Yes, we have a capital glut and no place to put it that will earn a reasonable return.
What's the limiting factor on investment? It's not capital; there's a glut of that. It's not land; outside a few big cities, there's plenty of space. It's not labor; there's no labor shortage. It's not management; there are lots of unemployed managers with good track records. It's not manufacturing capacity; there's plenty of idle capacity and more could easily be built if needed.
It's demand. We're out of demand. US workers are spent out and can't buy more. This stalls out the whole economy.
This is a new thing, historically. For most of history, the problem was making enough stuff. That's now a solved problem. In the developed world, just about anything you can consume can be delivered to your door within hours or days.
Market-based capitalism treats labor as a cost, not an output. (The measured output is return on investment.) As technology progresses, more work previously done by humans is done by machines. This reduces the relative value of labor.
But buying power comes from labor. As the buying value of labor declines (in the US, it peaked in 1973), the whole economy winds down.
We have no clue how to handle this.
An unanswered question: is there another stable point in this system? If wages were forced up above their economic value, by legislation, minimum wages, or unions, would overall economic output increase or decrease?
We do know how to increase aggregate demand. The formula:
D = C + I + G + NE
D = Demand
C = Consumer spending on private goods and services
I = Business investment in capital goods
G = Government expenditures on public goods & services
NE = Net exports (Exports - Imports)
Right now there is a huge economic opportunity to increase G due to historically low interest rates (cheap to raise debt) and stagnant wages (cheap labor). The economics are clear, but the way forward through fiscal policy roadblocks is not.
Doesn't have to be G. Couldn't business treat labor as a capital good, increasing I? (ala Henry Ford paying his workers more to reduce turnover... with the side benefit of them becoming wealthy enough to buy the cars, increasing C.)
Only if G isn't already overspent. In the US and several counties G is well over budget and has been for a long time. This combined with large liabilities coming down the pipeline and G should not be something we look to solve the issue.
Infrastructure spending in the US is backlogged for decades. Hard to argue we're overspending on that when we see a major bridge collapse disaster every 5 years.
Bring that schedule forward through issuing more debt at record-low interest rates, and bang, you've solved several problems at once. People have jobs, they spend money, that helps the economy, and we get the infrastructure out of it as well.
You'll even get some of that inflation that's been missing during the QE period, while all the fed economists looked at their macro textbooks in utter confusion.
For the reason you mention, there would be substantial upside from increased infrastructure spending & the timing is pretty close to optimal.
What's interesting is that through greasing the wheels of the economy via infrastructure investments (e.g. better broadband, connected/wired roadways, upgraded utilities and transportation hubs) you would see productivity gains which, over time, would further diminish the value of labor.
Have always been interested in how long-term goals of social/economic policy should influence short-term decision making, but there aren't any easy answers.
That is just a misallocation of funds, not a lack of budget. I think the federal government can find a way to fix bridges with a 4 Trillion dollar budget.
Calling it '4 trillion' is technically correct but I find that taking out the passthru social programs (SS, medicare, medicaid) leaves you with the real number of what's available to allocate differently. Hard to say that we could pay for something out of SS benefits while still collecting FICA tax, and if you want to eliminate the program entirely that's a different discussion.
> In the US and several counties G is well over budget and has been for a long time.
I don't agree. G has been reduced considerably recently. Under Bill Clinton, G was higher and the U.S. ran a budget surplus.
It's an old tactic: Cut taxes (now to historically low levels) and then say the country can't afford to pay for anything. The solution is to increase taxes. The U.S. economy is the largest in history (for the U.S. or any nation); the nation can afford more G than it ever could before.
All the money is concentrated in the hands of a few, but as long as they pay their share the federal budget, at least, shouldn't be a problem.
G is overspent. That does not necessarily mean the idea is wrong, however. What's missing is political will and trust.
The trust issue is like this: If we expand government to get the economy moving, then once demand picks up, we have to shrink the government back down. Do I trust Congress to do that? Absolutely not.
