Daniel W. Drezner

I’m not sure Bill Gross is wearing any clothes anymore

I’m not sure Bill Gross is wearing any clothes anymore

In my experience, pundits tend to be risk-averse in calling out a very rich person on their economic or financial analyses.  There’s a couple of intuitive logics at work here: 

1)  Most pundits don’t know much about economics, and so are leery of entering those waters;

2)  The really rich person likely became really rich because they demonstrated a shrewd understanding of the markets — therefore, who is the low-six-figure-or-less-earning pundit to challenge such high-yielding wisdom;

3)  Most pundits refuse to admit that they don’t understand something that reads like gobbledgook, because they’re afraid this makes them look like an idiot.

Well, your humble blogger has never been afraid of looking like an idiot… which brings me to PIMCO’s Bill Gross.  I’ll occasionally read his monthly newsletter when a link to it pops up in my Twitter feed.  Every time, I’m amazed at the florid, rambling, not-really-related-to-his-main-point way he opens these little essays. Sometimes I find the analysis afterwards useful, sometimes I find it eerily similar to what someone says after spending too much time with Tom Friedman.  I gather he’s had better years as an analyst than he did in 2011, but everyone has down years and bad predictions. 

Here’s the thing, though — I can’t understand a word of his latest Financial Times column:  Here’s how it opens: 

Isaac Newton may have conceptualised the effects of gravity when that mythical apple fell on his head, but could he have imagined Neil Armstrong’s hop-skip-and-jumping on the moon, or the trapping of light inside a black hole? Probably not. Likewise, the deceased economic maestro of the 21st century – Hyman Minsky – probably couldn’t have conceived how his monetary theories could be altered by zero-based money.

Things get a little clearer towards the end of the op-ed… but not much.  His February 2012 newsletter appears to be an expanded version of this op-ed (plus the usual wacky opening), so let’s go there to see what he’s trying to say: 

[W]hen rational or irrational fear persuades an investor to be more concerned about the return of her money than on her money then liquidity can be trapped in a mattress, a bank account or a five basis point Treasury bill. But that commonsensical observation is well known to Fed policymakers, economic historians and certainly citizens on Main Street. 

What perhaps is not so often recognized is that liquidity can be trapped by the “price” of credit, in addition to its “risk.” Capitalism depends on risk-taking in several forms. Developers, homeowners, entrepreneurs of all shapes and sizes epitomize the riskiness of business building via equity and credit risk extension. But modern capitalism is dependent as well on maturity extension in credit markets. No venture, aside from one financed with 100% owners’ capital, could survive on credit or loans that matured or were callable overnight. Buildings, utilities and homes require 20- and 30-year loan commitments to smooth and justify their returns. Because this is so, lenders require a yield premium, expressed as a positively sloped yield curve, to make the extended loan. A flat yield curve, in contrast, is a disincentive for lenders to lend unless there is sufficient downside room for yields to fall and provide bond market capital gains. This nominal or even real interest rate “margin” is why prior cyclical periods of curve flatness or even inversion have been successfully followed by economic expansions. Intermediate and long rates – even though flat and equal to a short-term policy rate – have had room to fall, and credit therefore has not been trapped by “price.” 

Even if nodding in agreement, an observer might immediately comment that today’s yield curve is anything but flat and that might be true. Most short to intermediate Treasury yields, however, are dangerously close to the zero-bound which imply little if any room to fall: no margin, no air underneath those bond yields and therefore limited, if any, price appreciation. What incentive does a bank have to buy two-year Treasuries at 20 basis points when they can park overnight reserves with the Fed at 25? What incentives do investment managers or even individual investors have to take price risk with a five-, 10- or 30-year Treasury when there are multiples of downside price risk compared to appreciation? At 75 basis points, a five-year Treasury can only rationally appreciate by two more points, but theoretically can go down by an unlimited amount. Duration risk and flatness at the zero-bound, to make the simple point, can freeze and trap liquidity by convincing investors to hold cash as opposed to extend credit (emplases in original).

And… sorry, I still don’t get it.  I get why zero interest rates are bad for bondholders like PIMCO.  I get that flat yield curves + high amounts of economic uncertainty = cash hoarding.   What I don’t get is that:

A)  Gross himself acknowledges that the yield curve ain’t flat;

B)  Low interest rates allow for private-sector deleveraging, which is a prelude to stimulating market demand;

C)  Low interest rates prevent today’s government binge from being even more expensive than it would be in normal times (by keeping financing costs down);

D)  If uncertainty is decreasing — and that appears to be the case with the U.S. economy — then low interest rates should spur greater entrepreneurial investments. 

So, at the risk of threatening my status in the International Brotherhood of Serious Global Political Econmy Bloggers That Talk Seriously About Economics, I hereby ask my commenters to explain Bill Gross’ concerns to me. Because I don’t get it — and I’m beginning to wonder if I’m not the only one.