I have never been able to figure out Bill Gross of PIMCO. He pleaded for government stimulus and quantitative easing when the economy was crashing and that earned him a place on our Crony Capitalist list.
When I read his op-ed piece today in the Financial Times and his monthly letter to clients, I wonder if he has somehow seen the light, or at least sees it somewhat as I see it. He is starting to see the result of his pleas for help.
Here is a quote from the FT article in which he talks about investing in a world of ZIRP and negative yields:
Both the lower-quality and lower yields of previously sacrosanct debt therefore represent a potential breaking point in our now 40-year-old global monetary system. Neither condition was considered probable as recently as five years ago. Now, however, with even the US suffering a credit downgrade to AA+ and offering negative 200 basis point policy rates for the privilege of investing in Treasury bills, the willingness of creditors – as opposed to debtors – to support the existing system may soon fade.
While all monetary systems are a struggle between debtors and creditors, it is usually creditor nations that establish the rules for transitions to new regimes. Such was the case in the late 1960s as France threatened to empty Fort Knox unless a new standard was imposed. Now, with dollar reserves widely dispersed in China, Japan, Brazil and other surplus nations, it is fair to assume that there will come a point where 2 per cent negative real interest rates fail to compensate for the advantages heretofore gained in buying sovereign bonds.
There is the potential for both public and private market creditors to effect a change in how credit is funded and dispersed – our global monetary system. What that will look like is a conjecture, but it is likely to be more hard money as opposed to fiat-based, or if still fiat centric, less oriented to a dollar-based reserve currency.
Those last words are quite correct. It can’t last.
In his essay to clients, he kind of wanders through banking history, noting that,
… since 1971, when Nixon cratered Bretton Woods, there has been no explicit or even implicit gold backing. The U.S. and therefore the world’s finance-based economies have been backed by an increasing amount of IOUs, which are simply paper promises to create more paper when there is an old-fashioned 20th century run on the banks, or incredibly enough – even when there is not. Lacking a disciplined parental example, the banks, investment banks, money managers and hedge funds piled paper on top of paper as well, creating derivatives and seemingly endless chains of repos and rehypothecation of repos to amass a total amount of credit that literally cannot be counted. Estimates suggest global credit in the financial sector exceeds $200 trillion, with developed economies’ central banks holding only $15 trillion in reserves or figurative “gold dust.” If so, then the global banking system is levered at least thirteen times. These numbers don’t even count the amount of side bets or credit default swaps, which can’t be used as burger payments, but which total $700–$800 trillion alone. Wimpy ["I'll gladly pay you Tuesday for a hamburger today"] has financed so many Whoppers that Tuesday can never come. Judgment day must always be around the corner or after the next weekend. Wimpy cannot pay the tab, except with more and more credit creation, as Euroland countries are discovering first hand.
This is true, of course: this credit money based debt cannot be repaid. What Mr. Gross fails to ask is where does all this credit come from?
He then mentions Austrian economic theory in relation to central banking:
Austrian school economists might say “no matter, forget the counting [of how much credit is out there]– all a central banker has to do is observe the interest rate, the price of credit, to know whether things have gotten out of hand.” And they may have had a point – even after 1971 and up to the mid-1990s, but then economies and the credit that was driving them morphed into a universe that the conservative Austrians would not have recognized. With the dotcoms, the subprimes and now the reflexive delevering of our financial system, it is practically impossible to know what interest rate is applicable. With the QEs and LTROs reducing real yields far below absolute zero, a central banker must wander aimlessly in policy space, wondering how much credit to create, how many Treasuries to buy, and how firm a twist to give the yield curve in order to allow Wimpy the chance for another burger and a side order of fries.
Well, he has a point here too, but he misrepresents Austrian views on central banking. The real point is that neither the Fed, nor any central bank, can ever know how much “money” is enough. Only the market can decide that. It is encouraging that he now understands that the global monetary system is out of control and that it probably cannot be controlled. What I’m not sure he understands is that it is the Fed and the government have created a flawed banking system: one that can simultaneously create base money and create credit money, without many limitations, bringing about the debasement of the dollar and the resulting economic chaos we keep experiencing. Central banking is nothing more than centralized economic planning, something that history has shown doesn’t work very well.
The solution to all if this is to go to a gold standard. Even Mr. Gross acknowledges that gold could be a part of a new monetary system. In a gold standard with free banking, the banking system will provide consumers with safe, privately insured, non-inflationary, depository and lending institutions offering different levels of returns and related risks. There would be no such thing as “too big to fail”.
I sense a lot of frustration in Mr. Gross. Perhaps he is starting to understand the underlying problems (all monetary and regulatory driven), and the consequences are frightening to him. He even admits that he is part of the problem,
We are all central bankers now, at least from the standpoint of endorsing stimulative policies that permit Wimpy and his seven billion counterparts to keep on eating burgers, and their lenders, by the way, to keep on coining profits.
What earned him our Crony Capitalist accolade was that he was one of the loudest members of our Wall Street-Washington Financial Complex to beg the Fed and the government to ‘do something.’ Well, they did what he asked for. It sounds rather shallow to hear Mr. Gross complain about it now that he has started to figure out where it all leads.