What about the possibility of deflation occurring?
We’re in a struggle between inflation and deflation right now. We may never get to a negative consumer price index, but the danger is a drop in asset prices and the destruction of credit. It means corporate bonds defaulting because companies aren’t getting enough business and they can’t pay off their debts. It means foreign governments defaulting. It’s individuals with mortgages who can’t get out from under their 16 tons of debt. The economy can’t recover, and unemployment stays high. Stocks would be in trouble because some companies would be going bankrupt while others couldn’t get the credit they need to grow.
So which is the bigger risk now — inflation or deflation?
Our investment committee has sketched out four possible scenarios. Scenario A is that the global economy rebounds back to past levels of high growth. B is just a decent rebound. C is that new normal — half-sized growth. And D is deflation, debt, destruction. I’d say we’re at a C — right now. We believe in the new normal, but what we’re seeing in Europe puts the minus on that C grade.
What does the “new normal” mean for our readers?
Instead of 10% returns for stocks, look for five or so. And instead of the past 20 years’ returns on bonds, which are actually better than stocks — close to double digits — it’s 4% going forward. So that’s what the new normal is. And it’s based upon the primary assumptions of a deleveraging of the private sector and the public sector being limited in what it can spend.
If stocks might return just a percentage point or two over bonds, does that justify the risk?
Barely.
Why is it so hard to get growth going?
The lack of what economists call aggregate demand. So much of the world’s growth and financial surplus have shifted to Asia, where people are fixated on saving instead of buying. Consumption in China is just 35% of GDP, half our rate.
What should investors make of the Fed’s policy of keeping rates close to zero?
The Federal Reserve wants your readers and Pimco to make a choice. You get almost nothing if you hold short-term Treasury bills. The Fed wants you and Pimco to buy the assets that were depressed 18 months ago — stocks, high-yield bonds, etc. — to restimulate the economy. Because this economy has been based on asset appreciation.
Are those the right policy moves? It seems as if we’re just maintaining America’s dependence on high asset values and debt.
I think it’s the only choice, although there’s debate here. You have people like economist Paul Krugman on one side who suggest we must do whatever is necessary to avoid deflation. Advocates on the other side basically echo what Treasury Secretary Andrew Mellon said at the start of the Depression, that we have to liquidate — let real estate, asset values, and wages fall — and then we can start to grow again. I’ve always felt that if you did that, if you liquidated everything, then optimism, the necessary ingredient for successful capitalism, would completely be eliminated.
At the same time, I admit we should have stopped the habit of debt and asset appreciation long ago. We didn’t. Too bad. But at this point what the Fed wants, what the Treasury wants, what the European Union wants, is for the economy to renormalize, so that governments can play lesser roles, and the private sector can do its thing.
If the biggest dangers are overseas, does it still make sense to diversify your portfolio globally?
Yes, definitely. As a bond investor, however, the problem is that many parts of the world that are doing well and will probably continue to do relatively well — China, much of Asia, Brazil — don’t have developed credit markets. We’ve been buying Brazilian bonds hand over fist. Brazil has low debt, and it has really high interest rates. But an individual would have a hard time doing that. Investors can’t buy a Chinese bond — their debt is internalized. But you can also diversify by investing in developing-market equities.
States and cities are going broke left and right. Should investors be worried about muni bonds?
Warren Buffett, as usual, zeroed in on this. It all depends on whether or not the federal government rescues the states. It has done it in the past 12 to 18 months, with stimulus packages, with Medicaid and education grants, and so on. And Obama is proposing more help.
So you’re suggesting there might be an opportunity there?
At the moment, the Republican orthodoxy is gaining sway, so the administration has to be careful as to what checks it writes. But I can’t imagine California, Illinois, or New Jersey going under. We’ve been buying some taxable munis. We bought New York City bonds last week, which gets us a 6.5% yield.
That’s a nice yield, but overall this “new normal” of low returns won’t be much fun.
The important thing to recognize is that if you’re looking for 10% returns to pay for college or to retire on, they’re not going to be there. We’ve been an asset-growth-based economy for so long. We’ve skimmed off the top, living off second and third mortgages on homes, and capital gains on stocks and even on bonds. Now instead of having money work for you, you’ve got to work for your money.
What Bill Gross Sees Coming
- Pat Regnier, CNNMoney
What the bond guru sees coming
What about the possibility of deflation occurring?
