Wednesday, October 27, 2010

PIMCO's Bill Gross: Fed QE is "If Truth be Told, Somewhat of a Ponzi Scheme"

Notice a theme here today?  I don't sound so crazy anymore do I?  The world's most powerful bond buyer, Bill Gross - while full of conflicts of interest himself [Feb 21, 2009: Fortune - Is PIMCO's Bill Gross too Powerful?]  - admits the truth as well in his monthly investment letter.  Only he is much kinder to Bernanke than many of us are... (I do agree with Gross that "all of us" are to blame because almost everyone wants more, more, more without sacrificing)  Effectively Gross says don't blame the drug dealer... he is just an enabler.  I disagree.

Frankly folks we're playing a huge game of chicken with the economy and markets.  Which is why I said the other day for those who are either bearish or run hedged portfolios.... your day will come.  The "long and strong and that's all we know crowd" will face the ring of fire in an egregious way down the road.  It may take years - this is the biggest ponzi of them all.... effectively it's an "all in" government/central bank ponzi.  Unfortunately the vast majority of investors are "long only" and frankly the damage to the economy itself is not going to be made up even by those extremely short.   The savers of the nation, (and fixed income seniors) are already being lashed with a whip, to fund the corporatocy (sp?) and debtors... and we're not even at the bubble bursting stage yet.  Something to look forward to - sigh.

Take a step back from the day to day and think about how this economy is now bring run.  It's just very sad for those who look through the trees at the forest but we have an room full of bureaucrats who pull levers, trying to manipulate the economy and asset prices to where they think they are correct, and they act in almost totally unchecked ways.  (isn't that the exact thing we berate other countries who have centrally planned economies from doing?)  Could anyone stand up to this nearly unchecked power and say stop tomorrow?  Nope.  Sort of like USSR 1974 except we call it 'the free market'.  this small select group of "wise (wo)men" supposedly knows better than the market.... notwithstanding all the evidence of the past 2 decades to the contrary.

Specific to the liquidity trap, I wrote about this a long while back - when everyone was blaming the banks for "not lending" I was saying, it's lack of demand for loans.  Massively indebted Americans cannot borrow like the old days - they have to default en masse (as many are doing) and then get those FICO scores back up, so we can start the whole process from scratch.   And small businesses which caters to Americans rather than the Asian buyer does not see big growth in his/her end demand, so has little need for loans - he/she needs customers.  Hence the liquidity trap... not the punditry's cry that "banks aren't lending" that was the meme 12 months ago.  Which as we go full circle, is why the Fed is trying to create a new bubble... we all get rich via 'asset inflation' and then we buy things, and the virtuous circle begins.   Unfortunately, economics is not played in a petri dish or in an ivory tower.  Unfortunately, we are stuck as Ben's guinea pigs, and by we I mean the world - China, Brazil, India - everyone is being affected by the mad man in the helicopter.   To that end:

  • Out-of-control printing of the U.S. dollar is forcing inflation on China, pushing up prices for commodities and labor, trade minister Chen Deming says in an escalation of rhetoric over currency and other tensions ahead of key international meetings.
  • "Uncontrolled printing of dollars and rising international prices for commodities are causing an imported inflationary 'shock' for China and are a key factor behind increasing uncertainty," the state-run newspaper China Business News quoted Chen as saying while attending the autumn session of the Canton Trade Fair.

The full PIMCO letter can be found here titled "Run Turkey Run"

Via Bloomberg here are some snippets:

  • Check writing in the trillions is not a bondholder’s friend,” Gross wrote in his monthly investment outlook posted on Newport Beach, California-based Pimco’s website today. “It is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme. It raises bond prices to create the illusion of high annual returns, but ultimately it reaches a dead end where those prices can no longer go up.”
  • “Having arrived at its destination, the market then offers near zero percent returns and a picking of the creditor’s pocket via inflation and negative real interest rates,” Gross wrote. “It will likely signify the end of a great 30-year bull market in bonds and the necessity for bond managers and, yes, equity managers to adjust to a new environment,” Gross wrote.
  • “This is not a Bernanke scheme, because this is his only alternative and he shares no responsibility for its origin,” Gross wrote. “I call it a Sammy scheme, in honor of Uncle Sam and the politicians -- as well as citizens -- who have brought us to this critical moment in time. You and I, and the politicians that we elect every two years, deserve all the blame.

On the liquidity trap
  • We are, as even some Fed Governors now publically admit, in a ‘liquidity trap,’ where interest rates or trillions in QEII asset purchases may not stimulate borrowing or lending because consumer demand is just not there,” Gross wrote. “Escaping from a liquidity trap may be impossible, much like light trapped in a black hole.
  • If QEII cannot reflate capital markets, if it can’t produce 2 percent inflation and an assumed reduction of unemployment rates back towards historical levels, then it will be a long, painful slog back to prosperity,” Gross wrote.  (but we are not Japan, right?

Folks, some of the comments made today by the market mavens are critically important to understand.  We are in uncharted territory, and the potential outcomes are incredibly numerous.  The Fed is throwing spaghetti at the wall - for now the market is sticking its face up to the wall and lapping at it as it only cares about asset inflation in the near term... the long term consequences be damned.  That's how a locust lives.  See the past 20 years for proof.  For those who are not "Wall Streeters", except to bear the brunt of the pain these consequences will bring. 

But until then, we clap like seals and party like Romans.

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