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Financial repression

Anyway, I quickly drifted back to my childhood days when I had a passbook at the local bank. Deposit rates were usually 4% or so back then, so I wondered how much money I would have needed then to produce the same $1.00 of interest I was receiving now. Twenty-five bucks! Whoa, $25 vs. $10,000! Seems like it was much better to be a saver back in 1958 and much better to be a spender in 2012. I could now take the $9,975 difference, spend it, and still have the same $1.00 of interest that I had back then! And that, Mr. Genie, with the Flavor Flav clock, is what is known as “financial repression.” By lowering interest rates to near zero through Fed Funds policy and quantitative easing, Ben Bernanke and his fellow central bankers are trying to force all of us to spend money.

Admittedly, the Fed’s theoretical foundation takes a different route to the same destination than does mine. Chairman Bernanke would say that by lowering yields, investors would logically sell their bonds to the Fed (QE I, II and III) and invest in something riskier and higher returning (high yield bonds, stocks and real estate). My $10,000 then, would do what capital has always done – gravitate to the highest reward/risk ratio available and in the process, stimulate investment and create jobs. The theoretical $9,975 that I might have chosen to “spend” in my first example would in the Chairman’s construct be eventually spent as well but in this case via investment and job creation, which in turn would lead to a virtuous cycle resembling the “old” as opposed to the “new” normal.

The difference between these two hypothetical models is critical. Is the money that is being made “available” through zero-based interest rates and quantitative easing being “spent” – or is it being “invested?” If it’s being spent, then at some point the game will come to an end – my $9,975 will have provided me and the economy some breathing room and some time to kick the future “big R” or “little d” down the road; but it will end. If it is being invested and invested productively, then we might eventually see the Old Normal on the horizon, reduce unemployment to less than 6% and return prosperity to the middle class.

Well, as President Obama might tell Governor Romney – “just do the math.” Or as Chris Berman might say on ESPN – “let’s go to the tape.” In the past three years of quantitative easing and financial repression, can we see a noticeable effect on investment as opposed to consumption? Is the Bernanke model working or is the $9,975 being spent on consumption? At first blush, an observer might vote for the Bernanke model. After all, the stock market has doubled in three-plus years, risk spreads are at historical lows, and housing prices are moving up – 10% higher in Southern California alone. Yet the real economy itself seems no different – still in New Normal gear. Surely by now, if the Bernanke model was as advertised, we would be seeing a pickup in investment as a percentage of GDP and a willingness to start saving “seed corn” as opposed to eating “caramel corn.” As Chart 1 points out – we are not. At the same time, we continue to consume at an “Old Normal” pace as shown in Chart 1 as well.

To confirm the point, let me introduce additional evidence for the prosecution, a chart that is periodically presented to our investment committee by PIMCO’s Saumil Parikh, who is turning out to be potentially a Pro Bowl replacement for recently retired All-Star Paul McCulley. It’s a little complicated sounding – “net national savings rate,” but it really speaks to the heart of the question. Net national savings is the amount of government, household and corporate savings that is left over after our existing investment stock is depreciated. Think of a building decaying and depreciating over 30 years so that you’d need to save each and every year to build and pay for a new one three decades down the road. If you don’t save, you can’t buy one: Net national savings.

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