January 8, 2010
Source: PIMCO - Bill Gross
Here’s the problem that the U.S. Fed’s “exit” poses in simple English: Our fiscal 2009 deficit totaled nearly 12% of GDP and required over $1.5 trillion of new debt to finance it. The Chinese bought a little ($100 billion) of that, other sovereign wealth funds bought some more, but as shown in Chart 2, foreign investors as a group bought only 20% of the total – perhaps $300 billion or so. The balance over the past 12 months was substantially purchased by the Federal Reserve. Of course they purchased more 30-year Agency mortgages than Treasuries, but PIMCO and others sold them those mortgages and bought – you guessed it – Treasuries with the proceeds. The conclusion of this fairytale is that the government got to run up a 1.5 trillion dollar deficit, didn’t have to sell much of it to private investors, and lived happily ever – ever – well, not ever after, but certainly in 2009. Now, however, the Fed tells us that they’re “fed up,” or that they think the economy is strong enough for them to gracefully “exit,” or that they’re confident that private investors are capable of absorbing the balance. Not likely.Quixotic journeys often make for great literature, but by definition are rarely productive. I am, after all, referring to windmills here – not their 21st century creation, but their 17th century chasing. Futility, not productivity, was the ultimate fate of Cervantes’ man from La Mancha. So it is with hesitation, although quixotic obsession, that I plunge headlong into a discussion of American politics, healthcare legislation, resultant budget deficits and – finally – their potential effect on financial markets. There will be windmills aplenty in the next few pages and not much good can come of these opinions or my tilting in their direction. Still, I mount my steed, lance in hand, and ride forward.
