Bill Gross on fiscal profligacy and dumping the negative real yields of treasuries
There are four ways to reduce real debt burdens:
- by paying down debts via accumulated savings.
- by inflating away the value of money.
- by reneging in part or full on the promise to repay by defaulting
- by reneging in part on the promise to repay through debt forgiveness
Right now, everyone is fixated on the first path to reducing (both public and private sector) debt. I do not believe this private sector balance sheet recession can be successfully tackled via collective public sector deficit spending balanced by a private sector deleveraging. The sovereign debt crisis in Greece tells you that. More likely, the western world’s collective public sectors will attempt to pull this off. But, at some point debt revulsion will force a public sector deleveraging as well.
When I read Bill Gross’ latest monthly letter to investors, this quote from a post last year came to mind. I was talking about the sovereign debt crisis and how to get rid of all the debt developed economy governments have been accumulating. Regardless of whether you believe sovereign currency nations like the U.S. or the U.K. can finance huge deficits indefinitely while users of currency like Portugal and Ireland are facing the music, you have to think that these debt burdens will reduce long-term growth.
So how do you deal with that as a government? Option #1 is an excruciating slow-growth semi-depressionary path. No politician wants that. Options 3 and 4, default, will also be avoided because that’s the last refuge of banana republics and failed states. Look at how the euro zone countries resist this outcome. So that leaves one with option #2, inflation and currency depreciation. In America that has meant negative real yields on T-bills. You are paying government to borrow from you.
Gross is so concerned with the negative real yields of Treasury debt that he has dumped treasuries entirely from his portfolio. He is now running with the bulls and chasing yield in emerging markets, where he believes fiscal discipline is superior. Gross’ view is that Central Banks are robbing bond holders and fuelling Inflation. Last month:
His contention is that government has four ways to rob bondholders of return:
- Outright default, something he says unlikely in the U.S.
- Currency depreciation: Gross contends this is a problem for the U.S. currency
- Unanticipated inflation: Gross believes the core vs. headline inflation numbers highlight this issue
- Negative real interest rates: His newsletter was very much about this point.
But, Gross has specific targets in mind here: entitlement spending. This month, he writes:
if the USA were a corporation, then it would probably have a negative net worth of $35-40 trillion once our “assets” were properly accounted for, as pointed out by Mary Meeker and endorsed by luminaries such as Paul Volcker and Michael Bloomberg in a recent piece titled “USA Inc”. However approximate and subjective that number is, no lender would lend to such a corporation. Because if that company had a printing press much like the US with an official “reserve currency” seal of approval affixed to every dollar bill, that lender/saver would have to know that the only way out of the dilemma, absent very large entitlement cuts, is to default in one (or a combination) of four ways: 1) outright via contractual abrogation – surely unthinkable, 2) surreptitiously via accelerating and unexpectedly higher inflation – likely but not significant in its impact, 3) deceptively via a declining dollar– currently taking place right in front of our noses, and 4) stealthily via policy rates and Treasury yields far below historical levels – paying savers less on their money and hoping they won’t complain.
Now, progressives see this as part of the right wing agenda to finally strip people of their last social safety nets after disenfranchising them in a number of other ways over the past thirty years.
My take: this is a political, a philosophical question about the use of real resources in the economy and the size and purpose of government. That’s how Stephanie Kelton who is against these kinds of cuts puts it as well.
As followers of the UMKC economics blog have discovered, we work within a framework that has been dubbed Modern Money Theory (MMT). The approach itself is fundamentally descriptive, although there are logical ways to apply the principles of the approach to any number of policy-oriented (i.e. prescriptive) economic problems. Above all, we are committed to describing the way government spending works in a modern money system. Once that is understood, it becomes apparent that a government with flexible exchange rates and a sovereign currency (US dollar, British pound, Mexican peso, etc.) can afford to purchase anything that is for sale in its own sovereign currency.
This means that debates about "affordability" become inapplicable. As this becomes more widely understood, we can begin to have a completely different — and vastly more important — debate about the size and role of government. What do we, as Americans, want? Medicare for all? A job guarantee? High-speed rail? Renewable energy?…
And, no, it does not follow that because the US government "can" do something that it "should" do it. It has the ability to purchase anything for sale in terms of its own currency. Let us accept that point and then debate whether, when, and to what extent it should exercise this power.
That’s the debate we should have, honestly and forthrightly. Economists like Dean Baker, Stephanie Kelton, James Galbraith and Randall Wray believe more real resources should be devoted to Medicare and Social Security and argue in favour of this as policy choice. In particular, they argue that Social Security is not an intractable problem at all. See New Deal 2.0’s recent post on Social Security as an example of the progressive view.
I agree that Social Security can be tweaked without draconian changes, especially given the regressive $106,800 payroll tax exclusion. But, I still want government’s role to be limited. And I certainly don’t want the outsized amount of real resources devoted to healthcare in the U.S. to continue. So my view is more in line with the so-called deficit terrorists like Bill Gross.
Here’s what Gross writes:
Unless entitlements are substantially reformed, I am confident that this country will default on its debt; not in conventional ways, but by picking the pocket of savers via a combination of less observable, yet historically verifiable policies – inflation, currency devaluation and low to negative real interest rates.
That’s my view as well. And let’s not forget military spending, where the U.S. spends as much on defense as the rest of the world combined. You can dress this debate up however you want – as a class war, an intergenerational struggle, or a creeping Latin American kleptocracy. But the reality is that there is only so many real resources available in any economy. There is an opportunity cost to every human and capital investment. While I would like to focus most on getting back to full employment, I don’t believe putting off the debate of how America’s real resources are allocated is a good solution.
This is the same political debate that is happening in all across the developed world – particularly in Western Europe and Japan. The questions are:
- Now that our populations are aging, how do we insure adequate social safety nets?
- What is an adequate social safety net?
- Can government help reduce the costs of healthcare or does it add to them?
- What kind of burden shifting will shoring up the social safety net entail and what effect will these changes have on economic growth?
The answers to these questions are unknowable. Again, it’s a philosophical question that has a lot to do with one’s views about the correct distribution of taxes and with government’s size and role. These issues are the third rail of politics for a reason. You can dress the issue up in any number of ways with statistics and charts if you like. However, at the end of the day, the entitlements issue is political – and it is emotionally charged.
I don’t see the issue being tackled without some sort of currency or inflation crisis. Look at Japan; their debt to GDP is 200% and they haven’t resolved these issues either. I think that’s about all I can say. I’d love to see the MMT folks offer a rebuttal. If they do, I will post it.
In any event, if you are a fixed income investor, you should expect low to negative real interest rates in the U.S. for a long time to come.
Source: Skunked – Bill Gross, Investment Outlook, April 2011