Bill Gross's Monthly outlook for June was pretty interesting. It seems to be prediction:
- higher taxes
- a decrease in the US standard of living
- higher yields on everything because no one will buy our treasuries or, hyperinflation because the buyer of last resort will be the FED, via quantitative easing
- less rich people overall because of its harder to be rich and also a lot of rich people are no longer rich
From
PIMCO I remember as a child my parents telling me, perhaps resentfully, that only a doctor, airline pilot, or a car dealer could afford to join a country club. My how things have changed. Now, as I write this overlooking the 16th hole on the Vintage Club near Palm Springs, the only golfers who shank seven irons into the lake are real estate developers, investment bankers, or heads of investment management companies. The rich are different, not only in the manner intoned by F. Scott Fitzgerald, but also in who they are and what they do for a living. Whether some or all of them are filthy is a judgment for society and history to make. Of one thing you can be sure however: over the next several decades, the ability to make a fortune by using other people’s money will be a lot harder. Deleveraging, reregulation, increased taxation, and compensation limits will allow only the most skillful – or the shadiest – into the Balzac or Forbes 400.
Readers who are interested in such things as the Forbes annual list of hoity-toities will have noticed that more and more of them are global, not U.S. citizens. The U.S., in other words, is not producing as much wealth in proportion to the rest of the world. Its fortune-producing capabilities seem to be declining, which might suggest that its relative standard of living is doing so as well. If so, the implications are serious, not just for Donald Trump but for wage earners and ordinary citizens, as reflected in their income levels and unemployment rates. Stockholders, 401(k) investors, and yes, bond managers will be affected too. Last week’s furor over the possibility of an eventual downgrade of America’s AAA rating demonstrates that only too clearly. On the night of May 20, Standard & Poor’s announced a downgrade watch for the United Kingdom and since the U.S. and U.K. are Siamese-connected, financially-levered twins, the implications were obvious: the U.S. might be next. In the space of 48 hours, the dollar declined 2%, and U.S. stocks and long-term bonds were down by similar amounts. Such a trifecta rarely occurs but in retrospect it all made sense: a downgrade would cast a negative light on the world’s reserve currency, and since stocks and bonds are only present values of a forward stream of dollar-denominated receipts, they went down as well.
Ok, so he is probably right, our standard of living is going to have to decrease, and it should. If you look at any chart with years on the x-axis and private debt (aka the US consumer) on the y-axis, you will see why. People in the US have finally enter the new reality: if you make 30K a year you can't own a flat-screen tv, a humer, a 2-car garage, have 4 kids, and go on two vacations a year. Ok, maybe I am exaggerating, but there are [were] a lot of people in the US that thought like this two years ago. I think we can all agree now the rise in the standard of living we have seen since 1982 till 1999 when the dot-com boom crashed was attributed to spending money we didn't have. Now all of these people can get a nice wiff of reality that their house is foreclosed on, their credit lines are cut off, (oh wait, Obama is making sure these evil credit card companies do not punish people who spent too much... thank god!) and oh no, gas prices are up 20% in the past few weeks and they can't drive 2 hours to work everyday in their GM SUV and still have money left over. I feel bad for these people (not really), but the US needs to change.
I see a lot of articles about the coming metamorphsis of the US. There was a good one in the economist this week actually, title "Trading Down":
Americans are trading down. If they still have jobs (as 91% of the workforce do), they are worried about losing them. Their homes are no longer cash machines and their investments are in a ditch. Household net worth fell by a staggering $11.2 trillion last year. The rich are cancelling orders for yachts. Working Americans are forgoing even small luxuries. Lindt & Sprüngli, a maker of exquisite chocolate truffles, is closing 50 of its 80 stores in America. Hershey’s, a maker of less chocolatey chocolate, is doing rather well. Limited Brands, which owns Victoria’s Secret, is not.
Americans are rediscovering thrift. Retail sales fell by 11% from their peak in late 2007 to April 2009. Personal consumption has fallen 2.5% since last summer. The Boston Consulting Group (BCG), a consultancy, finds that nearly three-quarters of Americans plan to curb their spending over the next year.
Trading down is not difficult. Instead of, say, blowing $4.50 on a Strawberries and Crème Venti Frappuccino from Starbucks, Americans are popping into Dunkin’ Donuts for a basic cuppa Joe at a buck or so. Instead of shopping at Neiman Marcus (a posh department store known colloquially as “Needless Mark-up”), they are driving to the out-of-town Wal-Mart superstore or shopping online for bargains at Amazon (see chart 2). A recent Pew poll found that 21% of Americans planned to grow their own vegetables, 16% had held a garage sale or sold things online and 10% had either taken in a friend or relative or moved in with one. Pundits are coining phrases such as “austerity chic” and “luxury shame”.
