The “New Normal” world of lower economic growth
By Bill Gross's
They say that reality is whatever
you wish it to be and I suppose that could be true. Just wish it, as Jiminy
Cricket used to say, and it will come true. Reality’s relativity came to mind
the other day as I was opening a box of Cracker Jacks for an afternoon snack.
That’s right – I said Cracker Jacks! I can’t count the number of people who
have told me during the seventh inning stretch at a baseball game to make sure
I sing Cracker Jack (without the S) because that’s what the song says. I care
not. No one ever says buy me some “potato chip” or some “peanut.” How about a
burger and some “french fry?” In all cases, the “s” just makes it flow better.
My reality is a box of Cracker Jacks, and I think little sailor Jack on the
outside of the box would be nodding his approval if he could ever come to life,
which maybe he can if the stars are aligned and reality is whatever we wish it
to be.
Having mentioned Jack and the game of baseball, let me give you some
opinions that come close to being hard cold facts, not wishes. First of all,
baseball is the most boring game in the world next to cricket. I don’t know how
to play cricket, which is the only reason I rank it second. CNN Sports did an
actual survey of how much time during an average two hour and 39 minute game
that baseball players are actually moving – you know, swinging a bat or running
to first base. Five minutes and 13 seconds! The rest of the time the boys of
summer are actually just standing around, scratching you know where, and
spitting tobacco juice onto the nice green grass. Most disgusting, I’d say. And
why, I wonder, does a baseball “season” consist of 162 individually boring
games? In football you only need 16 or so to declare a champion, in boxing
sometimes three minutes or less.
Now for some controversy: steroids, HGH and juicin’? I say, why not. They
can’t be cheating if they’re all cheating together. And as a matter of fact,
management and owners “cheat” all the time. If they have a lineup heavy with
left-handed hitters, they will shorten the right field fence. The Yankees and
now the Dodgers just “buy” championships with money from the game’s most
gargantuan TV rights (who’s watching?). That’s playing by the rules? If your
counterpoint on drugs is that it’s unnatural and harmful to the body, I wonder what’s
so healthy about the way they conduct spring training or do their pregame
warm-ups. Two or three half-hearted sprints in the outfield and they’re done.
If baseball was concerned about health or addiction, they’d be testing for lip
cancer or diabetes. Modern day relief pitchers, who now “exercise” for two
innings or less on the mound, have pot bellies that would make a sumo wrestler
proud. Why, the Babe was so fat he could hardly waddle back around to home
plate 60 times in one season.
Last point, because I know you’re dying to hear my opinion on Pete Rose and
the Hall of Fame. I say anyone as ugly as Pete deserves a free pass to Cooperstown or any town for that matter,
maybe the same free pass that you’d have to give me to go to a baseball game
again. Take me anywhere, but don’t take me out to the ball game and make me
stretch during the seventh inning while I’m eating my Cracker Jacks. Reality
can smack you in the face sometimes, like it did Pete Rose, but if I’m gonna be
smacked it’ll have to be on the gridiron or the hardwood, not Yankee Stadium.
Life’s ballgame ended several decades ago for Hyman Minsky, author of “Stabilizing an Unstable Economy” and
proponent of the notion that capitalism is inherently unstable, in part because
of the short term financing of long term capital assets such as bonds,
buildings, plant and equipment. His stabilizing solution was for Big Bank and
Big Government to intercede with monetary and fiscal pump priming, confident in
the notion that if the priming was large enough and the pumping fast enough,
that stability could at least be temporarily achieved. Yet Minsky played ball
in another era, before steroids and corked bats. He legitimately could not
foresee the time when what he labeled “Big Bank” and “Big Government” became so
large and stimulation so excessive that even temporary stability of a closed or
an evolving global economy would be difficult to attain.
