PIMCO's Gross: Can You Solve a Debt Crisis With More Debt?

(October 31, 2011) — Bill Gross, who manages the world’s largest bond fund at Pacific Investment Management Co. (PIMCO), has said in his monthly note that the investment question of the day should be “can you solve a debt crisis with more debt?”

He writes: “Policymakers have been striving to answer it in the affirmative ever since Lehman 2008 with an assorted array of bazookas and popguns: 0% interest rates, sequential QEs with a twist, and of course now the EU grand plan with its various initiatives involving debt write-offs for Greece, bank recapitalizations for Euroland depositories and the leveraging of their rather unique ‘EFSF’ which requires 17 separate votes each and every time an amendment is required. What a way to run a railroad. Still, investors hold to the premise that once a grand plan is in place in Euroland and for as long as the US, UK, and Japan can play scrabble with the 10-point ‘Q’ letter, then the markets are their oyster. Not being one to cast pearls before swine or little Euroland PIGS for that matter, I would tentatively agree with one huge qualifier: As long as these policies generate growth.”

The bond fund manager asserted that you cannot solve the debt crisis by creating additional debt. Instead, the answer should be a policy of creating growth, Gross said. However, attempts to create an increasingly attractive environment via rate cuts and discounted future cash flows can only achieve so much, Gross explained. “Growth is the elixir that seems to make every ache, pain or serious ailment go away. Sovereign debt too high? Just grow your way out of it. Unemployment rates hitting historical peaks? Growth produces jobs. Stock markets depressed? Nothing a lot of growth wouldn’t cure.”

The problem: growth is currently “the commodity that the world is short of at the moment.” He concluded: “In sum, with both earnings and bond yields near historic lows as a result of a lack of real growth in developed economies, investors will need to find lots of pennies to produce asset returns much above 5% in bonds or equities.”

Read Gross’ investment outlook report in full here. 

Gross’ negative view that monetary policymakers can jumpstart the economy through a series of policies that promote zero percent interest rates, and quantitative easing, along with large-scale debt plans in the European Union follow a similarly dismal view regarding a potential QE3. A research paper published earlier this month asserted that cries for a third round of quantitative easing will grow steadily louder during the rest of the year, yet are unwarranted.

“The central banks aren’t’ responding to economic forces but to the securities market,” Michael Litt, founder and chief investment officer at Arrowhawk Capital Partners, told aiCIO, noting that monetary policy is thus becoming less associated with the actual economy. “In fact, the economy of the United States is doing moderately well.”

According to Litt, QE3 would be incrementally less effective in stimulating US economic activity, creating a global arbitrage where investors borrow in US dollars, sell those US dollars, and then buy bonds from other countries with higher-yield currency units. Consequently, with QE3, Litt perceives an environment where little money flows into the US economy, with the Federal Reserve’s policy supporting only certain currencies while doing nothing to stimulate growth in the US.