Pimco’s Gross: Time to lower return expectations in age of inflation

The Lending Lindy

  • Our entire finance-based monetary system – led by banks but typified by insurance companies, investment management firms and hedge funds as well – is based on an acceptable level of carry and the expectation of earning it. 
  • In a New Normal economy where lenders dance to the Blue Danube instead of the Lindy, how should we move our own feet?  Carefully, I suppose, and with recognition that historic returns are just that – historic.

Citigroup’s Chuck Prince will likely join Irving Fisher in the annals of market history for his now infamous “As long as the music is playing, you’ve got to get up and dance.” Unlike Fisher’s quote, however, which affirmed a permanent plateau of prosperity in 1929, Prince’s faux pas may have been interpreted unfairly. History books will never record the context under which his statement was made, but what if instead of subprime-specific, Mr. Prince was referring to his job as a banker? What if he had rephrased his response to “It’s the job of a banker to keep on lending”? Well now, that would be a different story altogether. Today, that quote would earn him a Medal of Freedom from President Obama at a White House gala! And so I suggest in this instance we don’t take him at his literal word, but take him at his role as an ex-CEO of one of the world’s largest banks and see just where that takes the lot of us – sovereign, institutional and individual investors who in combination comprise what we now call our global financial system – all $150 trillion or so of it.

Too much debt Credit, of course, is what makes the global economy go. We wouldn’t have gotten very far over the past several centuries despite Edison, Bell and Steve Jobs if barter was the accepted form of commerce. Even cash, serving as a medium of exchange and a disreputable store of value could not have promoted 3–4% real GDP growth in this gargantuan economy unless borrowers and savers were willing to exchange future promises – to utilize credit. Wimpy – in my oft-cited cartoon – said it best, “I’ll gladly pay you Tuesday for a hamburger today.” So McDonald’s grew from a million to 500 billion served and Wimpy and his wimpalikes were delighted in the exchange, although their arteries and midsections inevitably came out a loser. Still, the point is that our modern financial system, levered and fragile as it is, has been a beneficial and productive component of prosperity. If it were otherwise, our global economy would resemble something out of the dark ages in the early 20th century. High fives, then, for the Princemeister and his alter ego Mr. Wimpy – they have made a great combo-platter. But in order to promote and indeed foster continuing symbiosis, both borrower and lender need to operate in a nutrient-rich environment, a “credit” petri dish of sorts which fosters strong bones and healthy lenders and borrowers in their adult years. That unfortunately does not seem to be the case.

Wimpy’s weight-challenged midsection is an obvious testament to the overleveraged condition of today’s global borrowers. Too much debt leads to forced diets and delevering, a process which has been ongoing since Lehman 2008. Not only households, but financial institutions as well as many countries have reduced their caloric intake, which in turn has promoted slow growth and in some countries near recession and/or depression. Borrowers are just not in a healthy place and if history is our guide, their restoration may be almost Biblical in terms of timing: seven years of fat followed by seven years of lean – perhaps even longer.

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