START A TRADE WAR” because you don’t get as much free publicity for that, or as much satisfying doom-and-gloom traction, as one does peddling “budgetary crystal meth” comparisons and painting pictures of bonds going down in flames…
So, Bill (if we can call you Bill), let’s leave the armageddon scenarios to sandwich-board street preachers and instead focus on the “serious” attendant risks to the global economy here and now, shall we?