Bill Gross Investment Outlook Sep_03

8/14/2019 Bill Gross Investment Outlook Sep_03

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InvestmentOutlook BillGross

September 2

What, WE Worry?

Let me describe a world for you: an

economic world for the most part andtherefore more of a scenario than a playwith live action gures, but de nitely nota ctionalized world. If this were a book,its Dewey Decimal would place it in thenon- ction row, not childrens fairytales,though as youre about to nd out, partof it resembles a compendium of thoseold MAD magazines. Still theres a ratherfrightening aspect to it a bad dream, thiscant be happening tone that moves it

closer to the Stephen King corner. But whydont I just let you the readers decide whatkind of book it is. After all, its your future,your country, your money.

My books thesis rests on the growingreality that the U.S. is overextended, not just militarily but economically. We aretrying to do too much, borrow too much,spend too much and sooner, perhaps later,we will have to suffer the consequences.We are a country in the beginningstages of what can be aptly describedas hegemonic decay. But decay from ahegemons perspective is something thatmore appropriately belongs in a GibbonsDecline and Fall of the Roman Empirecontext. Empires take decades if notcenturies to wither and the perspectiveis more easily viewed from a rear viewmirror as opposed to a windshield.

Politicians, investors, and citizens alike no

doubt would choose Alfred E. Newmanrather than Edward Gibbon as theirspokesman. What, we worry? is prettymuch our national motto when it comes toour nance-based economy and its futureprospects.

So for those of you that prefer Mad magazine to a history tome let meapproach this predicament from a morepersonal angle. Im gonna compare a

typical American family to a country, sothat the hegemon has a face and an actualpersonality. Pretend that youre a head orco-head of a household. You earn a goodsalary but it never seems to be enough.There are bills to pay, the Joneses to keepup with, youve had your eye on that goofyHummer for at least a few months now.Youd like to save money but you cant oryou wont, so you dont. As a matter of fact,each year for the past decade or so youvehad to borrow 4, 5, 6% of your annualincome to pay for what you want. Yourerunning a personal de cit not a surplus.But thats still ok you gure. Youre strong,vibrant, prospects are good, theres no wayyou shouldnt be able to handle it. You cangrow your way out of current liabilitiesand have more than enough to pay forfuture obligations such as college for thekids, that far away retirement for


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Investment Outlook

September 2003

you and the spouse, and healthcare if thatshould ever come up. And your creditorsundoubtedly will see it the same way too.They know a good risk when they see one.Come to think of it, should your Hummer

be that macho black or maybe, just maybethat outlandish canary yellow?

Well, lets shorten this personal fairytalea bit and introduce the catch, the chink in the armor, the unexpected, the heelof family Achilles, or in this case familyNewman. Something happens. For somereason you cant grow your way out of this.Your companys prospects sour, your raisesvirtually vanish, your health deteriorates,

your family life sours, who knows. The bigS happens. With no savings and a boatloadof debt the wheels all of a sudden go intoreverse. Creditors are not so friendly. Notonly will they not lend you that 6% of your salary every year, but they want ahigher interest rate on what youve already borrowed. Forget the Hummer pal black,yellow or polka dot purple. Youre thinkingabout survival, not staying up with the Joneses. This hegemon with a face has

started to decay.

Countries are no different than peopleexcept they ght with rockets, bombs, andcurrencies, instead of lawyers.The United States as a matter of fact is strikingly similar to theHummer wannabes - the AlfredE. Newmans - just described.Its strong and vibrant, with afuture seemingly about as bright

as any other country on theplanet. Productivity is soaring,its markets are recovering, itssalary (or GDP) shows decentincreases almost every year. Itgoes wherever it wants to go, its

Hummvees are symbolic of global militarydomination. Whats not to like here?Wheres the decay in this hegemon?

Well, maybe Im just pessimistic because

Im a Californian and the not so GoldenState currently resembles the pulp notthe juice of its once famous oranges. ButCalifornia is 15% of the nation and it isthe trendsetter in more ways than fashion,Hollywood, and tongue rings. We have ahuge de cit based on overspending whichwas in turn based on the anticipation thatnancial markets and their capital gainswould continue inde nitely. Our schoolsare a mess. Businesses are departing daily

to points unknown. But this Outlook willnot be a California diatribe. I use it only tosuggest that as California goes so goes thenation and at the moment its prospects arenot good, Terminator or no Terminator.

The U.S. is in a similar predicament asa matter of fact its story parallels not onlyCalifornia but our imaginary family, theNewmans. For years, Americans havewanted to save money but the savings

rate has hovered close to 0. They havedepended upon those 1990s capital gains


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to give the impression that their liquidassets were on the rise. In turn, U.S.citizens have had to borrow 4, 5, 6% of their annual income (GDP) in order to payfor what they want. Economists call that

the trade de cit, and Chart I amply pointsout the decay hegemonic to be sure.

