Friday, July 31, 2009

PIMCO's Bill Gross on "Investment Potions"

AlphaNinja - A bond manager recommends....wait for it...BONDS! No kidding.

Humor aside, Gross' August commentary touches on a topic I plan to discuss in more detail soon -->> the new "run rates" in everything from annual domestic auto sales, to GDP growth, to long-term unemployment rates.

While he doesn't explicitly give an endorsement of this policy, it is what he's been lobbying the government to do for years:

"Reflating nominal GDP by inflating asset prices is the fundamental, yet infrequently acknowledged, goal of policymakers. If they can do that, then employment and economic stability may ultimately follow."

Gross freely admits that we will see long-term unemployment of over 10% unless we borrow our way to economic growth. It'll work for awhile, until other options become available for foreign funds (instead of our treasuries).

"Now, however, things have changed, and it is apparent that there is massive overcapacity in the U.S. and indeed the global economy. As reflexive delevering has unveiled the ugly stepsister of the “great 5% moderation,” nominal GDP has not only sunk below 5%, but turned at least temporarily negative. If allowed to continue – and this is my critical point – a portion of the U.S. production capacity and labor market will have to be permanently laid off. Nominal GDP has to grow close to 5% in order for the economy’s long-term balance to be maintained. Otherwise, employment levels become unsustainable, retail shopping centers unserviceable, automobile production facilities unprofitable, and the economy itself heads towards a new normal where unemployment averages 8 instead of 5%, housing starts total 1.5 instead of 2 million, and domestic auto sales 12, instead of 16 million annual units. Critically in the readjustment process, debts are haircutted via corporate defaults and home foreclosures, and equity P/Es are cut based upon increased risk and substantially lower growth expectations. A virtuous circle of expansion turns into a vicious cycle of recession or low-growth stagnation. Label it what you will, but a modern capitalistic economy based on levered financing and asset appreciation cannot thrive if its “return on capital” or nominal GDP suffers such a significant shock."

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