Investment Outlook
Bill Gross | July 2008
Thought I would jot down this little note to President Obama.
It’s a little presumptive of course; first that he’ll even be President (he will)
and second that he’d read it (he won’t). But presumptiveness is an inherent
requirement of an investment manager and so I shall proceed.
Dear President Obama:You have inherited a mess. Your predecessor, fixated on emulating a former Republican icon from a far different economic era, chose to emphasize tax cuts for the rich and excessive consumption for all Americans. He promoted deregulation and free markets when, in fact, the markets and their institutions needed tough love. Over eight years, he failed to put forth a coherent energy policy. He needlessly invaded Iraq and lowered worldwide esteem for this nation as a symbol of freedom and benevolence.
But enough about W’s spilt milk. I’ve already ticked off so many readers that they’re questioning my Republican Party voter registration. What do I think you should do as the new President to rectify this mess? All I know is that any solution will come with a high price tag. Although your campaign slogan says “Yes we can,” I have my doubts. Granted, you’re going to raise tax rates on the rich, give a break to the lower/middle class and rebalance the scales of economic justice somewhat. I myself won’t enjoy paying that near 50 percent marginal tax rate after you remove the current cap on the payroll tax, but my wealthy neighbors and I in Newport Beach should just look at it this way: we’ve had an eight-year lease extension on the “high life.” Now it’s time to give something back and I suspect we won’t be working any less hard. That ol’ Laffer Curve has a certain logic to it, but it only makes sense at the upper margin. People did work less at confiscatory tax rates imposed pre-Thatcher/Reagan but once they got down to 50 percent or lower, it was all gravy – promoting conspicuous consumption as opposed to higher productivity and overtime at the office. Gosh, now we don’t even want those oversized trophy houses! The New York Times reports that the high-profile crowd now favors small ecologically certified “LEED” houses – “Leadership in Energy and Environmental Design.” My, what green eyes we have, Grandma! Anyway, so you’re gonna do the tax thing, Mr. President, and throw in some form of universal healthcare to boot that your buddy Hillary will help spearhead. You hope you can get a lot of this passed despite a potentially long string of filibusters from a Senate that won’t quite have sixty Democrats. In addition, you’ll need to provide some immediate relief to homeowners in the form of FHA (Federal Housing Administration) subsidies and low mortgage rate loans that somehow have been studied and studied in Congress for the past six months yet still haven’t been passed into law. By January, home prices will be down another 10 percent or so and our Japanese-style property deflation will be in full stride. Congress will have had its summer recess though and spent September and October on the campaign trail. They had to get re-elected you know, so those homeowners just had to wait.
But you’ll have your tax bill and your healthcare bill and your housing fix, and somehow it’ll all be paid for by wealthy hedge fund managers, oil companies or, pray tell, a robust economy that’s creating good jobs at home instead of exporting them abroad. Uh, I don’t think so, Mr. President. That’s where the “yes we can” morphs into “no we can’t.” Not that you won’t accomplish most of that – the robust economy and the good jobs notwithstanding. It’s just that you won’t be able to pay for it and it’s better to admit it now as opposed to later. No David Stockman confessions in your administration. You’re smarter than Ronald Reagan and too nice of a guy to distort reality like King George. So let’s start out by dropping all of that “budget neutral” rhetoric and admit where we’re headed. Your administration will produce this nation’s first trillion dollar deficit!
While the Republicans will blame you for years and label you “Trillion Dollar Obama” in future campaigns, there is in fact not much that you or any other President can do. You’ve inherited an asset-based economy whose well has been pumped nearly dry with lower and lower interest rates and lender of last resort liquidity provisions that have managed to support Ponzi-style prosperity in recent years. Foreign lenders have cooperated by purchasing Treasuries at yields which when combined with dollar depreciation have resulted in negative returns on their money. Even if these charades continue (and they may not), their stimulative effects – their magical powers to transform a 110-pound weakling into a Charles Atlas/Arnold Schwarzenegger mensch of an economy – are gone. What you need now is fiscal spending and lots of it. No ordinary Starbucks will do, Mr. President, you need to step up for a six-pack of Red Bull.
Now I know, Mr. President, that you’re already addicted to those nicotine smokes and I’m not trying to promote a caffeine habit here, but this economy will need an additional jolt of $500 billion or so of government spending real quick. It must replace both reduced residential investment and consumption whose decline has placed the U.S. economy near, if not in a recession. Some quick math for you Sir: gross private domestic investment (machines, houses, inventories) has declined by $200 billion since its peak in late 2006. Due to higher unemployment and energy costs, domestic consumption will soon be $300 billion less than it should be if we are to return to historical economic growth rates. According to that old C + I + G formula (scratch the trade deficit for now) when C + I is reduced by $500 billion, then G should increase by that amount in order to fill the gap. The G, Sir, is you – the government deficit, the fiscal stabilizer popularized by Keynes following the Depression. And since the fiscal deficit for 2008 is likely to press $500 billion even before you take the oath of office, well there you have it: $500 billion + $500 billion = $1 trillion big ones, probably by sometime in 2011 or so. It takes time to spend those types of bucks.
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