Over these five post-Lehman years, financial markets have grown leery of
the medicine Dr. Minsky recommended to calm the symptoms, if not the disease,
of capitalistic excess. During a crisis, Minsky’s solution was for Big
Government to generate substantial fiscal deficits which in turn would
stabilize corporate profits, financial asset prices and ultimately the real
economy. In turn, and concurrently, he advocated the growth of Big Bank, by
which he meant the ability of a central bank to lower interest rates and
reserve requirements in order to stimulate private lending via the monetary
channel. In combination, and if large enough, the two could stabilize asset
prices and eventually produce an “old normal” 3–4% real growth rate in
developed and presumably developing economies too. We have lived in a
Minsky-based policy world for some time now, but unfortunately in a “New
Normal” world of lower economic growth.
What perhaps Minsky couldn’t conceive of was the point at which debt,
deficits and interest rates would go to such extremes that the creation of
credit itself, which was and remains the heart of capitalism, would be
threatened. No longer might the seventh inning stretch lead to a Coke, some “Cracker
Jacks” and the resumption of the old ballgame. Instead, zero-bound interest
rates and debt/GDP ratios in a majority of capitalistic economies would begin
to threaten, not heal, the nature of finance and investment in the real
economy. Investors, leery of not only overleveraged investment banks such as
Lehman Brothers, but overextended countries such as Greece, Cyprus and a host
of Euroland lookalikes would derisk as opposed to rerisk as per the Minsky
model. As well, with interest rates close to the zero bound, investors in
intermediate and long term bonds would become dependent on Big Bank to do their
bidding. When that QE buying power became jeopardized via tapering and the
eventual ninth inning conclusion of asset purchases, then the process of maturity
extension and the terming out of historically modeled corporate lending was
prematurely threatened.
In short, and in too-abbreviated summation, debt-laden economies with
near-zero-bound interest rates became victims of their own excess, a condition
that was more difficult to stabilize cyclically because Big Government and Big
Bank had reached limits, and private market investors with huge portfolios of
their own began to leave the ballpark early. Why stick around if your team is
down by seven runs with only a few innings left? Why invest in financial or
real assets if bond prices could only go down, and/or stock prices could no
longer be pumped up via the artificial steroids of QE?
The rush for the exits seems to have been hastened recently not only by the
increasingly obvious limitations of Big Government and Big Bank but by the
additional knock-on effects of Big Investor and Big Regulation. The regulatory
aspect is not hard to see. Having threatened the global economy with
endogenously generated financial leverage, banks are under the government thumb
to recapitalize and derisk from a multitude of directions including Basel III,
SEC fines and criminal investigations, as well potential transaction taxes in
Euroland, to name a few. While this response would have been typical in an
historical Minsky model of normal economic recoveries, it is now no doubt
excessively so, if only because of the enormity of the Great Recession itself.
Whatever the cause, the duration of regulatory restraint, while long term beneficial,
has been short to intermediate term negative for “stabilizing an already
unstable economy.”
An analysis of “Big Investor” is a little more complicated, if only because
there are a multitude of “structural” investors with varied and in many cases
dissimilar interests. Our “unstable global economy” for instance has produced a
number of developing (China, Brazil, India, South Africa to name a few) and
developed economies (Japan to name one) that run substantial trade deficits or
surpluses that give rise to the artificial pricing of currencies and/or
government debt. As these imbalances raise concerns domestically or amongst
international investors, the quickened pace of bond purchases or liquidation
creates an unstable as opposed to a stable financial foundation. Minsky, I
fear, would be appalled, if only because Big Government and Big Bank cannot now
be coordinated in an open global as opposed to a closed domestic economy.
“Technical” considerations involving trillions of dollars of financial flows are
now dominating fundamentals in many markets.