You are not getting very far with this equation. Returns on investment are mostly defined by the C/I relation (government spending can go on either side) (and yes, that is on average, and nominal), and this is the one that needs fixing.
I completely agree, this is a consumer economy that has been actively killing off consumer power and wondering why growth/demand is over.
When a company like Nabisco closes in Chicago and opens in Mexico for instance, yes the company saves money but Chicago loses millions and possibly billions in consumer power in the community. This is never factored in, loss of consuming power for a community/city.
There has been a slow drain winding down of consumer purchasing capability as you mentioned since the 70's. Eventually you use it all up and everything stagnates.
Wage stagnation has played a huge role, it has gotten much worse since 2000, even people moving up are finding it harder to buy as incomes have fallen while inflation/costs rise dramatically to make up for lack of consumer power [1].
Since 2000, the middle class has been shrinking for a decidedly more alarming reason: Incomes have fallen.
1968 was the peak in purchasing power for lower to middle class. This graph shows a lack of wage increases at the bottom and minimum wage[2]. That has also delayed trickle up wage increases above. This has also caused people to load up on debt to make up for their lack of purchasing power, furthering the problem.
Too much money is locked up in capital and investments that never re-enter the economy. This is bad for the rich and poor, locked up capital stays under lockdown during downturns. Lower and middle class have to spend during downturns. Recessions are worse when so much capital is locked up. This is leading to a 'lost generation' of consumers that can't consume or buy what they need or add to corporate profits from consuming [3].
"I completely agree, this is a consumer economy that has been actively killing off consumer power and wondering why growth/demand is over."
Thanks. I point out this occasionally. I don't claim to have an solution. But I think I've described the problem correctly. We have insane amounts of productive capacity compared to previous generations but that doesn't push up the standard of living by much.
Too much political economic talk starts with a desired solution and tries to justify it. That isn't working.
The original article looks at this from a finance perspective. Finance is supposed to be a service function, like water supply. It's not supposed to be in charge. Especially in a capital glut.
Sounds good in theory but the Internet and globalization show us that the rewards accrue to the most driven/funded competitor, with the reward essentially being a monopoly for the "market leader." So for a lot of businesses, that wouldn't work, especially when people choose to work long hours for high pay, which is common in finance.
> Sounds good in theory but the Internet and globalization show us that the rewards accrue to the most driven/funded competitor, with the reward essentially being a monopoly for the "market leader."
Ah, the lovely "dog eats dog" story… We're humans, though, we should do better than that.
Now in practice, the winner is the one who wield the bigger guns. Meaning, the US will put its army where the oil is, though not before having talked of weapons of mass destructions, a dictator, terrorists, or whatever.
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Globalization or not, machines are eating our work. A good thing if you ask me: we don't want more work, we want less. People who ask for work don't give a shit about spending all day doing a thankless job. What they really want is dignity (there is shame in unemployment) and money.
Now the lucky few that love their jobs… more power to them. The rest of us would rather work 3 days a week instead of 5 if it didn't mean losing so much of their income.
> for a lot of businesses, that wouldn't work, especially when people choose to work long hours for high pay, which is common in finance.
In finance, long hours are not exactly voluntary, they're expected. Moreover, you don't get the high pay right away, you have to "pay your dues" first —as if you owed you employer for the privilege of being hired.
Paying your dues is just the finance industry version of the "apprentice" phase in the traditional "novice, apprentice, journeyman, master" trade progression that has persisted in various forms for centuries now.
Apprenticeship is no reason to work insane hours, no matter the trade.
In French, "paying one's dues" spells "faire ses preuves", meaning, prove one's worth. That way no one is tricked into believing they owe anything to their employer. Sure, it's only an idiomatic phrasing, we don't think of the debt any more. Yet I'm sure it wasn't so at first, and I'm sure the idea lingers.
Like the Japanese saying "sumimasen" (forgive me, excuse me) to say "thank you" in some circumstances.
"the economy" predates human history. The ones who fight the best for resources gets them. We have only recently become more civilized where we don't have to literally fight for resources. But as long as there is human desire for status over other humans, there will be haves and have nots.
