understand him at all. I can study investors like Ray Dalio and “get” where he is coming from. Ditto Soros and Rogers. But Mr. Gross has yet to express a philosophy that seems consistent with anything that he does, and I’ve been reading his observations for quite a while. Perhaps it is, as he says in his latest letter, that he just makes it up as he goes along.
Today he has come out with his latest letter, “Life — And Death Proposition“, which if you are looking for consistency in his views, you will be as lost as I was. The only consistency is his admiration of Chairman Bernanke’s policies. His view of the economy and its causes and cures is quite conventional, reflecting the mainstream view expresses by most economists, analysts, and investment advisers.
Yet in his latest letter, which starts with an expression of grief for his deceased brother-in-law and the “meaning of life”, concludes with an interesting view on deleveraging:
My intent really is to alert you, the reader, to the significant costs that may be ahead for a global economy and financial marketplace still functioning under the assumption that cheap and abundant central bank credit is always a positive dynamic. When interest rates approach the zero bound they may transition from historically stimulative to potentially destimulative/regressive influences. Much like the laws of physics change from the world of Newtonian large objects to the world of quantum Einsteinian dynamics, so too might low interest rates at the zero-bound reorient previously held models that justified the stimulative effects of lower and lower yields on asset prices and the real economy. …
At the heart of the theory, however, is that zero-bound interest rates do not always and necessarily force investors to take more risk by purchasing stocks or real estate, to cite the classic central bank thesis. …
Because this is so, lenders require a yield premium, expressed as a positively sloped yield curve, to make the extended loan. A flat yield curve, in contrast, is a disincentive for lenders to lend unless there is sufficient downside room for yields to fall and provide bond market capital gains. This nominal or even real interest rate “margin” is why prior cyclical periods of curve flatness or even inversion have been successfully followed by economic expansions. …
Where does credit go when it dies? It goes back to where it came from. It delevers, it slows and inhibits economic growth, and it turns economic theory upside down, ultimately challenging the wisdom of policymakers. We’ll all be making this up as we go along for what may seem like an eternity. A 30-50 year virtuous cycle of credit expansion which has produced outsize paranormal returns for financial assets – bonds, stocks, real estate and commodities alike – is now delevering because of excessive “risk” and the “price” of money at the zero-bound. We are witnessing the death of abundance and the borning of austerity, for what may be a long, long time.
(You can read the entire letter here.)
His points can be better explained by Austrian economic theory of money and credit, i.e., the supply of and demand for it. He sees it in terms of the Keynesian liquidity trap (his comment that—I paraphrase—”it’s supposed to work, dammit”, above), but in fact what he is seeing is that you can’t expand credit when banks, consumers, and businesses (mostly small business now) are still in the deleveraging process. There is no demand for credit while there is still serious deleveraging going on. Our problem right now is not that banks aren’t willing to lend (they are) or that they are looking for a positive yield curve, but that the demand for credit is low.
He is correct that ZIRP has driven capital into the financial markets rather than into business, thus stimulating the markets. He is also correct and clever for noticing that post boom cheap credit leads to distortions in the economy, although he and Mr. Bernanke justify this as being necessary to “save the economy.” Austrian theory would deny this and point to the “solution” as the cause of our current malaise.
His conclusion is that we are going Japanese in the sense that we will be zero bound for quite a while, that we are still in a process of deleveraging, and that the economy is not going anywhere for quite some time. He blames this on ZIRP for deterring lenders and investors from taking risks. Thus he comes around to the Austrian conclusion through his own, in my opinion, confused analysis.
To add to the confusion, in today’s CNBC interview video, below, he concurs that we will have QE3 in 2012, and that politically, he says “I’m a little Ron Paulish …” Wow, Bill. So there you have it. Where is Bill Gross coming from?
The Ron Paul bit comes in at 6:24 (thanks to Zero Hedge for this).
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