Add to that, new evidence that ourgovernments de cit, the budgetde cit shown in Chart II, is running at$450 billion+, with few prospects forimprovement (a new prescription drug billand Alternative Minimum tax adjustmentwill add nearly 100 billion annually to thetotal and Iraq perhaps $50 billion more).

President Bush and his economic teamclaim that the $450 billion is well spent,that it is an investment in America, andafter all, we owe it to ourselves. Suchnonsense belongs in Mad magazine. The$450 billion is paying for overconsumption,for Hummers in L.A. and Hummvees inIRAQ and we increasingly owe it to foreigncreditors. It is plain for all to see that weare living beyond our ability to pay if for some reason the Big S happens on a

national scale.

Could it? Better yet, how could it? Well,I suppose S could happen in a number

of ways with alternative time horizons.Typically though, with families suchas the Newmans and countries such asthe United States, the spending/savingsdiscipline necessary to right their scal

ship has to come from the outside. Theywont stop on their own. Hummers andHummvees are way too cool to say no to.So its the creditors that say no. And theirdiscipline has already started. Bond marketvigilantes, (not so vigilant it seems priorto June of 03) have suddenly recoiled inhorror at the U.S. budget de cit and thefailure of the Fed to guarantee its fundingat exorbitantly low interest rates. In turn,foreign creditors for more than a year have

been liquidating dollars in favor of othercountrys currencies with current account/trade balances closer to neutral, and budgetdisciplines resembling that of an adultas opposed to a neurotic teenager with acredit card. But despite the resultant higherinterest rates and cheaper dollar that theseactions imply, our countrys economyappears to be chuggin right along thank you very much. If this is my idea of the big Shappening, then bring it on as Commander

Bush might hypothetically intone. Wheresthe big, bad wolf in this story?

Well in addition to future domesticallyinduced bond market selloffs destroying the housingmarket, and a nance-basedeconomy inexorably slowingdown as restrictively higheryields work their historicalmagic, the fulcrum of

a future creditor basedrevolt likely rests in Beijingas opposed to NYC orWashington DC.


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840 Newport Center D

Newport Beach, CA 9

949.720

Chart III shows the potential for Chinesewater torture in two different forms. Firstsince its monthly trade surplus of $10 billion+ with the United States implies a$120 billion annual addition to its dollarreserves, there will come a time when theirhundreds of billions if not a half trillionor so in holdings of U.S. notes and bondslook a tad too risky. In turn the hundredsof billions that the Japanese and otherAsian countries have been buying in order

to keep their currencies competitive withthe Chinese Yuan (Renminbi) and the U.S.dollar will be subject to a sanity check

as well. The currency/bonds/stocks of are ating economy engaged in guns and butter, Hummer and Hummvee spendingof near historical proportions are badinvestments. Sooner, perhaps later, our

Asian creditors will wake up and smell thecoffee. Perhaps their java will take the formof dollar or Treasury Note sales. Perhapsthe aroma will resemble a revaluation of the Yuan and then the Yen. Either waywe pay the price: higher import costs,a cutback in spending on cheap foreigngoods, rising in ation, perhaps chaoticnancial markets, a lower standard of living. Mark these words well for whattheyre worth (not much some will say):

China holds the keys to our kingdom, andour Hummers. Their willingness to buyour bonds, their philosophy of xing theircurrency to the U.S. dollar will one day betested. And should their patience be foundwanting, all of their neighboring AsianChina wannabes will move in near unison.Re ations second round will have begun,U.S. interest rates will rise, our goods inthe malls and the showrooms will be lessaffordable, and the process of national

belt tightening and increased savings willhave begun. Are the Newmans worryingyet? Not if they bought stocks six monthsago. Not if they re nanced their home inearly June or bought that Hummer with0% nancing. But they will. The Newmansrepresent your future, your country, andyour money and to think otherwise wouldclearly be MAD.

William H. Gross

Managing Director

Chinese Water Torture


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Past performance is no guarantee of future results. This publication contains the current o pinions of the author and does notrepresent a recommendation of any particular security, strategy or investm ent product. Such opinions are subject to change withoutnotice. This publication is distributed for educational purposes only and should not be considered as investment advice or an offer of any security for sale. Information contained herein has been obtained from sources believed reliable, but not guaranteed. No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission. Paci cInvestment Management Company LLC. 2003 PIMCO. IO018-0828 03

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Bill Gross Investment Outlook Sep_03