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Bill Gross: Central bank 'casinos' to run out of luck

Bill Gross
Tim Boyle | Bloomberg | Getty Images

Investors should cut risk heading into 2016 as central banks trying to pump up their respective economies make losing bets, bond guru Bill Gross says.

Institutions like the Federal Reserve and the European Central Bank are like "casinos" that create money instead of chips "they'll never have to redeem," said Gross, founder of bond giant Pimco who now runs the $1.4 billion Janus Global Unconstrained Fund for Janus Capital.

Furthering the gambling analogy, he said central bankers are using a familiar ploy — doubling down on losing bets until they break even.

In the years after the financial crisis, the Fed, the ECB, the Bank of Japan and other global counterparts have created money used to buy various assets. Financial markets have climbed as a result, but real economic growth has been more elusive.

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"How long can this keep going on? Well, theoretically as long as there are financial assets (including stocks) to buy," Gross said in his monthly letter to clients. "Practically the limit is really the value of the central bank's base currency. If investors lose faith in a reasonable range for a country's currency, then inflation will quickly hit targets and then some."

"No rational observer would call these post-Lehman efforts a success," he added, referring to the collapse of investment bank Lehman Brothers on Sept. 15, 2008, the event many consider to be the seminal event of the financial crisis.

Gross' comments come at a crossroads for global central bank policy and were released the same morning that ECB President Mario Draghi promised to keep the easing spigots open albeit at a slower flow. Draghi's comments were initially interpreted as being a bit more hawkish than expected, briefly causing a selloff in U.S. stock futures and a gain in the euro.

After seven years of keeping its key policy rate near zero, the Fed is widely expected to begin normalizing later this month with a quarter-point hike. Traders are pricing in a 75 percent chance of a move.

However, the Fed will be tightening as others continue easing.

Gross said the policies together have caused heavy amounts of damage.

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"They keep alive zombie corporations that are unproductive; they destroy business models such as insurance companies and pension funds because yields are too low to pay promised benefits; they turn savers into financial eunuchs, unable to reproduce and grow their retirement funds to maintain expected future lifestyles," he said.

For investors, the likelihood that the positive effects of central bank policy, in particular the huge jump over the years in risk assets like stocks, will continue are diminishing, though he conceded that's hard to know when the change will come.

However, he said reducing risk in portfolios will be the best bet for the long term.

"The faster and faster central bankers press the monetary button, the greater and greater the relative risk of owning financial assets," Gross wrote. "I would gradually de-risk portfolios as we move into 2016. Less credit risk, reduced equity exposure, placing more emphasis on the return of your money than a double digit return on your money. ...They may not run out of chips but like Atlantic City, the gamblers eventually go home, and their doors close."