In his February newsletter, Bill Gross of PIMCO surmises that from now on central bankers will target nominal GDP growth in their fight to prevent a systemic financial collapse. Sign-up for my 100% FREE Alerts
Nothing new there, but Gross believes the threat of stagflation could be with us for a lot longer than investors expect.
The Bond King stated he believes that the “Fed provides assurances that short and intermediate yields will not change,” which therefore invites investors fearful of a total loss into an arrangement with the U.S. Treasury whereby the return of investors’ capital is “assured” but at the cost of declining purchasing power of their capital.
And for how long will this arrangement between investor and the Fed be extended? “We are witnessing the death of abundance and the borning of austerity, for what may be a long, long time,” Gross wrote, as he expects 30-50 years of leveraged capital to continue to unwind for many years to come.
So the Fed’s plan is to trap fearful investors into a real loss for as long as they can tolerate it. Then, at some point, the pain of rising living expenses and no end to sluggishness economic conditions reaches a point of investors taking action. Austrian economist Ludwig von Mises (1881 – 1973) explains the reaction of investors to the “liquidity trap” the Fed has faced since Lehman and for an additional “long, long time.”
“Inflation can be pursued only so long as the public still does not believe it will continue,” wrote von Mises. “Once the people generally realize that the inflation will be continued on and on and that the value of the monetary unit will decline more and more, then the fate of the money is sealed. Only the belief, that the inflation will come to a stop, maintains the value of the notes.”
The endgame is a declining dollar and higher living costs, according to von mises.
Gross believes that the Fed has no options that include economic growth rates exceeding interest rates, which explains targeting ‘nominal’ GDP.
Therefore, the two options the Fed have are between allowing the financial system to painfully collapse to the point whereby capital comes out of hiding once again, while on the other hand the Fed could prop up the deleveraging process at the expense of a return on capital.
What makes matters worse is that Gross believes the Fed (and other central banks) is inadvertently promoting a liquidity trap, further hasting the process out of Treasuries by investors and more Fed monetization of those absent buyers of its debt, creating a virtuous process of no growth, higher Fed balance sheets, higher debt-to-GDP and so forth.
“When all yields approach the zero-bound, however, as in Japan for the past 10 years, and now in the U.S. and selected ‘clean dirty shirt’ sovereigns, then the dynamics may change,” he stated. “Money can become less liquid and frozen by ‘price’ in addition to the classic liquidity trap explained by ‘risk.’”
Gross goes on to state that institutional money won’t let go of its balance sheet while an economy deleverges. Therefore, the slack in demand will come from government spending, a Keynesian prescription that is expected to lead to higher and higher deficits and lower and lower currency rates against other currencies as well as the ‘things’ consumed on a day-to-day basis.
“Where else can one go, however? We can’t put $100 trillion of credit in a system-wide mattress, can we?” Gross asked rhetorically. “Of course not, but we can move in that direction by delevering and refusing to extend maturities and duration … It may as well, induce inflationary distortions that give a rise to commodities and gold as store of value alternatives when there is little value left in paper.”
The way out has always been to secure gold. Sign-up for my 100% FREE Alerts