January 5th, 2011
Econintersect: Bill Gross, Managing Director of PIMCO wrote a scathing missive on the growing debt aimed at American politicians and posted on PIMCO's website. Gross believes the debt will undermine the economy and gave four examples:
- American wages will lag behind CPI and commodity price gains.
Because policy stimulus is focused on maintaining current consumption as opposed to making the United States more competitive in the global marketplace, American workers’ real wages will almost necessarily lag historical norms. Chart 1 points out the graphical evidence of an erosion of labor’s share of the American economic pie, falling from 62% of GDP
Follow up:just recently to a current anemic 58%. Blame it on poor education, blame it on globalization, but an ongoing rebalancing of rich country/poor country wages inevitably will keep U.S. wages compressed as deficit spending serves to reflate commodity and end product prices in future years but not paychecks. Americans will feel the pain but like the male mantis, probably not understand why they’ve lost their head.
- Dollar depreciation will sap the purchasing power of U.S. consumers, as well as the global valuation of dollar denominated assets.
Unique amongst almost all other global citizens, Americans are ignorant of the merits (and the negatives) of currency depreciation. Unless they are smacked with the reality of an expensive hotel or a meal in a foreign port of call during summer vacation, we have few concerns when the dollar depreciates against a basket of foreign currencies. If our stock market goes up 10% annually in dollar-denominated terms, we assume we are 10% richer even if the dollar sinks at the same time. If the cost of imported goods and especially gasoline goes up more than our paychecks, we blame it on a political conspiracy. The fact is that annual budget deficits in the trillions of dollars add a like amount to the stock of outstanding dollars, resulting in currency depreciation, higher import inflation, and a degradation of dollar based assets in global financial markets. We become less, not more wealthy, losing our heads while we “hold on firmly and go on with (our) business”!
- One of the consequences of perpetual trillion dollar deficits is the need to finance them, and at attractively low interest rates for as long as possible.
Currently, the Fed is doing both, holding short term interest rates near zero, and engaging in Ponzi like Quantitative Easing II purchases of longer dated Treasuries in the open market. The combination offers bondholders about as an attractive situation as the one facing a male praying mantis: zero percent interest rates if you stay in cash, or probable principal losses if you take durational risk by buying 5 and 10 year maturities. Eventually, as reflationary policies take hold, long-term bondholders lose their heads (and a portion of their principal as well), as yields rise to reflect higher future inflation. Bondholders’ metaphorical warning: “don’t go near those longer term bonds you fool.”
- Trillion dollar annual deficits add up, and eventually produce a stock of debt that can become unmanageable: witness Greece, Ireland, or a host of Latin American countries of generations past.
According to Carmen Reinhart and Kenneth Rogoff’s excellent research in This Time Is Different, once a country’s debt approaches 90% of GDP (as the U.S. is now doing), its economic growth slows by up to 1% annually as the interest payments drain resources that should be going for productivity enhancements. Sovereign credit risk increases and yield spreads rise relative to global competitors. Future generations pay the price for their parents’ mindless thrusting.