'Bond King' Bill Gross Claims the Fed Is Killing Capitalism

Near-zero interest rates are driving nails into the coffin of American-style capitalism, says 'Bond King' Bill Gross. He faults the Fed, but doesn't mention socialism or Bernie Sanders.
By Carleton English ,

UPDATE: This article, originally published at 10:42 a.m. on Nov. 3, 2015, has been updated with video and a statement from the Federal Reserve.

There can, in fact, be too much of a good thing -- especially when the thing in question is money.

That is why Bill Gross, whose investing prowess after helping found Pimco in the 1970s earned him the nickname "Bond King," argues it's past time for the Federal Reserve to start raising interest rates.

Keeping rates near zero, where the central bank set them to bolster the economy during the 2008 financial crisis, has not only exhausted its usefulness but also begun to cause harm, says Gross, now a portfolio manager at Janus Capital.

"If an investor has money on deposit with an investment bank/broker that not only appears to be at risk but returns nothing, then why maintain the deposit?" Gross wrote in a 2011 op-ed in the Financial Times, a piece he cited in his monthly investment outlook published Tuesday. "Perhaps an investor would be more comfortable with a $100 bill at home in a mattress than a $100 bill on deposit with a broker."

Gross has a problem with more than low interest rates. The Fed took a variety of other steps to protect the U.S. economy during the crisis, including authorizing several rounds of asset purchasing to bolster liquidity, and launching "Operation Twist," in which the central bank sold short-term government bonds and used the money to buy longer-term Treasury notes.

For a time, those measures prevented the crisis from deepening and even may have stimulated growth. But by Gross' measure, the usefulness of the measures has passed its tipping point. He proposes reversing the measures of "Operation Twist," for instance, in a strategy he would call "Operation Switch."

"After nearly six years of such policies producing only anemic real and nominal GDP growth, and -- importantly -- declining corporate profit growth, it is appropriate to question not only the effectiveness of these historical conceptual models, but entertain the increasing probability that they may, counter-intuitively, be hazardous to an economy's health," he wrote.

In the short term, low interest rates create a favorable borrowing environment. After all, would you rather buy a house when mortgage rates are around 4% or would you rather have made a purchase in the early 1980s, when rates were near 20%?  

However, if you're an investor -- or even a saver -- low rates mean that you're not earning anything on your money. And once inflation begins to rise, that lack of return will pinch your wallet even more.

That prompts some would-be savers to seek returns outside of banks, and the smaller deposit base that results means banks have less money available to lend. In turn, slower loan growth means that businesses can't get the financing they need to expand, so productivity and corporate profits decline and GDP growth narrows.

Overall, the near-zero rate environment "lowers incentives to expand loans and create credit growth," wrote Gross, who recently filed a lawsuit against Pimco over his 2014 ouster.

When pension funds and insurance companies can't earn a sufficient return on their investments to cover future liabilities, "then capitalism stalls or goes in reverse," Gross said. "When our modern financial system can no longer find profitable outlets for the credit it creates, it has a tendency to slow and begin to inhibit economic and profit growth in the overall economy."

There's no indication so far that the Fed considers that an immediate threat. In a statement after its October meeting, the central bank's monetary policy committee said economic conditions may warrant keeping interest rates lower "for some time," even after employment and inflation reach its goals.

As an example of how Fed policy might hurt the U.S. over the long term, Gross offers "the lost decades of Japan." Japan's economy soared in the 1980s, fueling conspicuous consumption financed by banks that didn't pay much attention to credit quality.

But since the bubble burst -- as bubbles are known to do -- in the early 1990s, Japan's economy has struggled to rebound.

The Fed can help the U.S. avoid a similar fate, Gross suggests, by raising its inflation target from 2% to 3% so that rates on longer-term bonds would also rise.

He also suggests that the Fed do the reverse of "Operation Twist" and swap its longer-term notes for short-term securities, a plan he dubs "Operation Switch."

The flood of long-term debt on the market would lower prices and raise yields, which would benefit savers, as well as liability-based businesses and the economy itself, he says.

"All central banks should now commonsensically question whether ultra-cheap money continually creates expansions as opposed to reducing profit margins and hindering recovery. Recent experience would confirm the latter."

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