We’re in a struggle between inflation and deflation right now. We may never get to a negative consumer price index, but the danger is a drop in asset prices and the destruction of credit. It means corporate bonds defaulting because companies aren’t getting enough business and they can’t pay off their debts. It means foreign governments defaulting. It’s individuals with mortgages who can’t get out from under their 16 tons of debt. The economy can’t recover, and unemployment stays high. Stocks would be in trouble because some companies would be going bankrupt while others couldn’t get the credit they need to grow.
So which is the bigger risk now — inflation or deflation?
Our investment committee has sketched out four possible scenarios. Scenario A is that the global economy rebounds back to past levels of high growth. B is just a decent rebound. C is that new normal — half-sized growth. And D is deflation, debt, destruction. I’d say we’re at a C — right now. We believe in the new normal, but what we’re seeing in Europe puts the minus on that C grade.
What does the “new normal” mean for our readers?
Instead of 10% returns for stocks, look for five or so. And instead of the past 20 years’ returns on bonds, which are actually better than stocks — close to double digits — it’s 4% going forward. So that’s what the new normal is. And it’s based upon the primary assumptions of a deleveraging of the private sector and the public sector being limited in what it can spend.
If stocks might return just a percentage point or two over bonds, does that justify the risk?
Barely.
Why is it so hard to get growth going?
The lack of what economists call aggregate demand. So much of the world’s growth and financial surplus have shifted to Asia, where people are fixated on saving instead of buying. Consumption in China is just 35% of GDP, half our rate.
What should investors make of the Fed’s policy of keeping rates close to zero?
The Federal Reserve wants your readers and Pimco to make a choice. You get almost nothing if you hold short-term Treasury bills. The Fed wants you and Pimco to buy the assets that were depressed 18 months ago — stocks, high-yield bonds, etc. — to restimulate the economy. Because this economy has been based on asset appreciation.
Are those the right policy moves? It seems as if we’re just maintaining America’s dependence on high asset values and debt.
I think it’s the only choice, although there’s debate here. You have people like economist Paul Krugman on one side who suggest we must do whatever is necessary to avoid deflation. Advocates on the other side basically echo what Treasury Secretary Andrew Mellon said at the start of the Depression, that we have to liquidate — let real estate, asset values, and wages fall — and then we can start to grow again. I’ve always felt that if you did that, if you liquidated everything, then optimism, the necessary ingredient for successful capitalism, would completely be eliminated.
At the same time, I admit we should have stopped the habit of debt and asset appreciation long ago. We didn’t. Too bad. But at this point what the Fed wants, what the Treasury wants, what the European Union wants, is for the economy to renormalize, so that governments can play lesser roles, and the private sector can do its thing.
If the biggest dangers are overseas, does it still make sense to diversify your portfolio globally?
Yes, definitely. As a bond investor, however, the problem is that many parts of the world that are doing well and will probably continue to do relatively well — China, much of Asia, Brazil — don’t have developed credit markets. We’ve been buying Brazilian bonds hand over fist. Brazil has low debt, and it has really high interest rates. But an individual would have a hard time doing that. Investors can’t buy a Chinese bond — their debt is internalized. But you can also diversify by investing in developing-market equities.
States and cities are going broke left and right. Should investors be worried about muni bonds?
Warren Buffett, as usual, zeroed in on this. It all depends on whether or not the federal government rescues the states. It has done it in the past 12 to 18 months, with stimulus packages, with Medicaid and education grants, and so on. And Obama is proposing more help.
So you’re suggesting there might be an opportunity there?
At the moment, the Republican orthodoxy is gaining sway, so the administration has to be careful as to what checks it writes. But I can’t imagine California, Illinois, or New Jersey going under. We’ve been buying some taxable munis. We bought New York City bonds last week, which gets us a 6.5% yield.
That’s a nice yield, but overall this “new normal” of low returns won’t be much fun.
The important thing to recognize is that if you’re looking for 10% returns to pay for college or to retire on, they’re not going to be there. We’ve been an asset-growth-based economy for so long. We’ve skimmed off the top, living off second and third mortgages on homes, and capital gains on stocks and even on bonds. Now instead of having money work for you, you’ve got to work for your money.
What Bill Gross Sees Coming
- Pat Regnier, CNNMoney