I love reading various investment commentaries, especially those of a generally macroeconomic nature. However, since I only have so much time for this, I generally have to pick and choose which to peruse. One that I always try to make time for though is Bill Gross' monthly investment outlook for PIMCO. This is partially because Gross is entertaining and a valuable point of view to consider, but also because Gross runs the largest bond fund in the world, the PIMCO Total Return fund, and hence his views have an outsize influence on the markets.
So it was as always with great interest that I clicked on Gross' latest missive, just up on the PIMCO website. In his piece, Gross outlines what he calls the "Ring of Fire", which are those countries with the highest public sector deficits and the greatest structural gap needed to close the deficit.
One quote though from Gross' commentary jumped out at me, which is his comparison of the U.S. to Greece:
"IF we continue to close our eyes to existing 8% of GDP deficits, which when including Social Security, Medicaid and Medicare liabilities compose an average estimated 11% annual "fiscal gap," then we will begin to resemble Greece before the turn of the next decade."
Not surprisingly, this is the quote that has appeared in every major financial headline, including - with evident delight - on many gold websites and blogs.
Let me start by saying that I quite agree with Gross on much of what he says in his essay. Our budget deficit is becoming threateningly large, and certainly the debt overhang in the U.S. threatens to become a substantial weight on economic growth.
Where I completely disagree with Gross, however, is with his comparison of the U.S. to Greece. The U.S. is NOT Greece, and neither for that matter are our fellow Ring of Fire residents, the U.K. and Japan. The reason for this is that the U.S. controls its own currency, while Greece (as well as Spain and France) do not as they are locked in to a modern-day version of the Gold Standard through their membership in the eurozone.
People tend to think of the Federal Government as an entity like a family, whose revenue is constrained, and whose income must match its debts (a favorite analogy of politicians). This is simply not true, nor is it true for Japan and the U.K. for that matter. One of my favorite writers, Cullen Roche, who runs the excellent blog Pragmatic Capitalism, says it clearly in a recent post:
The U.S.A. has an institutional arrangement in which it is a currency issuer. That is, while the Treasury is an operational currency user (meaning it must always have funds in its account at the Fed before it can spend those funds) it is always able to harness the banks to procure funds. This is achieved through bond auctions in which the dealers are required to bid… So there's never a concern about auctions failing in the U.S.A. That is, the Treasury is a currency user, but the government as a whole can be seen as a currency issuer by institutional design because of this implicit funding guarantee.
So, even if many of Gross' points about the debt are legitimate, I still think it is a serious mistake to place the U.S. in the same "ring" as Greece, Spain and France, countries which do not control their own currencies.
One thing I always find somewhat hilarious is the never ending doom-mongering about how hyperinflation is right around the corner and how the "bond vigilantes" are surely going to send bond rates soaring. If that is the case, then why have the interest rates on 10 year Treasuries collapsed to microscopic levels over the last five years at the same time as our total government debt has increased substantially? Indeed, those who had the foresight to invest in longer-dated Treasuries the last several years such as the iShares Barclays 10-20 Year Treasury Bond ETF (NYSEARCA:TLH) have done exceedingly well.
By contrast, another member of Gross' Ring of Fire, eurozone member Spain (which actually has a lower government debt to GDP level then the U.S., approximately 68% versus the U.S. at around 90%), has seen its bond yields explode and is on the verge of requiring a second bailout.
The difference is that Spain does face a true solvency crisis, because Spain is dependent on what is essentially a foreign central bank, the ECB. It is not surprising, therefore, that investors are worried about buying Spanish bonds, because the Spanish government funding crisis is real. Were Spain to have its own central bank and its own currency, it would not have any problem whatsoever funding its government debt.
Again, I am not saying that Gross is wrong about the debt; of course it would be better if the U.S. government's debt was lower. However, we are not - and never will be - like Greece or any other eurozone country.