Central bankers around the world are enthralled by quantitative easing, says Bill Gross. That should make investors very nervous, says the co-founder of PIMCO, the world’s biggest bond fund.
In his January newsletter, he notes that “the world’s six largest central banks have collectively issued six trillion dollars’ worth of checks since the beginning of 2009 in order to stem private sector deleveraging.”
Why do they like QE so much? Well for them it must feel like they’ve found a way to game the financial system, says Gross. “The Fed and other central banks such as the Bank of England (BOE) actually rebate the interest they earn on the Treasuries and Gilts that they buy.” That means that they give the interest back to the government so the Treasury gets to issue debt for free.
Even if interest rates were to rise and losses accrue to the central bank portfolio as bond prices fall, they can just “record it as an accounting liability owed to the Treasury, which need never be paid back.”
From a government’s point of view “this is about as good as it can get”, says Gross. “Money for nothing. Debt for free.”
And that’s exactly why investors should be worried, he continues. Because whenever governments think they’ve found a way to game the financial system, it always goes horribly wrong.
To make his point he cites the example of the South Sea Bubble in England in the 1700s, when government bonds were sold to finance the exploitation of a far-off, resource-rich land.
“At the time Sir Isaac Newton was asked about the apparent success of the plan and he responded by saying that ‘I can calculate the movement of the stars but not the madness of men.’ The madness he referred to was the rather blatant acceptance by government and its citizen investors, that they had discovered the key to perpetual prosperity: ‘essentially costless’ debt financing.”
The trouble is, says Gross, that nothing apart from the air we breathe is actually costless. “The future price tag of printing six trillion dollars’ worth of checks comes in the form of inflation and devaluation of currencies either relative to each other, or to commodities in less limitless supply such as oil or gold.”
Given that the Fed says it will keep QE until US unemployment falls to 6.5%, the associated economic distortions will continue to grow.
Investors also need to reposition their portfolios, says Gross. They “should be alert to the long-term inflationary thrust of such check writing.” That means avoiding long-term bonds “confine your maturities and bond durations to short/intermediate targets supported by Fed policies.” Translation? Beware the bursting of the QE-powered bond bubble.