Gross, El-Erian on Europe, Strategy, Treasuries
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This is a good video with Bill Gross and Mohamed El-Erian below. I don’t have a lot of commentary because the copy provided via Bloomberg TV below is very complete. i would point out one thing, however. Earlier today, Warren Mosler wrote the following about QE:
I have no fear whatsoever of the Fed causing inflation. In fact, theory and evidence tells me their tools more likely work in reverse, due to the interest income channels. That’s because when they lower rates, they are working to remove net interest income from the private sector, and when they buy US Treasury securities (aka QE/ quantitative easing) they remove even more interest income from the economy. Remember that $79 billion in QE portfolio profits the Fed turned over to the Treasury last year? Those dollars would have otherwise remained in the economy.
This makes a lot of sense to me. QE and permanent zero are supposed to aid the economy. Of course, low rates mean monster savings on interest income for households that can refinance their mortgage debt. But for every debtor there is a saver and likely the debtors who benefit from lower rates are not the ones most distressed because those debtors are underwater.
In practice, these policies have robbed savers and picked our collective pockets. If the household sector wants to deleverage, lower rates don’t help on the interest income side. So when Bill gross and Mohamed El-Erian talk about financial repression below, they are talking from the point of view of bond investors, savers. There is good reason to worry that financial repression has only made things worse.
Bloomberg copy and video below
PIMCO’s Mohamed El-Erian and Bill Gross spoke exclusively with Bloomberg Television’s Tom Keene today from the company’s headquarters in Newport Beach, CA about Europe’s crisis, PIMCO’s investment strategy and Treasury yields.
Gross says that Europe can turn around its crisis, but “they have to get it together.” El-Erian reiterates that it’s ultimately about Germany, which “needs to make a decision.” On investment opportunities in Europe, Gross says “we cannot clean the dirtiest shirt.”
On what they’ve learned in 2011:
Gross: “I think we’ve learned that policymakers are most important in these types of markets. We have seen that in Operation Twist, policy in terms of lack of fiscal spending and a move towards stringency, all of which has affected bond and equity markets. Follow the policymakers to the extent you can.”
El-Erian: “A couple of things. The Europeans have taken a long time to understand the depth of their issues. The other thing is that the rest of the world is standing there, puzzled as to how the U.S. and Europe can be having so many difficulties. That is important because we all live in a world where the core is the West. The rest of the countries depend on this core and they are seeing this core weak. What I learned is that people that are unsettled. They are confused, and hopefully, we are going to have some anchors restored.”
El-Erian on whether there will be a shift in IMF votes soon:
“I hope so. Part of the problem the IMF has is that it is not viewed as credible and legitimate enough. Part of that is because Europe has all the votes compared to the developing world. What we are seeing is a slow process, but hopefully it will get accelerated. But we need the IMF. We need a conductor to help organize what is increasingly very conflicting policy measures at the regional and national level.”
El-Erian on whether he’s surprised by the speed of economic changes in the last 18 months:
“We have not been surprised for several reasons. We had a sense, as a society, that we would have to pay back for all the over borrowing and over leveraging. Secondly, we are now catching up with the reality of slow growth for a long time. Part of Europe’s problem is it has not been growing enough for years. Therefore, deleveraging safely their economy is proving to be difficult.”
Gross on whether it’s a strategy of PIMCO to take advantage of Europe’s crisis to find value in equities or better quality bonds:
“We cannot clean the dirtiest shirt. The Netherlands is on the borderline, they are close. It’s not liquid. Germany obviously qualifies. France, perhaps, mom and I have mild disagreements there. But the other countries are at risk, from the standpoint of spread, investors’ perception of growth and the standpoint of the ECB and their willingness to move all in. They certainly haven’t done that. They didn’t do that today with 2 billion worth of purchases in terms of Italy.”
On whether Europe can turn around its crisis:
Gross: “They can, but they have to get together. They are dysfunctional. They are a family that does not function well. That’s obviously because the fiscal and monetary authorities are not co-joined. They cannot get together and agree on things. Germany wants to do it their way, Greece wants to do it their way. There is never a total agreement, no significant change. It’s always ad hoc and at the margin.
El-Erian: “It is about Germany. Germany needs to make a decision. It needs to decide does it want a fiscal union with greater political integration. The model I have in my mind is what West Germany decided about East Germany. The West said it will be a fiscal union with political integration. Yes, that’s a big bill, but we’re willing to pay it. Or does Germany opt for a smaller and less than perfect union of countries with similar conditions? Germany holds the key. Germany needs that to make that decision.”
Gross on tension in short-term bank paper in Europe compared to the U.S.:
“Much more tense. Spreads are much wider, which means more risk. At least perceived risk in terms of the banking system. Obviously, there is an interchangeable flow between dollars in the United States dollars in Europe and to that extent it helps, but there is much greater risk on the banking system at the moment.”
Gross on the risk investors need to focus on in the bond market:
“The risk in the bond market, certainly in the cleanest dirty shirt bond market, let’s talk about Treasuries. They are artificially suppressed. Everyone knows that. There is a twist, a two-year point of time where the Fed will stay at 25 basis points. All of that produces a 10-year treasury at 2%. That is an artificial yield. The question is how long it will be artificial. What we are suggesting is, it will probably be artificial probably for a number of years. The real risk comes at the long end, the 30-year Treasury, where investors wonder what will happen when QEs disappear.”
Gross on whether he’s been a victim of financial repression this year:
“I think we all are. To the extent that real interest rates are negative, that basically means that investors in the bond market and in the stock market cannot keep up with purchasing power. That is what financial repression does. It takes money from savers and reallocates to the government’s balance sheet. All investors, going forward, to the extent real interest rates stay negative, to the extent that that’s an example for equity markets in terms of valuation, it means that investors will only earn lower rates of return relative to inflation than they have in the past.”
El-Erian on how politicians should adapt to the reality of financial repression:
“They have to realize this is structural in nature. This is not a cyclical world. These are fundamental changes that will be with us for awhile. They have to think structurally, which they have failed to do. The second thing that we all have to realize is that we are changing the dynamics of markets. We are a market-based economy, and the dynamics of markets are changing. You see this in terms of shifts in the demand curve. Italy is starting to lose investors for a long time. They’re not going to come back. I think there’s a real concern about banking fragility. Lots of people have stepped back to see how this plays out. We also have to be concerned about how the landscape has changed. Banks in this country are being turned into utilities over time. We are going through something fundamental where the function of markets itself will change, going forward, and politicians and all of us will have to understand that.”
El-Erian on what sort of institutional solution he would like to see in Europe:
“First, you need a circuit breaker. You need to calm things down. That’s the ECB. Secondly, Germany has to step up. They both have to step up to the plate. One is short term, the ECB is a bridge, but a bridge to a stronger union, which is Germany.”
On what PIMCO looks for when hiring:
El-Erian: “First, we look for the best athlete. PIMCO has been very good at bringing somebody and then finding new positions for them on the team, and then finding that they excel. Some of the people you talk to are excelling in new positions. The second issue is putting people together in teams. PIMCO functions in teams. We need an economist, a mathematician, and somebody who has a street instinct, gut instinct on the markets. You want to make sure we have these individuals together in teams so that we can go out and earn returns for our clients.
Gross: “Common sense is a neglected ingredient, I think. It is hard to find common sense and to basically interview for it. But intelligence, to my way of thinking, is a significant overvalued quantity. We need a CQ in addition to an IQ. Put them together and you’ve got a great investor.”
Source: Bloomberg Television