Just an old-fashioned love song
Comin’ down in three-part harmony.
Three Dog Night
In many ways the global economic crisis is like a marriage gone bad. As the Three Dog Night sang years ago, global economies have functioned harmoniously for many years, but suddenly the love songs have become strident and cacophonous, the policy coordination morphing into a war of the roses as opposed to a giving of them. Instead of three-part harmony we are now experiencing, at a minimum, tri-party disharmony, teetering on the brink of “divorce,” which in economic parlance means a possible “developed economy” recession – a downturn from which reconciliation may be difficult due to a lack of policy options and cooperation. But I get ahead of myself. Let’s first ring the wedding bells, then take you through an explanation of three separate global marriages and how each of the partners have grown apart.
Oh those feisty Europeans! Always fighting like a dating couple and then finally resolving their differences by saying “I do” sometime in the 1950s with the creation of the Common Market and the European Economic Community (EEC). In doing so, France and Germany said “never again,” and even though they didn’t like each other (read “hate”) they decided to make economic lurv in the hopes that they wouldn’t destroy the continent again. It later turned into a formal union, a European Community (EC), where they invited lots of witnesses to the ceremony and created instant family members, if that’s metaphorically possible. Twenty-seven of them, including Italy, Spain and the U.K. were now relatives despite some liking pasta and others preferring horrid cuisines featuring Shepherd’s Pie or fish and chips. The marriage progressed to the point of a smaller monetary union sometime in 1999, but critically, without a common budget. Husband and Wife – Germany and Greece – decided to have a joint bank account, but with separate allowances and no oversight. Greece could issue bonds at nearly the same yield as could its Northern hard-working neighbors, but were free to spend it any way they chose. This was an economic version of an open marriage where one party gets to have all the fun and the other worked nine-to-five and came home too exhausted for whoopee. Well sometime last year, global lenders said enough is enough and soon the whole cheating European Union (EU) was at each other’s throats, hiring lawyers and threatening to break up. Calmer heads prevailed when the ECB decided to make nice and use its checkbook. Last week Angela Merkel and France’s Sarkozy sort of got engaged for at least the second time, nixing expanded funding for their Southern neighbors and placing the burden even more on the ECB. Who knows where it goes now, but let’s put it this way – Germany and France are sleeping in a king-size bed while the rest of its EU family are sleeping in separate bedrooms. As a result Euroland faces economic contraction.
This impending divorce in America is not about sex or sleeping around, but more about romancing the now stone-cold notion that anyone could be a millionaire in the good old U.S. of A. if only they worked hard enough. Our Statue of Liberty proclaimed “give us your tired, your poor…” and sent many of them West to build a little house on the prairie or strike it rich in the goldfields of Sacramento, California or Skagway, Alaska. Many of them did and a century later, the option-laden fields of Silicon Valley provided modern-day examples of rags to riches fairytales come true. But this odd couple marriage of rich (and poor hoping to be rich), now seems on rather shaky ground. Instead of boundless opportunity, the nursery rhyme describing Jack Sprat – who could eat no fat – and his wife – who could eat no lean – appears to be the starker of the two realities. There are the poor and there are the very rich, with the shrinking middle class resembling Mr. Sprat rather than his wife.
During this country’s recent economic “recovery,” real corporate profits increased by four times the amount of working wages in dollar terms, and, as the chart below shows, are 50% higher than at the turn of the century while wages remain relatively unchanged, something that has not occurred since this country’s nuptials were concluded over three centuries ago. Is it any wonder that preliminary battlefield skirmishes in Wisconsin and Ohio between labor and capital promise to spread across every state of this land? (Not Texas!) Is it any wonder that Republican orthodoxies favoring tax cuts for the rich and Democratic orthodoxies promoting entitlements for the poor threaten to hamstring any constructive efforts to reduce unemployment over the foreseeable future? We are witnessing romantic love turning into a spiteful, bitter clash between partners in name only.
The Asian Miracle
Confucius say, “Can there be a love which does not make demands on its object?” While not a marriage, there has definitely been a love affair between Western consumers and their Chinese producer “objects” for several decades now. We loved them because they made cheap goods, but somehow they seemed to love us more as they slowly but surely put their people to work while ours were hitting the unemployment lines. Imperceptibly, the developed world’s manufacturing base was gradually eroding and being replaced by securitized finance that destroyed itself and nearly its economies in 2008.
China, meanwhile, calmly played its cards with a decades-long plan centered around capitalistic mercantilism, a game the United States claimed to play best but somehow forgot most of the rules. Even when holding the trump card of a reserve currency, mercantilistic domination depends on making something the rest of the world wants. We don’t and they do. The Chinese “object” has turned into an object lesson for developed economies that debt-financed consumerism is reaching an end. This affair then, which has sustained global growth during much of the 21st century, is vulnerable. Both parties still play kissy face and say “luv ya” (weak form for “I love you”) but there is tension there. China questions our credit quality and the yields on their trillion dollars of Treasury bonds. The U.S. questions their exchange rate and claims currency manipulation behind closed doors. This couple claims to still be dating, but “hooking up” may be more like it. Even then, no one stays the night, claiming they left their toothbrush at home.
