Wednesday, January 5, 2011

PIMCO's Bill Gross' January 2011 Letter - Off with Our Heads

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I'm starting to become afraid as Bill Gross is starting to sound a lot like Tradermark. ;) Some of the things in the January 2011 letter are almost verbatim from various entries on FMMF.   The thrust (literally) of January 2011's letter, is what I have labeled intergenerational arbitrage.  Taking from the those with little or no voice (tomorrow) to give to the today.  A selfish act, but one we have perfected.  We often speak of the lack of cost-benefit analysis in modern America; everything is benefit-benefit analysis.  "If we only spend/tax cut/stimulate/hand out/beg/borrow/steal $XXX, well we can make almost any economic figure surge".   Indeed, PIMCO itself noted we just bought some extra GDP with the massive package passed late in 2010.  [Dec 10, 2010: PIMCO Joins Goldman in Raising GDP Forecasts for 2011 as United States "Buys Itself" to Prosperity]  I am still giggling at the hard fought "compromise" between the GOP and Dems on that one - only in Cramerica do you call it compromise when you give both sides what they want.  Did I mention how hard fought it was?

The current excuse is we are just going to grow our way out of all our problems.  Sure, why not - it's only money.  I've proposed we cut all taxes to $0 and hand every American $10 million ... surely with the prosperity we create from those acts we will "grow" in a way no other country in the history of countries has.  Why do it half way? After all it's all about benefit-benefit analysis. :)

Anyhow as long as we see the benefits today, and any and all costs are pushed out til tomorrow (preferably to a generation we never have to look in the eye) it's all good.  Buy stocks - David Tepper style (we can't lose remember?).  And houses. And cars.  And shop your local mall - often.  American exceptionalism baby.

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Here is a link to this month's letter, entitled "Off with Our Heads" - some highlights
  • Americans, unlike their developed world counterparts, have been eating their fill lately, and supping at a dinner table laden with pork and tax breaks for all. Unequivocally, we have been playing the part of the female mantis, munching on the theoretical heads of future generations, while paying no mind to the wretches that will eventually be called upon to pay the bills.
  • Unlike Euroland or the United Kingdom, which appear to have gone on an extreme fiscal diet, the American answer to a bulging waistline is always “maƱana.” Debt commission recommendations are tossed in the trashcan, tea party election rhetoric eventually focuses on minuscule and merely symbolic earmarks, and both Democrats and Republicans congratulate each other on their ability to reach a bipartisan agreement for the good of the nation. Munch! Munch! Off with our heads!
  • The problem is that politicians and citizens alike have no clear vision of the costs of a seemingly perpetual trillion dollar annual deficit. As long as the stock market pulsates upward and job growth continues, there is an abiding conviction that all is well and that “old normal” norms have returned. Not likely. There will be pain aplenty and it’s imperative that we recognise now what the ultimate cost of blueberries will mean for American citizens of tomorrow.

Four major factors come to mind:
  1. American wages will lag behind CPI and commodity price gains.  Because policy stimulus is focused on maintaining current consumption as opposed to making the United States more competitive in the global marketplace, American workers’ real wages will almost necessarily lag historical norms. Chart 1 points out the graphical evidence of an erosion of labor’s share of the American economic pie, falling from 62% of GDP just recently to a current anemic 58%. Blame it on poor education, blame it on globalization, but an ongoing rebalancing of rich country/poor country wages inevitably will keep US wages compressed as deficit spending serves to reflate commodity and end product prices in future years but not paychecks. Americans will feel the pain but like the male mantis, probably not understand why they’ve lost their head.
  2. Dollar depreciation will sap the purchasing power of US consumers, as well as the global valuation of dollar denominated assets. Unique amongst almost all other global citizens, Americans are ignorant of the merits (and the negatives) of currency depreciation. Unless they are smacked with the reality of an expensive hotel or a meal in a foreign port of call during summer vacation, we have few concerns when the dollar depreciates against a basket of foreign currencies. If our stock market goes up 10% annually in dollar-denominated terms, we assume we are 10% richer even if the dollar sinks at the same time. If the cost of imported goods and especially gasoline goes up more than our paychecks, we blame it on a political conspiracy. The fact is that annual budget deficits in the trillions of dollars add a like amount to the stock of outstanding dollars, resulting in currency depreciation, higher import inflation, and a degradation of dollar based assets in global financial markets. We become less, not more wealthy, losing our heads while we “hold on firmly and go on with (our) business”! 
  3. One of the consequences of perpetual trillion dollar deficits is the need to finance them, and at attractively low interest rates for as long as possible. Currently, the Fed is doing both, holding short term interest rates near zero, and engaging in Ponzi like Quantitative Easing II purchases of longer dated Treasuries in the open market. The combination offers bondholders about as an attractive situation as the one facing a male praying mantis: zero percent interest rates if you stay in cash, or probable principal losses if you take durational risk by buying 5 and 10 year maturities. Eventually, as reflationary policies take hold, long-term bondholders lose their heads (and a portion of their principal as well), as yields rise to reflect higher future inflation. Bondholders’ metaphorical warning: “don’t go near those longer term bonds you fool”.
  4. Trillion dollar annual deficits add up, and eventually produce a stock of debt that can become unmanageable: witness Greece, Ireland, or a host of Latin American countries of generations past. According to Carmen Reinhart and Kenneth Rogoff’s excellent research in This Time Is Different, once a country’s debt approaches 90% of GDP (as the U.S. is now doing), its economic growth slows by up to 1% annually as the interest payments drain resources that should be going for productivity enhancements. Sovereign credit risk increases and yield spreads rise relative to global competitors. Future generations pay the price for their parents’ mindless thrusting.

[Dec 3, 2010: PIMCO's Bill Gross' December 2010 Letter - We're All Living in Allentown, PA]
[Oct 27, 2010: PIMCO's Bill Gross: Fed QE is "Truth be Told, Somewhat of a Ponzi Scheme"]


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