Bill Gross: Devil’s Bargain
Bill Gross is at it again. The bond king who has taken a populist turn is out with another monthly investment commentary that features a negative view of Wall Street (God’s work) and Federal Reserve monetary policy. I want to hone in on the Fed piece.
In a piece entitled, "Devil’s Bargain", Gross makes the following points:
- Money has become the economic and political wedge for profound changes in American society.
- Perhaps the most deceptive policy tool to lessen debt loads is the “negative” or exceedingly low real interest rate that central banks impose on savers and debt holders.
- Old-fashioned gilts and Treasury bonds may need to be “exorcised” from model portfolios and replaced with more attractive alternatives both from a risk and a reward standpoint.
Central bankers have lowered the cost of money for 30 years now, legitimately following global disinflationary forces downward, but also validating increased leverage via lower real interest rates. Today’s rock-bottom yields, however, have less to do with disinflation and more to do with providing fuel for an asset-based economy that promotes unsustainable wealth creation and a false confidence in perpetual capital gains. Real 10-year interest rates fell from over 5% in the early 1980s to just under 1% in recent months and have arguably been responsible for 3,000–4,000 Dow points and 2–3% annual appreciation in bonds over those three decades.
Ultimately, however, the devil gets his due or at least the central bankers run out of mathematical room to lower real yields below commonsensical floors. Today’s negative real yield on a 5-year TIPS (Treasury Inflation Protected Securities) is perhaps reflective of a market that has lost its fundamental value anchor. A century-long history of average 5-year real yields would point out that bond investors in Aaa 5-year sovereign space have demanded and received a real interest rate return of 1.5% instead of today’s -0.1%. We are being shortchanged, in other words, by 160 basis points from the get-go, a “haircut” that is but one of four ways that governments attempt to escape from an over-levered national balance sheet.
You could see Gross making similar noises at the Barron’s Roundtable that I profiled last month. What Gross is saying is a version of Michael Pettis’ story of how crises get resolved. The real cost of non-performing loans is some form of loss socialisation, whether overt or through surreptitious means. In the case of bond holders like Gross, the Fed (and the Bank of England) is taking money away from investors by reducing the real yields that they can earn. It’s as if Ben Bernanke (and Mervyn King) reached into Bill Gross’ pocket. That’s what zero rates are about.
To rebalance debt loads and re-equitise financial institutions that should have known better, central banks and policymakers are taking money from one class of asset holders and giving it to another. A low or negative real interest rate for an “extended period of time” is the most devilish of all policy tools. And the asset class holder that it affects, or better yet, “infects”, is the small saver and institutions such as insurance companies and pension funds that hold long-term fixed income assets. It is anyone who holds bonds with coupons that cannot keep up with inflation or the depositor in a local bank who cumulatively holds trillions of dollars in time deposits that don’t earn a real rate of interest. This is the framework that has been created by modern-day policymakers who have innovated far beyond their biblical counterparts. To put it bluntly, they are robbing savers and taking money surreptitiously from longer-term asset holders who are incorrectly measuring future inflation. [emphasis in original text]
Now, Gross says "It is still possible to produce 4–5% returns from a conservatively positioned bond portfolio – you just have to do it with a different mix of global assets." Here’s the thing though. Pension funds are huge bond managers and real yields at zero percent or below are not going to cut it. They have liabilities in the form of pension benefits already granted which they must pay for. And their actuarial assumptions are saying 8, 9, 10% nominal yields on investments. How are you going to achieve this in a world of zero percent real bond yields? I don’t see 4-5% returns from ‘conservatively’ positioned bond portfolios as likely. More likely, bond managers will reach for yield by taking on risk and pension funds will re-balance portfolios away from low-yielding bonds into riskier investments. And greater risk doesn’t always mean greater reward. Sometimes risks do materialise in the form of losses. There’s no such thing as a free lunch.
Source: Devil’s Bargain – Bill Gross, Pimco