Bill Gross: Economy needs a better seventh inning stretch

What perhaps Minsky couldn’t conceive of was the point at which debt, deficits and interest rates would go to such extremes that the creation of credit itself, which was and remains the heart of capitalism, would be threatened. No longer might the seventh inning stretch lead to a Coke, some “Cracker Jacks” and the resumption of the old ballgame. Instead, zero-bound interest rates and debt/GDP ratios in a majority of capitalistic economies would begin to threaten, not heal, the nature of finance and investment in the real economy. Investors, leery of not only overleveraged investment banks such as Lehman Brothers, but overextended countries such as Greece, Cyprus and a host of Euroland lookalikes would derisk as opposed to rerisk as per the Minsky model. As well, with interest rates close to the zero bound, investors in intermediate and long term bonds would become dependent on Big Bank to do their bidding. When that QE buying power became jeopardized via tapering and the eventual ninth inning conclusion of asset purchases, then the process of maturity extension and the terming out of historically modeled corporate lending was prematurely threatened.

In short, and in too-abbreviated summation, debt-laden economies with near-zero-bound interest rates became victims of their own excess, a condition that was more difficult to stabilize cyclically because Big Government and Big Bank had reached limits, and private market investors with huge portfolios of their own began to leave the ballpark early. Why stick around if your team is down by seven runs with only a few innings left? Why invest in financial or real assets if bond prices could only go down, and/or stock prices could no longer be pumped up via the artificial steroids of QE?

The rush for the exits seems to have been hastened recently not only by the increasingly obvious limitations of Big Government and Big Bank but by the additional knock-on effects of Big Investor and Big Regulation. The regulatory aspect is not hard to see. Having threatened the global economy with endogenously generated financial leverage, banks are under the government thumb to recapitalize and derisk from a multitude of directions including Basel III, SEC fines and criminal investigations, as well potential transaction taxes in Euroland, to name a few. While this response would have been typical in an historical Minsky model of normal economic recoveries, it is now no doubt excessively so, if only because of the enormity of the Great Recession itself. Whatever the cause, the duration of regulatory restraint, while long term beneficial, has been short to intermediate term negative for “stabilizing an already unstable economy.”

An analysis of “Big Investor” is a little more complicated, if only because there are a multitude of “structural” investors with varied and in many cases dissimilar interests. Our “unstable global economy” for instance has produced a number of developing (China, Brazil, India, South Africa to name a few) and developed economies (Japan to name one) that run substantial trade deficits or surpluses that give rise to the artificial pricing of currencies and/or government debt. As these imbalances raise concerns domestically or amongst international investors, the quickened pace of bond purchases or liquidation creates an unstable as opposed to a stable financial foundation. Minsky, I fear, would be appalled, if only because Big Government and Big Bank cannot now be coordinated in an open global as opposed to a closed domestic economy. “Technical” considerations involving trillions of dollars of financial flows are now dominating fundamentals in many markets.

But Big Investor is now influenced not just by public and sovereign entities but by an enormously expanded private market with liquid alternatives and choices. Call it pension-related or institutional severance monies. Call it retail, call it Mom & Pop with their 401(k)s, but they all have a host of choices at today’s ballpark snack bar. Bonds, stocks, cash – emerging/developed – euros, dollars, pesos. Sounds like a good game to play, does it not? The problem is that as Big Government, Big Bank and Big Regulation begin to tighten their purse strings and the risk budgets of their constituent vassals, then the liquidity to choose amongst a varied menu of assets becomes more limited. At the extreme, Mom & Pop have only themselves to buy from or sell to. When policymakers say so long to QE, and investment banks are no longer able to inventory large blocks of stocks and bonds, then historical liquidity is challenged. ETFs and mutual funds, once energized by excessively generous fiscal and monetary policies, have only themselves to sell to. At the extreme, the new game is now played in a Pogo ballpark, with the enemy, the opponent, the buyer of last resort being “us” as opposed to “them.” Minsky’s hoped-for stability, if only temporary, falls short because Big Government and Big Bank are now much smaller than historical proportions in an economy dominated by private funds or individual country flows.

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