Monday, February 25, 2008

Bill Gross Channels Keynes

I have often commented here about Bill Gross' penchant for talking his book. Gross is the biggest bond manager on the planet and always seems to find a way to make his economic outlook favor the bonds he owns. Perpetually bullish is an understatement. In his latest Outlook, Gross seems to have lost his mind (and his copy of The Road to Serfdom) in praising Paul Krugman:

Economists, TV talking heads, (and yours truly) can be early or late to a party as well. I marvel at the seemingly countless number of "celebrity" experts espousing the continuation or even extension of wealthy tax cut, supply side, freer regulatory policies that have lost not only their potency but their constituency as we turn the corner into 2008. Describing these pundits as being "late" in recognizing the increasing threats that their laissez-faire ideology poses to the U.S. economy, would be more than generous. "Never" is more likely the reality. One economist, however, who while early is more than likely to guide future policy solutions is Paul Krugman, op-ed columnist for The New York Times. Long before he accepted his current assignment at the Times he was a world-respected economist at MIT, proposing revolutionary solutions for the Japanese recessionary malaise of the 1990s and writing a book in 1998 entitled The Return of Depression Economics. While his book’s title features the "D" word, the content proposed nothing of the sort, but simply referred to the fact that the crucial task of future policy would be to bolster demand as was the case in the FDR-driven 1930s as opposed to encourage supply which has been the case since the Reagan revolution. Although Krugman doesn’t comment, in my opinion, it’s not that Reagan was wrong – he was in fact brilliantly correct and timely in his supply-side revolution.


This is truly depressing stuff. What Gross advocates here are the very policies that produced the Great Depression:

The U.S. needs a Krugman "demand-based" fiscal package alright, but a $300-$500 billion permanent one, in addition to the proposed temporary package, because as mentioned in last month’s Outlook, as the system of modern day levered shadow finance slows to a crawl or even contracts at the edges, its ability to systemically fertilize economic growth must be called into question. But government writing checks for American consumers which then flow to foreign central banks is not the permanent solution; it only makes sense in the short-term as a life preserver. To provide a stable recovery path, government spending needs to fill the gap – not consumption. Public works programs, badly needed infrastructure repairs, as well as spending on research and development projects should form the heart of our path to recovery. Assistance for homeowners? That too – figure out a fiscal/regulatory way to stop the slide in housing prices and foreclosures but please – no traffic jams at the Wal-Mart checkout counter in 2009 and beyond.


These are also the same policies that produced a 15 year stagnation of the Japanese economy after their experience with bubble bursting.

Gross realizes the problem is one of monetary policy:

That pendulum, however, appears to have swung too far in the direction of the private market. But Krugman (and yours truly) was a tad early in his forecast for reversal I think, because of the failure to recognize the potency and the inventiveness of modern finance. Until recently, U.S. and therefore global demand has been driven by the ability to lower interest rates and extend credit to an increasing majority of Americans. Mortgages, auto finance, and credit cards were offered on increasingly liberal terms and continually lower yield and risk spreads because of Wall Street ingenuity and – importantly – the na├»ve endorsement of their black magic by rating services willing to sell AAAs for a fee. If you’re offered a new home with nothing down and nothing to lose, you’d take it and many Americans did. If you’re offered a new car with 0% financing for 5 years, you’d buy it and many Americans still do. Demand, as Krugman would likely retrospectively recognize, was bolstered and supported by innovative, securitized finance which in turn was nurtured by lax regulation and a belief that things could not go wrong – and if they did – that policy makers, both monetarily and fiscally oriented, would make things right. The repair, if needed, was labeled the "Keynesian compact" and it made for a deal with the American public: it would be OK to have free markets because policymakers know enough to prevent another Great Depression. Demand could always be stimulated with a combination of easy money/budget deficits. Prosperity in effect, was guaranteed.


The logical response to bad monetary policy should not be to compound the problem with bad fiscal policy. Gross falls back on the discredited policies of Keynes:

As Keynes theorized and then Krugman affirmed, when private demand falters, it becomes the responsibility of government to fill the breach. Because it likely will not do so effectively until after a new Administration is elected in late 2008, the U.S. economy and its somewhat coupled global companion will sleep walk for some time and a resumption of prosperity as we knew it will be dependent on reforms of monetary and fiscal policy resembling the 1930s more than our past decade. Better late than never.


I hope he's wrong. It was those policies, more than anything else, that prolonged the downturn that became the Great Depression. All we need is a modern version of Smoot-Hawley and we can get an exact replay. Gross even plays in that sandbox for a while but stops short of calling for import restrictions:

Some have even suggested – and with my somewhat grudging concession – that this package will help the Chinese economy more than ours. Americans will use the rebates to buy Chinese imports offered at Wal-Mart and the $150 billion will then wind its way inevitably back to Asian coffers....But government writing checks for American consumers which then flow to foreign central banks is not the permanent solution; it only makes sense in the short-term as a life preserver.


I have little respect left for Bill Gross and it is less today than yesterday.

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