Judge Judy’s Verdict
What to do when a love affair goes bad? How should you invest when Euroland is at each other’s throat, when a thinly disguised battle between labor and capital freezes policy action in the United States, when a mercantilistic partnership between developed and developing nations produces more questions than answers, more losers than winners? Increase the odds for a divorce, we’d suggest, which in investment markets means focusing on the return of your capital as opposed to the return onyour capital. Of the three rocky relationships, Euroland has the most immediacy. Mohamed El-Erian is increasingly of the persuasion that one or more of the outer periphery (Greece, Ireland and Portugal) may be forced to vacate the premises. If so, technically destabilizing liquidity concerns may affect all peripheral bond markets unless the ECB counters the rush for the exits with an enlarged daily checkbook.
In the U.S., strangely enough, matrimonial discord between rich and poor has led to lower, not higher, Treasury yields as approaching recessionary winds force the Fed and private investors to favor bonds. There are limits, however. Ten-year Treasuries at 2.25% are discounting a heap of trouble (none of it strangely enough due to its own credit standing), and neither investor nor borrower may emerge from this brouhaha unscathed. We prefer the “cleaner” dirty shirt countries of Canada, Australia, Mexico and Brazil, where higher yields and more pristine balance sheets prevail.
And what of China and its fling as mercantile dominatrix? Here to stay – get used to it, PIMCO would say, but at the same time a substantial currency revaluation would assist its image and economy in its new role as the global economy’s economic locomotive. Consider investing, therefore, in non-dollar currencies that have strong trade ties with the Asian continent. Global equities? They’re cheap – dividend yields are higher than bonds in many cases – yet if growth falters there may be more downside to come.
A good relationship, as any adult knows, takes hard work and even then true love never runs smooth. We are into the “bumpy journey” phase of our New Normal where fear, lack of policy options and loss of control can dominate relationships. At a minimum, investors need to prepare for disharmony even with the hope of eventual reconciliation. Those old-fashioned love songs have become new-fangled freshly entangled ones from which an escape may be hard to envision.
William H. Gross
Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission. | PIMCO Europe Ltd (Company No. 2604517), PIMCO Europe, Ltd Amsterdam Branch (Company No. 24319743), and PIMCO Europe Ltd- Italy (Company No. 07533910969) are authorised and regulated by the Financial Conduct Authority (25 The North Colonnade, Canary Wharf, London E14 5HS) in the UK. The Amsterdam and Italy Branches are additionally regulated by the AFM and CONSOB in accordance with Article 27 of the Italian Consolidated Financial Act, respectively. PIMCO Europe Ltd services and products are available only to professional clients as defined in the Financial Conduct Authority’s Handbook and are not available to individual investors, who should not rely on this communication. | PIMCO Deutschland GmbH(Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany) is authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The services and products provided by PIMCO Deutschland GmbH are available only to professional clients as defined in Section 31a para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2), Brandschenkestrasse 41, 8002 Zurich, Switzerland, Tel: + 41 44 512 49 10. The services and products provided by PIMCO Switzerland GmbH are not available to individual investors, who should not rely on this communication but contact their financial adviser. | PIMCO Asia Pte Ltd (8 Marina View, #30-01, Asia Square Tower 1, Singapore 018960, Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Asia Limited (Suite 2201, 22nd Floor, Two International Finance Centre, No. 8 Finance Street, Central, Hong Kong) is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246862 (PIMCO Australia) offers products and services to both wholesale and retail clients as defined in the Corporations Act 2001 (limited to general financial product advice in the case of retail clients). This communication is provided for general information only without taking into account the objectives, financial situation or needs of any particular investors. | PIMCO Japan Ltd (Toranomon Towers Office 18F, 4-1-28, Toranomon, Minato-ku, Tokyo, Japan 105-0001) Financial Instruments Business Registration Number is Director of Kanto Local Finance Bureau (Financial Instruments Firm) No.382. PIMCO Japan Ltd is a member of Japan Investment Advisers Association and The Investment Trusts Association, Japan. Investment management products and services offered by PIMCO Japan Ltd are offered only to persons within its respective jurisdiction, and are not available to persons where provision of such products or services is unauthorized. Valuations of assets will fluctuate based upon prices of securities and values of derivative transactions in the portfolio, market conditions, interest rates, and credit risk, among others. Investments in foreign currency denominated assets will be affected by foreign exchange rates. There is no guarantee that the principal amount of the investment will be preserved, or that a certain return will be realized; the investment could suffer a loss. All profits and losses incur to the investor. The amounts, maximum amounts and calculation methodologies of each type of fee and expense and their total amounts will vary depending on the investment strategy, the status of investment performance, period of management and outstanding balance of assets and thus such fees and expenses cannot be set forth herein. | PIMCO Canada Corp. (199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, ON, M5L 1G2) services and products may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. | PIMCO Latin America Edifício Internacional Rio Praia do Flamengo, 154 1° andar, Rio de Janeiro – RJ Brasil 22210-906.
Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk; investments may be worth more or less than the original cost when redeemed. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio.
This article contains the current opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.