But Big Investor is now influenced not just by public and sovereign
entities but by an enormously expanded private market with liquid alternatives
and choices. Call it pension-related or institutional severance monies. Call it
retail, call it Mom & Pop with their 401(k)s, but they all have a host of
choices at today’s ballpark snack bar. Bonds, stocks, cash – emerging/developed
– euros, dollars, pesos. Sounds like a good game to play, does it not? The
problem is that as Big Government, Big Bank and Big Regulation begin to tighten
their purse strings and the risk budgets of their constituent vassals, then the
liquidity to choose amongst a varied menu of assets becomes more limited. At
the extreme, Mom & Pop have only themselves to buy from or sell to. When
policymakers say so long to QE, and investment banks are no longer able to
inventory large blocks of stocks and bonds, then historical liquidity is
challenged. ETFs and mutual funds, once energized by excessively generous
fiscal and monetary policies, have only themselves to sell to. At the extreme,
the new game is now played in a Pogo ballpark, with the
enemy, the opponent, the buyer of last resort being “us” as opposed to “them.”
Minsky’s hoped-for stability, if only temporary, falls short because Big
Government and Big Bank are now much smaller than historical proportions in an
economy dominated by private funds or individual country flows.
So what to do here, folks? For those of you who are still fans of the old
American pastime – in this case capitalism and the making of money as opposed
to baseball – how do you play on this rather unstable field of our own making?
Which pitch do you swing at? Well, commonsensically, in an unstable global
economy that is increasingly difficult to stabilize, an investor should seek
out the most stable of assets. At the extreme, that would be cash in the
world’s most stable currency. But whether dollars, euros, or pounds be your
first choice (ours being dollars), cash or overnight deposits in any of them
yield next to nothing. So say you want something but don’t want to lose your
money either; a modern day Will Rogers. More concerned about the return of your
money than on your money but still a little greedy (or perhaps just needy) too.
Well, some say stocks – the only game in town. But I don’t know. When the Fed
stops the QE game, it seems that stocks might be at risk. After all, haven’t
they more than doubled in price since 2009 in part because of it? Without Big
Government deficits and Big Bank check writing and with the advancing risks
posed by Big Regulation and the technical whimsy of Big Investor, the safest
pitch to swing at may not be stocks but the asset that will soon be the nearly
sole focus of central banks. Instead of QE, central bankers are shifting to
“forward guidance” which, if reliable, allows financial markets and real
economies to plan several years forward in terms of financing rates and
investment returns. If unemployment and inflation rates can be at least closely
guesstimated, then front-end yields become the most reliable bet in the
ballpark, Pete Rose notwithstanding. While low, they can at least form the
basis for curve rolldown and volatility strategies that have higher return/risk
ratios than alternative carry options such as duration, credit or currency.
With Big Investor unsure or perhaps unable to catch stock, long bond or
currency fly balls in today’s afternoon sun, it’s perhaps best to field boring
slow-rolling grounders based on policy rate stability for “an extended period
of time.” Recall as well that the result of Minsky’s “Big Government” and “Big
Bank” policies has always been accelerating inflation at some future time. We
recommend longer-dated TIPS as insurance against just such an outcome.
Baseball’s old saw pleads to “buy me some peanuts and Cracker Jack, I don’t
care if I never get back.” Jack or Jacks aside, getting back to the old normal
Minsky world of stabilization via Big Government and Big Bank is now being
challenged, as are the investment choices and future returns dependent on them.
Grab for the prize at Jack’s bottom if you will, but the safer and perhaps most
rewarding treat lies at the top with those front-end yields and
inflation-protected securities based on our evolving age of central bank
“forward guidance.” I have a hunch that even Pete Rose would bet on this one.
Seventh Inning Speed Read
1.
Hyman Minsky’s hoped-for “Stability in an Unstable
Economy” must be updated for the exhaustion of Big Government and Big Bank
2.
Private market technicals can temporarily overwhelm
fundamental considerations
3.
Bond investors should focus on “safer” front-end
positions in Treasuries or credit space because of the Fed’s shift to forward
guidance
4.
Don’t bet on baseball games. Bookies take too much,
plus it’s boring!
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