You are being overly reductionist. You are conflating "the economy" with economics. "The economy", the noun is very recent. Treating economic activity as an abstract system without its sociopolitical context, tacitly assuming that its telos is to grow and grow, this is all very new. Aristotle spoke of economy. Pundits today talk about the Economy. Job creators. Growth. It is a cargo cult.
Cooperation shapes and drives biology just as much as competition does. Civilization did not give us prosocial tendencies. The founding myth of civil government is exactly that. A myth. It is historical revisionism. It is reductionist. It is a mutilated view of people. Hobbes was wrong.
> But as long as there is human desire for status over other humans, there will be haves and have nots.
Honestly i am so tired of conversations that appeal to human nature as some immutable, invariant, unassailable truth. This isn't an argument, this is an assertion. Speak for yourself. If you desire status over other people, admit it. I find your characterization of the billions rest of us crude.
gravity existed long before we 'discovered' it. Trade and "the economy" existed long before we 'discovered' it too.
The economy is just as much about Cooperation as Competition. That's why we call it Free Trade.
> If you desire status over other people, admit it.
No, it's an observation of human behavior. When I see a large scale change in human behavior, I will change my opinion. What purpose do you debate on an internet forum that doesn't boil down to 'status seeking'. Think of all the the things we do all day that are essentially motivated by 'status seeking'.
The economy is not a thing that exists without society. Using it to refer to a specific object is at best a metaphorical shorthand for real phenomena or a dangerous fetishism. "Economy" is an ancient concept, perhaps one of the oldest human concepts. "The economy" is new. The way we use words changes, the way we use words is related to the way we understand the world. I really don't care what specifically you think the term "the economy" refers to in this context: I'm talking about the word, not the referent. I made an observation about a shift in the way we understand economy. Here: http://www.npr.org/sections/money/2014/02/28/283477546/the-i...
> No, it's an observation of human behavior. When I see a large scale change in human behavior, I will change my opinion. What purpose do you debate on an internet forum that doesn't boil down to 'status seeking'. Think of all the the things we do all day that are essentially motivated by 'status seeking'.
Um, do you honestly think i gain any status at all whatsoever with anyone because i argue on the Internet? Like, you have no idea what else could possibly be the result of conversation?
i don't think you have as deep an insight into human behavior as you think you do. You still haven't supported the assertion. Either your definition of status seeking renders the statement banal and vacuous, or incorrect. I'd like to hear what your definition is and your justification. What you see in human behavior isn't good enough: we see the same raw reality. We interpret it in different ways. Acting like your interpretation is just obvious doesn't cut it, especially when we're talking about the intentions of human beings. It is quite impossible to directly observe intention. It can only be interpreted from behavior.
For a while the lack of wages could be compensated with cheap consumer credits. I guess that's maxed out too.
I strongly believe that forcing wages up (within reason) would increase economic output. We certainly don't need to push more money to the top people like most republican candidates want to do. The money would "trickle up" because people would actually buy things and entrepreneurs could take advantage of that purchasing power.
Well there have been the studies showing that for every dollar given to the top quarter of society, the economy gets 75 cents of so. Where as for every dollar given to the bottom quarter the economy gets back 2, maybe 3 dollars.
So there is some argument for giving the bottom / poorest of people a simple basic income.
Great post, I agree. It's also interesting that the constant increase in demand leads to continuous and increasing destruction of the environment and consumption of natural resources. Perhaps less demand will be better in the long run. Can we reach a new healthier equilibrium without escelating social unrest?
Not necessarily. Aggregate demand grows the economy as a whole, and as it grows, more funding is available for innovations that solve today's problems in incredible ways.
Case in point: video rental. Netflix removed the necessity of physical stores, therefore less plastic being used to make boxes and vhs tapes and so on.
There is also a culture factor. The economy and the environment get along best when people live near the things they want. I live in a small city surrounded by nature and so many of our products can be locally sourced, sustainably.
This interesting! Never thought of it this way. Is there any kind of research showing that electric power to run the servers and hardware (which gets old and must be replaced) has a lower impact than boxes and vhs tapes?
