Bill Gross on realities of the new normal

Pimco's picks based on structural changes of economy

Living is easy with eyes closed

Misunderstanding all you see

I think I know a yes but it’s all wrong

That is I think I disagree

 

Strawberry Fields forever

The Beatles

 

You didn’t built that  ....... 332

I built that .................... 206

Well, I guess that settles it: you didn’t build that after all. Or maybe you did, but not all of it. Or maybe like the convoluted John Lennon above “you think you know a yes, but it’s all wrong. That is you think you disagree.” Whatever. Rather than an economic mandate, November’s election was more of social commentary on the Republicans’ habit of living with eyes closed. Their positions on what Conan O’Brien labeled “female body parts” – immigration, gay rights and student loans – proved to be big losers, and they will have to amend rather than defend those views if they expect to compete in 2016. I suspect they will. Political parties are living social organisms that mutate in order to survive. We will see straight talking Chris Christie or Hispanic flavored Marco Rubio leading the Republican charge four years from now vs. a reenergized Hillary Clinton. It should be quite a show with a “No Country for Old (White) Men” caste to it.

But whoever succeeds President Obama, the next four years will likely face structural economic headwinds that will frustrate the American public. “Happy days are here again” was the refrain of FDR in the Depression, but the theme song from 2012 and beyond may more closely resemble Strawberry Fields Forever, as Lennon laments “It’s getting hard to be someone but it all works out.” Why is it so hard to be someone these days, to pay for college, get a good-paying job and retire comfortably? That really was the economic question of the 2012 election towards which very few specifics were applied from either side. “There’s a better life out there for us,” Governor Romney bellowed to a crowd of thousands in Des Moines, Iowa just days before the election, but in truth he never told us how we were going to achieve it or, importantly, why we weren’t realizing it in the first place. The president’s political mantra of “Forward” was even more vague.

Their words were mum if only because the real cause of slower economic growth lies hidden in a number of structural as opposed to cyclical headwinds that may be hard to reverse. While there are growth potions that undoubtedly can reduce the fever, there may be no miracle policy drugs this time around to provide the inevitable cures of prior decades. These structural headwinds cannot just be wished away as we move “forward” whether it be to the right, the left or dead center. Last month in a major policy speech at the New York Economic Club, Fed Chairman Ben Bernanke concurred that the U.S. economy’s growth potential had been reduced “at least for a time.” He in effect confirmed PIMCO’s New Normal which has been in place for three years now, laying the blame in part on the financial crisis, diminished productivity gains, and investment uncertainty due to the near-term fiscal cliff. We do not disagree. However, there are numerous other structural headwinds that may reduce real growth even below the New Normal 2% rate that Bernanke has just confirmed, not only in the U.S. but in developed economies everywhere. They are:

1) Debt/Delevering

Developed global economies have too much debt – pure and simple – and as we attempt to resolve the dilemma, the resultant austerity should lower real growth for years to come. There are those that believe in the “Brylcreem” approach to budget balancing – “a little dab‘ll do ya.” Just knock a few percentage points off the deficit/GDP ratio, they claim, and the private sector will miraculously reappear to fill the gap. No such luck after 2–3 years of austerity in Euroland, however. Most of those countries are mired in recession and/or depression. Political leaders there should have studied the historical evidence presented by Carmen Reinhart and Ken Rogoff in a critically important paper titled, “Growth in a Time of Debt.” They conclude that for the past 200 years, once a country exceeded a 90% debt/GDP ratio, economic growth slowed by nearly 2% for both developed and developing nations for an average duration of nearly a decade. Their work displayed below in Chart 1 (next page) shows the result in the United States from 1790–2009. The average annual U.S. GDP rate growth, while clearly influenced by the Great Depression, was -1.8% once the 90% barrier was exceeded. The U.S., by the way, is now at a 100% debt/GDP ratio on the basis of the authors’ standard measuring yardstick. (Note as well the 5.5% average inflation rate during the same periods.)

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