Run Turkey, Run

FYI, Bill Gross is probably the biggest money manager on wall street.   
He currently has about $1.2 Trillion in assets under his management  
and is primarily in the bond market.
For that reason alone, I usually take what he says with a grain of  
salt (he is usually just "talking his book").  However this is a  
pretty significant statement by him.  (Calling the FED a Ponzi!)
-L

---------------
http://www.pimco.com/Pages/RunTurkeyRun.aspx

William H. Gross  |  November 2010
Run Turkey, Run

They say a country gets the politicians it deserves or perhaps it  
deserves the politicians it gets. Whatever the order, America is next  
in line, and as we go to the polls in a few short days it’s incumbent  
upon a sleepy and befuddled electorate to at least ask ourselves,  
“What’s going on here?” Democrat or Republican, Elephant or Donkey,  
nothing much ever seems to change. Each party has shown it can add  
hundreds of billions of dollars to the national debt with little to  
show for it or move our military from one country to the next chasing  
phantoms instead of focusing on more serious problems back home. This  
isn’t a choice between chocolate and vanilla folks, it’s all rocky  
road: a few marshmallows to get you excited before the election, but  
with a lot of nuts to ruin the aftermath.

Each party’s campaign tactics remind me of airport terminals pre-9/11  
when solicitors only yards apart would compete for the attention and  
dollars of travelers. “Save the Whales,” one would demand, while the  
other would pose as its evil twin – “Eat Whale Blubber,” the makeshift  
sign would read. It didn’t matter which slogan grabbedyou, the end of  
the day’s results always produced a pot of money for them and the  
whales were neither saved nor eaten. American politics resemble an  
airline terminal with a huckster’s bowl waiting to be filled every two  
years.

And the paramount problem is not that we contribute so willingly or  
even so cluelessly, but that there are only two bowls to choose from.  
Thomas Friedman, the respected author of The World Is Flat, and a  
weekly New York TimesOp-Ed author, recently suggested “ripping open  
this two-party duopoly and having it challenged by a serious third  
party” unencumbered by special interest megabucks. “We basically have  
two bankrupt parties, bankrupting the country,” was the explicit  
sentiment of his article, and I couldn’t agree more – whales or no  
whales. Was it relevant in 2004 that John Kerry was or was not an  
admirable “swift boat” commander? Will the absence of a mosque within  
several hundred yards of Ground Zero solve our deficit crisis? Is  
Christine O’Donnell really a witch? Did Meg Whitman employ an illegal  
maid? Who cares! We are being conned, folks; Democrats and Republicans  
alike. What have you really heard from either party that addresses  
America’s future instead of its prurient overnight fascination with  
scandal? Shame on them and of course, shame on us. We’re getting what  
we deserve. Vote NO in November – no to both parties. Vote NO to a two- 
party system that trades promises for dollars and hope for power, and  
leaves the American people high and dry.

There’s another important day next week and it rather coincidentally  
occurs on Wednesday – the day after Election Day – when either the  
Donkeys or the Elephants will be celebrating a return to power and the  
continuation of partisan bickering no matter who is in charge.  
Wednesday is the day when the Fed will announce a renewed commitment  
to Quantitative Easing – a polite form disguise for “writing checks.”  
The market will be interested in the amount (perhaps as much as an  
initial $500 billion) as well as the targeted objective (perhaps a  
muddied version of “2% inflation or bust!”). The announcement,  
however, has been well telegraphed and the market’s reaction is likely  
to be subdued. More important will be the answer to the long-term  
question of “will it work?” and perhaps its associated twin “will it  
create a bond market bubble?”

Whatever the conclusion, not only investors, but the American people  
should recognize that Wednesday, even more than Tuesday, represents a  
critical inflection point in determining our future prosperity. Of  
course we’ve tried it before, most recently in the aftermath of the  
Lehman crisis, during which the Fed wrote $1.5 trillion or so in  
“checks” to purchase Agency mortgages and a smattering of Treasuries.  
It might seem a tad dramatic then, to label QEII as “critical,” sort  
of like those airport hucksters, I suppose, that sold whale blubber  
for a living. But two years ago, there was the implicit assumption  
that the U.S. and its associated G-7 economies needed just an espresso  
or perhaps an Adderall or two to get back to normal. Normal just  
hasn’t happened yet, and economic historians such as Kenneth Rogoff  
and Carmen Reinhart have since alerted us that countries in the throes  
of delevering can takemany, not several, years to return to a steady  
state.
The Fed’s second round of QE, therefore, more closely resembles an  
attempted hypodermic straight to the economy’s heart than its mood  
elevator counterpart of 2009. If QEII cannot reflate capital markets,  
if it can’t produce 2% inflation and an assumed reduction of  
unemployment rates back towards historical levels, then it will be a  
long, painful slog back to prosperity. Perhaps, as a vocal contingent  
suggests, our paper-based foundation of wealth deserves to be buried,  
making a fresh start from admittedly lower levels. The Fed, on  
Wednesday, however, will decide that it is better to keep the patient  
on life support with an adrenaline injection and a following morphine  
drip than to risk its demise and ultimate rebirth in another form.

We at PIMCO join with Ben Bernanke in this diagnosis, but we will tell  
you, as perhaps he cannot, that the outcome is by no means certain. We  
are, as even some Fed Governors now publically admit, in a “liquidity  
trap,” where interest rates or trillions in QEII asset purchases may  
not stimulate borrowing or lending because consumer demand is just not  
there. Escaping from a liquidity trap may be impossible, much like  
light trapped in a black hole. Just ask Japan. Ben Bernanke, however,  
will try – it is, to be honest, all he can do. He can’t raise or lower  
taxes, he can’t direct a fiscal thrust of infrastructure spending, he  
can’t change our educational system, he can’t force the Chinese to  
revalue their currency – it is all he can do, and as he proceeds, the  
dual questions of “will it work” and “will it create a bond market  
bubble” will be answered. We at PIMCO are not sure.