Disagree on the land point - land in/near cities is immensely more valuable due to network effects, and land use restrictions create artificial scarcity there.
The solution is fairly straightforward: give people money so that the machines can work. Basically, buying power coming from labor is an arbitrary historical accident - mostly coming from the whole Protestant work ethic scene. If buying power instead comes from being a person, then the machines can make more material goods for us.
I would not say it's a new thing historically, this is why it's been important to have strong (decently large, and broadly spread throughout the economy and geographically) middle class. And that middle class has been squeezed. Poor people don't buy much stuff, and there aren't that many rich people.
My dad lived through the Great Depression. I remember that he talked about people carefully saving thread, not because thread was so expensive (or money so scarce), but because no new thread was being made, because the factories had shut down because the companies went broke. So I'm not sure I buy your interpretation.
He's been called the bond king and his old firm PIMCO was at one point the biggest bond trading firm in the world. Over the past 5 years PIMCO's sold volatility to the rest of hte world.
He was booted out of PIMCO a couple of years ago and he's had a really tough time getting his new fund at Janus going.
As you'll see from the PDF, he's a very eloquent writer and is always on TV as a markets expert.
Just keep in mind when reading that everyone who runs a fund is always talking their own book when they talk in public. He might be right with his pessimism but keep in mind that before he released this he has almost certainly put on a position that will be benefited by people reading his work and believing him.
Just keep in mind when reading that everyone who runs a fund is always talking their own book when they talk in public. He might be right with his pessimism but keep in mind that before he released this he has almost certainly put on a position that will be benefited by people reading his work and believing him.
Yes - he has two goals... The more people who pile in to his investments, the better the returns look. (Until everyone piles out at the same time) Also, he gets paid on Assets Under Management, so these documents are marketing to get more money to invest.
It's both. He wants people to invest in Janus, and he wants other large money managers to copy his idea with a slight lag. (Drive up the price of his positions after he's in, and leave slightly after he gets out)
The secret in a negative interest rate world that poses extraordinary
duration risk for AAA sovereign bonds is to (1) keep bond maturities short and (2) borrow at
those attractive yields in a mildly levered form that provides a yield (and expected return) of
5-6%. Janus unconstrained portfolios attempt to do that and are inching to the head of its
asset universe day by day. No guarantees. The advice about borrowing at low yields above
obviously has to be matched with investments that are less volatile and least affected by
the evolving changes of our monetary system. But it can be done. Closed end funds at deep
discounts, highly certain acquisition arbitrage stocks, as well as volatility sales at tails are
general examples.
Gross spends 5 pages exposing the flaws of the current financial/economic investing climate, then does a 180 and says the model is fine, and that Janus has some vague advantage in reliably finding a) discounts b) arbitrage and c) tail-end volatility - short term profit centers that all banks are searching frantically for right now.
Seems like a rather strange and disconcerting investment outlook, with Gross ultimately resigning to do his best within a broken system. Does not bode well as an outlook for actual reformation of the system or a call to action in this direction.
The idea of borrowing cheap in one place and investing for higher yield isn't new. Banks and investors borrowed German bonds to invest in Greek bonds, and investors borrowed in Japan to invest in Iceland. It works for a while until it doesn't. When you're levered the end goes from bad to worse, and usually has cyclical implications. (Forced sales to make margin calls depresses the stocks even more as people rush the exits)
Yes, I guess this was written to appeal to everyone who agrees that the finance/econ system is screwed. Gross is saying "I get it, I agree, no one understands this better than me," which differentiates him from a lot of other managers who like to reiterate that things are fine, don't take your money out of our funds, thank you.
An interesting but self-defeating ploy. If the system is set up to shrink/collapse, I'm not going to put my money into said system, even if you vaguely promise me 5-6% returns until collapse.
Not that my opinion matters as my net worth is marginal, and this outlook will probably get some of the doom and gloom crowd to sign up with his fund.
Funny how much of finance is marketing...how much of everything is marketing...
