Bill Gross, founder and co-chief investment officer of Pimco, the world’s largest mutual fund, made news last month when he dumped all U.S. Treasurys from the $1 trillion fund he operates. I spoke with him by phone yesterday afternoon. He had a solemn warning: The United States has a year or two to change course or face a debt crisis akin to what Greece, Portugal and Ireland have experienced.
He describes bond traders as “vigilant but not vigilantees,” meaning they are cautious and on the outlook for signs that inflation (“the enemy of bonds”) will rear its head. He explained that he got out of Treasurys because the return was too small relative to the huge risk on the horizon. Moreover, the Federal Reserve, he says, has masked the problem because “the right hand is buying from the left,” referring to the Fed’s controversial move in November to engage in huge buying of U.S. debt (“quantitative easing”). Gross says, “Mortgage rates would have been 1 percent higher if the Fed hadn’t done what it did.” (In other words, it is getting increasingly hard to lure purchasers of U.S. debt so long as a massive debt goes unaddressed.)
He doesn’t think much of the Fed’s inflation model, which doesn’t account for increasing demand for commodities from emerging countries. He thinks it is “definitely possible” we will have some form of stagflation, “3 percent or 2 percent or 4 percent inflation and low growth.”
Gross got out of Treasurys ahead of the crowd. But, he says, “It’s like California in the 1960s with Datsuns and Toyotas.” It took a while for the rest of the country to figure out what good cars these were, and by then “it was too late” for American car companies to straighten themselves out. He says, “Pimco already bought a Toyota.” The implication is clear: If we go merrily on our way and everyone buys a “Toyota” (i.e. dumps U.S. debt holdings), then the government , the United States, like the car companies, is going to find itself without time to fix the problem.
How long do we have before lots of investors begin to bail out of Treasurys? Gross said that half the debt is held by foreign governments. It would be a “political tsunami” if foreign central banks dumped Treasurys. And there are also institutional investors (e.g. insurance companies) who will look elsewhere if they fear their bonds will not sustain their value (i.e. the United States will have no choice but to print money to pay off its debt). He warns that “investors can’t wait too long.” Moreover, the “mom-and-pop investors” now have many investment options, he explains. “They don’t have to buy bullion,” he remarks. (For example, they can go into commodity funds.)
So how do we avoid the “Toyota/Datsun” revolution? Gross says the precise timing and contours of a budget deal are not that important. “For us,” he says, “it is important to be on the right trajectory.” He’s a bit skeptical, having seen budget plans come and go for 30 years. He warns, “It behooves Republicans and Democrats to begin to set an agenda for changing the direction of the country.” As for Rep. Paul Ryan’s plan he’s most enamored of the Medicaid reform. He says if we go to a block grant system “then there is hope” to get entitlements under control.
Does the mix of taxes and spending matter? He says, “You do have to make a choice about how it results in long-term growth.” On that score, he favors the debt commission — “not that it didn’t have problems,” he says. He’d like a “balanced mix of taxes and spending cuts.”
Gross’s view of the debt crisis is one held by the debt commission’s co-chairmen and by Ryan. However, Ryan wants to reform the tax system, not raise rates. Conservatives argue that raising taxes now is a mistake, a sure-fire way to snuff out growth. Moreover, their aim is not simply to balance the books. (Otherwise we could spend $5 trillion and raise taxes $5 trillion-plus and declare victory.) Conservative want to balance the budget AND spur growth, return to a more limited government and preserve individual freedom. As Ryan put it in his interview with Time magazine: “My fear is, if you raise revenues you take the pressure off of spending. The money always comes in for spending. And more importantly if you’re taking more of a tax burden out of the economy that’s hurting growth.”
Ryan’s budget may or may not carry the day. But for now it’s the only remotely responsible plan out there. If not Ryan’s, then what plan is going to spare us from the agony of a European-style debt crisis?