Still, while next Wednesday’s announcement will carry our qualified  
endorsement, I must admit it may be similar to a Turkey looking  
forward to a Thanksgiving Day celebration. Bondholders, while  
immediate beneficiaries, will likely eventually be delivered on a  
platter to more fortunate celebrants, be they financial asset classes  
more adaptable to inflation such as stocks or commodities, or perhaps  
the average American on Main Street who might benefit from a hoped-for  
rise in job growth or simply a boost in nominal wages, however  
deceptive the illusion.Check writing in the trillions is not a  
bondholder’s friend; it is in fact inflationary, and, if truth be  
told, somewhat of a Ponzi scheme. Public debt, actually, has always  
had a Ponzi-like characteristic. Granted, the U.S. has, at times, paid  
down its national debt, but there was always the assumption that as  
long as creditors could be found to roll over existing loans – and buy  
new ones – the game could keep going forever. Sovereign countries have  
always implicitly acknowledged that the existing debt would never be  
paid off because they would “grow” their way out of the apparent  
predicament, allowing future’s prosperity to continually pay for  
today’s finance.

Now, however, with growth in doubt, it seems that the Fed has taken  
Charles Ponzi one step further. Instead of simply paying for maturing  
debt with receipts from financial sector creditors – banks, insurance  
companies, surplus reserve nations and investment managers, to name  
the most significant – the Fed has joined the party itself. Rather  
than orchestrating the game from on high, it has jumped into the pond  
with the other swimmers. One and one-half trillion in checks were  
written in 2009, and trillions more lie ahead. The Fed, in effect, is  
telling the markets not to worry about our fiscal deficits, it will be  
the buyer of first and perhaps last resort. There is no need – as with  
Charles Ponzi – to find an increasing amount of future gullibles, they  
will just write the check themselves. I ask you: Has there ever been a  
Ponzi scheme so brazen? There has not. This one is so unique that it  
requires a new name. I call it a Sammy scheme, in honor of Uncle Sam  
and the politicians (as well as its citizens) who have brought us to  
this critical moment in time. It is not a Bernanke scheme, because  
this is his only alternative and he shares no responsibility for its  
origin. It is a Sammy scheme – you and I, and the politicians that we  
elect every two years – deserve all the blame.

Still, as I’ve indicated, a Sammy scheme is temporarily, but not  
ultimately, a bondholder’s friend. It raises bond prices to create the  
illusion of high annual returns, but ultimately it reaches a dead-end  
where those prices can no longer go up. Having arrived at its  
destination, the market then offers near 0% returns and a picking of  
the creditor’s pocket via inflation and negative real interest rates.  
A similar fate, by the way, awaits stockholders, although their  
ability to adjust somewhat to rising inflation prevents such a  
startling conclusion. Last month I outlined the case for low asset  
returns in almost all categories, in part due to the end of the 30- 
year bull market in interest rates, a trend accentuated by QEII in  
which 2- and 3-year Treasury yields approach the 0% bound. Anyone for  
1.10% 5-year Treasuries? Well, the Fed will buy them, but then what,  
and how will PIMCO tell the 500 billion investor dollars in the Total  
Return strategy and our equally valued 750 billion dollars of other  
assets that the Thanksgiving Day axe has finally arrived?



We will tell them this. Certain Turkeys receive a Thanksgiving pardon  
or they just run faster than others! We intend PIMCO to be one of the  
chosen gobblers. We haven’t been around for 35+ years and not figured  
out a way to avoid the November axe. We are a survivor and our clients  
are not going to be Turkeys on a platter. You may not be strutting  
around the barnyard as briskly as you used to – those near 10%  
annualized yields in stocks and bonds are a thing of the past – but  
you’re gonna be around next year, and then the next, and the next.  
Interest rates may be rock bottom, but there are other ways – what we  
call “safe spread” ways –to beat the axe without taking a lot of risk:  
developing/emerging market debt with higher yields and non-dollar  
denominations is one way; high quality global corporate bonds are  
another. Even U.S. Agency mortgages yielding 200 basis points more  
than those 1% Treasuries, qualify as “safe spreads.” While our “safe  
spread” terminology offers no guarantees, it is designed to let you  
sleep at night with less interest rate volatility. The Fed wants to  
buy, so come on, Ben Bernanke, show us your best and perhaps last  
moves on Wednesday next. You are doing what you have to do, and it may  
or may not work.But either way it will likely signify the end of a  
great 30-year bull market in bonds and the necessity for bond managers  
and, yes, equity managers to adjust to a new environment.

If a country gets the politicians it deserves, then the same can be  
said of an investor – you’re gonna get what you deserve. Vote No to  
Republican and Democratic turkeys on Tuesday and Yes to PIMCO on  
Wednesday. We hope to be your global investment authority for a new  
era of “SAFE spread” with lower interest rate duration and price risk,  
and still reasonably high potential returns. For us, and hopefully  
you, Turkey Day may have to be postponed indefinitely.

William H. Gross
Managing Director

-- 
dadl-ot mailing list
http://mail.thehood.us/mailman/listinfo/dadl-ot_thehood.us
http://news.gmane.org/gmane.music.dadl.ot