"Talking your book" == putting money where your mouth is. Bill Gross, especially when he was at PIMCO running the world's largest bond fund, had to invest in what he believed in. They couldn't market themselves out of a losing position.
I respectfully think you have it backwards. Generally financiers put their mouth where their money is, not the other way around. (They talk up where they are investing, not choosing to back their ideas up with investments) They're in the investment business, not the talking business. This isn't a comment on their ethics, just their incentives. Talking their book helps them in winning positions too - it can provide greater liquidity.
If it was positive NPV for them to keep quiet, every investor would.
Maybe if you're Bill Gross this is true, but the vast majority of fund managers never get on TV to talk their book in the first place. Just like (good) VCs have an investment thesis, most fund managers do too.
Going public can be a risky strategy. You only want to do it when you benefit from the exposure. You do it after you're already in the position and won't want to get more. (For instance, "I am long High Yield credit") If you're still accumulating something harder to access ("I'm buying Inverse Mortgages") then you don't want to be public. You also hold yourself up to be second-guessed. It's a tradeoff.
CNBC and Bloomberg TV are full of talking heads all day long, though they only scratch the surface on potential fund managers.
Seems like a rather strange business model: don't produce any actual good, but find enough pieces of paper that award enough numbers to sit back and collect short term profit.
The underpinning to this business model is to receive capital which governments decide must be expended to meet some goal -- be it GDP, exports, local currency exchange rate.
In other terms it could be viewed as arbitraging participants who don't care to participate in the market for a marketable good. For example, if Jet.com was selling an item at a fixed loss (to expand marketshare or hit some VC targeted numbers, etc) and you just kept buying that item and selling it at the market rate on another exchange.
The other piece to this is that one is not simply just sitting back and doing nothing but rather accumulating a lot of risk from other parties who do not wish to do so. In itself that is reasonable, but when the parties involved don't have the capital to cover losses should they appear, that is another issue.
I don't think a comparison with physical goods markets is applicable. Moving physical goods from market to market takes enormous work and space compared to the work and space needed to transmit some bits around to account for paper/electronic transactions.
Accumulating risk might be an apt description of the model. However, the risk is not isolated. Do we really want people not only sitting back, doing nothing, but actively accumulating risk? Sounds like a disaster waiting to happen.
When an involved party is a bank, they, by charter, will not have enough capital to survive some losses.
The recent collapse in worldwide bank stock prices can be
explained not so much by potential defaults in the energy/commodity complex, as by investor
recognition that banks are now not only being more tightly regulated, but that future ROE’s
will be much akin to a utility stock. Observe the collapse in bank stock prices ... Banking/finance seems to be either a screaming sector
ready to be bought or a permanently damaged victim of write-offs, tighter regulation and
significantly lower future margins. I’ll vote for the latter.
I don't want to make one paragraph representative of an industry, but it matches some other things I've read: He's omitting the massive fraud and incomptence by that sector - on an historic scale - which caused the largest economic calamity in several generations, the Great Recession of 2008 (and they and we were saved from a much worse calamity by central bankers and tax-payers). Yet he seems to forget that minor detail and calls the financial sector a "victim" and blames the regulation that will prevent another catastrophe!
It's as if the first catastrophe never happened. Perhaps that psychology, as much as anything, explains the financial sector's problems. You also see it when people in that industry complain about being 'demonized', as if they totally deny the reality for which they are criticized (and for which they've gotten off easy: bailed out by the taxpayers ad government, nobody in jail, few went out of business, and since then have returned to record profits while much of the economy stagnates).
In my first job in finance, I worked for a professor who was developing what at the time became the first model to accurately price bond options. As we visited potential clients, one of the common complaints from their quants was that the model allowed for the possibility of negative interest rates. Alas, that was back in the days of 10+% rates in the US so I guess negative rates seemed like a pretty remote chance.
My email is in my user details. I'd love to hear about the models you helped develop.
I wasn't in the industry in the 80's due to being way too young, but I've gone through the early work that was done in the early 80's on bond option pricing and some of the newer papers that have come out in the mid 2000's.