Four-fifths of Americans told the BCG they would defer big purchases that can wait. The most obvious example is a car. After a home, this is the most expensive object a typical family buys. New cars are nice, but old ones can last a long time, as any third-world taxi-driver knows. So Americans are keeping their old wheels on the road. Repair shops are bustling. Desperate dealers are offering interest-free finance. Hyundai, a maker of unflashy cars, has lifted its share of the American market by saying: buy a car from us, and if you lose your job we’ll buy it back.
If there is one really great thing about this US, we are very dynamic. It is one of the reason our economy is [was] was great, and its one of the reason why important economist are predicting we will be one of the first countries to leave recession (that and we were one of the first to enter it).
Sorry about the rant ... Back to Bill Gross
The current annual deficit of $1.5 trillion does not even address the “pig in the python,” baby boomer, demographic squeeze on resources that looms straight ahead. Private think tanks such as The Blackstone Group and even studies by government agencies, such as the Congressional Budget Office, promise that Federal spending for Social Security, Medicare, and Medicaid will collectively increase by 6% of GDP over the next 20 years, leading to even larger deficits unless taxes are increased proportionately. Collectively these three programs represent an approximate $40 trillion liability that will have to be paid. If not, you can add that present value figure to the current $10 trillion deficit and reach a 300% of GDP figure – a number that resembles Latin American economies such as Argentina and Brazil over the past century.
The obvious solution to both dollar weakness and higher yields is to move quickly towards a more balanced budget once a sustained recovery is assured, but don’t count on the former or the latter. It is probable that trillion-dollar deficits are here to stay because any recovery is likely to reflect “new normal” GDP growth rates of 1%-2% not 3%+ as we used to have. Staying rich in this future world will require strategies that reflect this altered vision of global economic growth and delevered financial markets. Bond investors should therefore confine maturities to the front end of yield curves where continuing low yields and downside price protection is more probable. Holders of dollars should diversify their own baskets before central banks and sovereign wealth funds ultimately do the same. All investors should expect considerably lower rates of return than what they grew accustomed to only a few years ago. Staying rich in the “new normal” may not require investors to resemble Balzac as much as Will Rogers, who opined in the early 30s that he wasn’t as much concerned about the return on his money as the return of his money.
Ten years from now I would image if I have the time to re-read this article (and hopefully I will not even have the time at that point) that roughly half of this will turn out to be true. Yes, the US standard of living will go down. Yes, the interest rates are going to go up. I have serious doubts of entertaining hyperinflation at this point because:
A) If the US is going to have to print its way out of this problem, it seems as though they are going to have to do it under Obama's first term. Obama is not the God everyone thinks he is, he is just a normal man trying to be re-elected, and I know one thing is for sure, hyperinflation is not going to be good for the campaign trail.
B) Everyone talks about the FED's quantitative easing and the hyperinflation its going to cause the road so matter-of-factly, but the real fact of the matter is no one knows what the hell is going on. Yes, the FED is creating money, to the tune of $300-$400 billion out of thin air, and using this money to buy assets right now. Inflation expectations remain "tied down", and with the deflationary spiral out there right now (watch out for the crash of CMBS coming up in the coming months), I can't see "it" being raised anytime soon (besides increases due to relatively small fluctuations in fuel costs). If inflation does start to take off, then there are new ways (which have not been used in the past) in which the FED can control inflation (besides conventional monetary policy and raising interest rates) like:
a)
paying higher interest on bank reservesb)
Congress could give the FED power to issue its own debt (aka f-bills)Those are just two of the options I thought sounded pretty good when I read about them a few months ago. There are certainly other ideas. Regardless, the point is, I doubt we will see hyperinflation.
Weaker dollar: no shit Bill, we are issuing 1.5 trillion t-bills this year, its the law of supply and demand.
My bet is that the green revolution will play out to be another dot-com boom-and-bust scenario. I am sure when (its more a question of if, not when) it does take place, a majority of the start-ups will be in the US (assuming Obama's protectionist I-hate-rich people-but-now-I-am-one bullshit doesn't pan out), and just like in the dotcom boom, we will pay off a bunch of this deficit with the capital gains tax receipts.
That is it for now. Time will tell who is right. Hopefully its neither Obama or Gross!
