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Central Bankers Strike 'Devils Bargain'; US 'Heart Transplant': Gross

Wednesday, 2 Feb 2011 | 10:39 AM ET
Bill Gross of PIMCO participates in a conference on the future of housing finance at the Treasury Department in Washington, DC.
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Bill Gross of PIMCO participates in a conference on the future of housing finance at the Treasury Department in Washington, DC.

Central bankers compare unfavorably to the devil, America needs a heart transplant, and financial advisors “have failed miserably” at reaching their most important goal, Pimco’s Bill Gross says in his latest commentary.

The managing director of the world’s largest bond fund manager spares scorn for no one in an evaluation of what has happened because of overwhelming debts in global nations.

Sub-zero real interest rates are destroying the wealth of savers, while policy makers fritter away, doling out political gifts and ignoring the brewing inflation storm, in his view.

We need to find a new economic Keynes or at least elect a chastened Congress that can take our structurally unemployed and give them a chance to be productive workers again. We must have a President whose idea of “centrist” policy is not to hand out presents to the right and the left and then altruistically proclaim the benefits of bipartisanship. We need a President who does more than propose “Win The Future” at annual State of the Union addresses without policy follow-up. America requires more than a makeover or a facelift. It needs a heart transplant absent the contagious antibodies of money and finance filtering through the system. It needs a Congress that cannot be bought and sold by lobbyists on K Street, whose pockets in turn are stuffed with corporate and special interest group payola. Are record corporate profits a fair price for America’s soul? A devil’s bargain more than likely.

Gross also takes central bankers to task for 30 years of currency devaluation used to mask reckless spending and burgeoning debts and deficits.

He outlines four strategies “devils” at central banks use to escape from deficit-laden balance sheets: Giving “haircuts” to bond holders in the form of lost principal on government debt; devaluing currency to cheapen exports; using CPI numbers that help mask the real levels of inflation; and imposing negative real interest rates and penalizing savers, pension funds and insurance companies with returns lower than inflation.

“To rebalance debt loads and re-equitize financial institutions that should have known better, central banks and policymakers are taking money from one class of asset holders and giving it to another,” Gross writes. “A low or negative real interest rate for an “extended period of time” is the most devilish of all policy tools.”

As for the portfolio managers, investment advisors and money managers who have lined their pockets even as the financial system has self-destructed? Gross points out that nearly a quarter of the top 400 on the annual Forbes list of people, nearly a quarter “make their money from money.”

As a profession we have failed miserably at our primary function—the efficient and productive allocation of capital: The S&L debacle of the early 1980s, the Asian crisis, LTCM, dotcoms, subprimes, Lehman and the resurrection, instead of the reformation, of Wall Street, are major sins of the modern era of money. Hang your heads, moneychangers. And no, it is not yet time to move on, as many banking CEOs suggest. How can bond traders make ten, one hundred, one thousand times more money than an engineer or social worker given their dismal historical performance? Why is it that some of today’s doctors are using food stamps while investment banking executives complain about millions of dollars in compensation that might be deferred in case of a future bailout?

For investors, the fallout has been a difficult way to squeeze profits out of a low-yield rising-inflation scenario. He prescribes a “safe-spread” solution that uses varying risk strategies.

Maturity extension is just one of them, yet if yields are too low based on historical example, an investor should analyze other yields or other “spreads” which are not. That is what we call “safe spread—The recognition that credit spreads, or emerging market returns, or currencies with positive and high real interest rates are more attractive than those old-fashioned gilts and Treasury bonds offering 2-3%,” he writes. “Those are markets that need to be ‘exorcised’ from model portfolios and replaced with more attractive alternatives both from a risk and a reward standpoint. It is still possible to produce 4–5% returns from a conservatively positioned bond portfolio—you just have to do it with a different mix of global assets.”

Gross makes some dark allusions to black magic in the financial markets while offering a bit— just a bit—of hope.

“Bondholders may be presented with a devil’s bargain, but exorcists are coming to life,” he says. “Bondholders and citizens of America unite! Mammon may be ascendant in this secular world, but there’s always space for heavenly intentions and their antidotes for policy haircuts. Practice ‘safe spread,’ fear the devil, and avoid the barbershop.”

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