A whale in the waters of negative yields - FT.

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Last updated: May 14, 2012 6:34 pm

A w hal ei nt he w at ers ofnegat i ve yi el ds

By Bill Gross

I n nat ure,t he m i ght y w hal e depends upon t he l ow l y pl ankt on f or i t s survi valand t he sam e anal ogy ri ght l y appl i es t o gl obal devel oped econom i es,w hi ch have dom i nat ed t rade and f i nance att he expense ofdevel opi ng nat i ons.N ow t he t i des m ay be t urni ng as once m i nuscul e gl obaleconom i es f i nd t hem sel ves i n possessi on ofa pl et hora ofreserves.The hunt ed m ay be t urni ng i nt ot he hunt er and t he gl obalm onet ary syst em ,w hi ch has evol ved and m orphed over t he pastcent ury butal w ays i nt he di rect i on of easi er,cheaper and m ore abundantcredi tm ay have reached a poi ntatw hi ch i tcan no l onger operat ei nt he sam e w ay.M aj or changes t o our gl obalm onet ary syst em m ay l i e on a vi si bl e hori zon. The st ruggl e bet w een f i nanci alw hal es and pl ankt on pow erf ulreservel adened credi t ors and m uch w eaker debt l adened borrow ersi s si gni f i cant l y dependenton t he successf ulf unct i oni ng ofhow t he ary syst em ) .H i st ori cal l y,severaldi f f erentsyst em s have been em pl oyed but w orl d conduct s and pays f or com m erce ( our gl obalm onet t hey have ei t her been com m odi t ybased syst em s gol d and si l ver pri m ari l y or a f i atsyst em paper m oney.Af t er rej ect i ng t he gol d st andard atBret t on W oods i n 1944,devel oped nat i ons accept ed a hybri d based on dol l ar convert i bi l i t y and t he f i xi ng ofgol d at$35 per ounce. W hen t hatw as overw hel m ed by U S f i scaldef i ci t s and dol l ar pri nt i ng i nt he l at e 1960s,Presi dentN i xon ushered i n a rat her l oosel y i dat ed good def i ned syst em t hatw as st i l ldol l ardependentf or t rade and m onet ary t ransact i ons butrel i ed on t he consol behavi our ofG 7 cent ralbanks t o pri ntm oney parsi m oni ousl y and t ot argeti nf l at i on cl ose t o 2 per cent . H eart ened by PaulVol cker i n 1979,m arket s and econom i es gradual l y accept ed t hi si m pl i ci tprom i se and gl obalcredi tm arket s and ng up t onnes ofdebt rel at ed pl ankt on as t hey m at ured.The gl obalm onet ary syst em t hei r econom i es grew l i ke baby w hal es,sw al l ow i seem ed t o be w orki ng sm oot hl y,and i nst ead ofSham u,i tw as l abel l ed t he greatm oderat i on . Funct i oni ng yes,butperhaps notso m oderat el y or sm oot hl y especi al l y si nce 2008.Pol i cy responses by f i scaland m onet ary hori t i es have m anaged t o preventsubst ant i alhai rcut t i ng oft he $200t n or so off i nanci alasset st hatcom pri se our gl obalm onet ary aut syst em ,yeti nt he process have i ncreased t he ri sk and l ow ered t he yi el d ofsoverei gn securi t i es w hi ch representi t s core. i os i n previ ousl y sacrosanctt ri pl e A count ri es have m ade f undi ng i ncreasi ngl yaf unct i on Soari ng debtt o gross dom est i c productrat ofcent ralbanks as opposed t o pri vat e m arketi nvest ors.Q uant i t at i ve easi ng and l ongert erm ref i nanci ng operat i onst ot al l i ng ut ure ret urns have pl unged,present i ng not t ri l l i ons have been publ i cl y spaw ned i n recentyears.I nt he process,how ever,yi el ds and f a w arm Paci f i c O cean ofposi t i ve reali nt erestrat es,buta f ri gi d,Arct i ci cel adened sea ofnom i nalyi el ds w hen com pared w i t ht hose 2 per centi nf l at i on t arget s ofpri or decades.
Yields and future returns have plunged, presenting a frigid, Arctic ice-ladened sea of nominal yields

ousl y sacrosanctdebtt heref ore representa pot ent i al Bot ht he l ow erqual i t y and l ow er yi el ds ofprevi breaki ng poi nti n our now 40yearol d gl obalm onet ary syst em .N ei t her condi t i on w as consi dered probabl e as recent l y as f i ve years ago.N ow ,how ever,w i t h even t he U S suf f eri ng a credi tdow ngrade t o AA+ and of f eri ng negat i ve 200 basi s poi ntpol i cy rat es f or t he pri vi l ege ofi nvest i ng i n Treasury bi l l s,t he wi l l i ngness ofcredi t ors as opposed t o debt ors t o supportt he exi st i ng syst em m ay soon f ade.

W hi l e al lm onet ary syst em s are a st ruggl e bet w een debt ors and credi t ors,i ti s usual l y credi t or nat i ons t hat sh t he rul es f or t ransi t i ons t o new regi m es.Such w as t he case i nt he l at e 1960s as France t hreat ened t o em pt y FortKnox unl ess est abl i a new st andard w as i m posed.N ow ,w i t h dol l ar reserves w i del y di spersed i n Chi na,Japan,Brazi land ot her surpl us nat i ons,i ti sf ai r t o assum e t hatt here w i l lcom e a poi ntw here 2 per centnegat i ve reali nt erestrat es f ai lt o com pensat ef or t he advant ages heret of ore gai ned i n buyi ng soverei gn bonds. There i st he pot ent i alf or bot h publ i c and pri vat e m arketcredi t ors t o ef f ecta change i n how credi ti sf unded and di spersed our hatw i l ll ook l i ke i s a conj ect ure,buti ti sl i kel yt o be m ore hard m oney as opposed t of i at based,or i f gl obalm onet ary syst em .W hatt st i l lf i atcent ri c,l ess ori ent ed t o a dol l arbased reserve currency. i cy evol ut i ons i n eurol and w hi ch f orm t he basi s The w orl d s f i nanci alm arket s seem obsessed w i t h dai l y m onet ary and f i scalpol f or ri sk on/ri sk of fdays i nt he m arket pl ace and t he overal lsuccessf uldepl oym entofcarry st rat egi es so i m port antt o assetm arket t ot alret urns.Eurol and i sj usta l ocal i sed t um our,how ever.The devel opi ng credi tcancer m ay be m et ast asi sed,and t he gl obal m onet ary syst em f at al l yf l aw ed by i ncreasi ngl y ri sky and unaccept abl yl ow yi el ds,produced by t he debtcri si s and pol i cy responses t o i t .The greatw hi t e w hal el i es on t he hori zon.I nvest ors shoul d sai lcaref ul l y. Bill Gross is founder and co-chief investment officer of Pimco

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17/05/2012