The Monthly Investment Outlook from Pimco’s Bill Gross is always worth a read. Gross is best-known as the manager of Pimco’s flagship bond fund, Pimco Total Return (PTTRX). Sometimes, he goes too far with cutesy metaphors, but who among us has not been guilty of metaphoric excess anyway. In the March column, Gross does not disappoint on the metaphor front, but he also made some serious points about Federal Reserve intervention in the financial markets [emphasis added]:
…no clue or outright signal could have been any clearer than the one given in December 2008, labeled “Quantitative Easing.” While the term was new, the intent was obvious: (1) pump public money into the financial system to replace private credit that was being destroyed in the process of deleveraging; (2) lower interest rates on intermediate and long-term mortgages/Treasury bonds and in the process flush money into risk assets – most visibly the stock market; and (3) forecast publically then hope that higher stock prices would lead to a wealth effect, and in turn generate new private sector lending, job creation and a virtuous circle of economic expansion that would heal the near-fatal wounds of Lehman and its aftermath. If that was the game plan, then so far, so good, I’d say. Interest rates are artificially low, stocks have nearly doubled since QE I’s first announcement in December of 2008, and the U.S. economy will likely expand by 4% this year, although a $1.5 trillion budget deficit must share QE’s Oscar for most stimulative government policy of 2009/2010.
Gross believes Quantitative Easing (QE) and its sequel, QEII, have been successful so far. I would disagree that they have lowered interest rates at the long end, even though I’d agree with Gross that rates are still low. However, these is no question that the stock market has rallied strongly. So, what’s not to like? Well, one big problem is that this may well be an artificial recovery and a symptom of Federal intervention rather than healthy growth.
Many critics, though, including yours truly, would wonder whether Quantitative Easing policies actually heal, as opposed to cover up, symptoms of an unhealthy economy. They might at the same time ask simplistically whether it is possible to cure a debt crisis with more debt...
In fairness, to the Fed, I don’t think they were trying to cure a debt crisis with more debt. The Fed is just trying to avert deflation and reinflate the economy without regard, in my view, to the long-term implications of sharply higher levels of debt.
I think of our economy as a patient who has had a serious heart attack. The medics are just trying to keep him alive until more effective, long-term measures such as surgery can be taken. The Federal Reserve is the medic in this scenario and it is trying to prevent deflation while hoping and waiting for the private sector economy to get back to healthy growth. Heroic measures (QE and QEII) have been taken, but we do not know if the patient’s system can now take over without help.
…If on June 30, 2011 (the assumed termination date of QE II), the private sector cannot stand on its own two legs – issuing debt at low yields and narrow credit spreads, creating the jobs necessary to reduce unemployment and instilling global confidence in the sanctity and stability of the U.S. dollar – then the QEs will have been a colossal flop…
To visualize the gaping hole that the Fed’s void might have, PIMCO has produced a set of three pie charts that attempt to point out (1) who owns what percentage of the existing stock of Treasuries, (2) who has been buying the annual supply (which closely parallels the Federal deficit) and (3) who might step up to the plate if and when the Fed and its QE bat are retired…
In this graphic (click to enlarge), we have three pie charts. The left hand chart shows traditional Treasury buyers. The middle one shows who is buying now. As you can see, the Fed is buying the bulk of new Treasury securities. The pie chart on the right illustrates the doubt facing us when the Fed stops buying. The big question mark is who will buy when the Fed stops?
In his inimitable style, Gross finishes up with this:
…By eliminating QE II, the Fed would be ripping a Band-Aid off a partially healed scab. Ouch!…Yields may have to go higher, maybe even much higher to attract buying interest…
Now that is a metaphor! Gross seems to think the Fed might end QE II at the end of June. I don’t think so, in fact, I think the Fed is now addicted to taking on more debt. Any sign of an economic slowdown around June 30th will be greeted with the sequel to QE II. It won’t be called QE III though. My contribution to the naming game would be QE Squared.