Approaching the Zero Bound

"An Attempted Hypodermic
Straight to the Economy’s Heart"

A fascinating, even feverish dialogue is taking place right now -- joined by some of the financial world's most influential thinkers -- concerning what will happen next week, and what economic consequences will flow from that outcome.

The elections next Tuesday?

Try, the Fed's much-signalled intention to initiate another round of quantitative easing (also called "printing money") when it meets next Wednesday.

Here is Bill Gross' take, from his perch at PIMCO, the nation's (world's?) largest investor in bonds:

Quantitative easing is temporarily, but not ultimately, a bondholder’s friend. It raises bond prices to create the illusion of high annual returns, but ultimately it reaches a dead-end where those prices can no longer go up. Having arrived at its destination, the market then offers near 0% returns and a picking of the creditor’s pocket via inflation and negative real interest rates.

--Bill Gross, "Run Turkey, Run"; PIMCO Investment Outlook (Nov., 2010)

So why do it?

Because the Fed, caught in a liquidity trap, is out of other options.

Gross again:

Ben Bernanke can’t raise or lower taxes, he can’t direct a fiscal thrust of infrastructure spending, he can’t change our educational system, he can’t force the Chinese to revalue their currency – it (more quantitative easing) is all he can do.

--Bill Gross

Will "it" work?

Gross, whose credentials are as good as anyone's, thinks the jury's out.

PIMCO's Bill Gross

Limits to "Hair of the Dog" Fix
For Sovereign Borrowing Hangover

Can you get out of a debt crisis by piling on another layer of debt?

The answer, of course, is that “it depends.”

Replacing corporate and mortgage debt with a government checkbook is initially beneficial because the sovereign is assumed to be more creditworthy than its private market serfs. It taxes, it prints, it confiscates wealth if need be and so this substitution is medicinal in the early stages of a financial crisis aftermath – especially if debt/GDP levels are low to begin with.

But based on existing deficit trends and the expectation that not much progress will be made in reducing them, markets are raising interest rates on sovereign debt issuance either in anticipation of higher future inflation, increased levels of credit risk, or both. This places a potential “cap” on the “debt” that supposedly can be created to get out of the “debt crisis.”

--Bill Gross, PIMCO March 2010 Investment Outlook

Anyone who runs almost $1 trillion in bond investments -- as PIMCO's Bill Gross does -- automatically rates a listen.

More to the point: the reason Gross oversees that much money is that . . he's a very smart guy!

Hard to disagree with any of his analysis (above).