Would love it if you could point me to the research you worked on.
A few commenters are noting that Gross is just talking his book with this pessimistic outlook.
To be fair, he's had a consistently pessimistic long view over the years.
2010:
Several months ago I rhetorically asked whether it was possible to get out of debt crisis by increasing debt. Yes – was the answer, but it was a qualified yes. Given that initial conditions were favorable – relative low debt as a % of GDP, with the ability to produce low/negative short-term policy rates and constructively direct fiscal deficit spending towards growth positive investments – a country could escape a debt deflation by creating more debt. But those countries are few – the U.S. among perhaps a handful that have that privilege, and investors, including PIMCO, have strong doubts about U.S. fiscal deficits leading to strong future growth rates.
Bond yields and stock prices are resting on an artificial foundation of QE II credit that may or may not lead to a successful private market handoff and stability in currency and financial markets. 15% gratuities may lie ahead, but more than likely there is a negative two-bit or even eight-bit tip lying on the investment table. Like I did 45 years ago, PIMCO’s not sticking around to see the waitress’s reaction.
We are in a “New Normal” world where the negative effects of private sector deleveraging are only being weakly addressed by monetary and fiscal authorities. If so, then Treasury yields should stay low and my money market fund should continue to read “.01%.” The “cult” of equity – or better yet the cult of “total return” – for both bonds and stocks – is over, if that definition presumes a resumption of historical patterns anywhere close to double digits. The era of financial repression continues.
What if zero-bound interest rates define the end of a total return epoch that began in the 1970s, accelerated in 1981 and has come to a mathematical dead-end for bonds in 2012/2013 and commonsensically for other conjoined asset classes as well? What if a future epoch favors lower than index carry or continual bouts of 2008 Lehmanesque volatility, or encompasses a period of global geopolitical confrontation with a quest for scarce and scarcer resources such as oil, water, or simply food as suggested by Jeremy Grantham? What if the effects of global “climate change or perhaps aging demographics,” substantially alter the rather fertile petri dish of capitalistic expansion and endorsement? What if quantitative easing policies eventually collapse instead of elevate asset prices? What if there is a future that demands that an investor – a seemingly great investor – change course, or at least learn new tricks? Ah, now, that would be a test of greatness: the ability to adapt to a new epoch.
This is all ending. The successful portfolio manager for the next 35 years will be one that refocuses on the possibility of periodic negative annual returns and miniscule Sharpe ratios and who employs defensive choices that can be mildly levered to exceed cash returns, if only by 300 to 400 basis points....
I wish to still be active in say 2020 to see how this ends. As it is, in 2015, I merely have a sense of an ending, a secular bull market ending with a whimper, not a bang. But if so, like death, only the timing is in doubt. Because of this sense, however, I have unrest, increasingly a great unrest.
So now that the basic "obvious" assumption that interes rates are nonnegative (an assumption of every financial model until 3 years ago) has been proved wrong, we all cry "foul".
Just another finance "axiom" going burst because human beings are complicating things... Like in physics... oh, wait! It took 150 years to improve Newton (not precisely debunk him).
What's the limiting factor on investment? It's not capital; there's a glut of that. It's not land; outside a few big cities, there's plenty of space. It's not labor; there's no labor shortage. It's not management; there are lots of unemployed managers with good track records. It's not manufacturing capacity; there's plenty of idle capacity and more could easily be built if needed.
It's demand. We're out of demand. US workers are spent out and can't buy more. This stalls out the whole economy.
This is a new thing, historically. For most of history, the problem was making enough stuff. That's now a solved problem. In the developed world, just about anything you can consume can be delivered to your door within hours or days.
Market-based capitalism treats labor as a cost, not an output. (The measured output is return on investment.) As technology progresses, more work previously done by humans is done by machines. This reduces the relative value of labor.
But buying power comes from labor. As the buying value of labor declines (in the US, it peaked in 1973), the whole economy winds down.
We have no clue how to handle this.
An unanswered question: is there another stable point in this system? If wages were forced up above their economic value, by legislation, minimum wages, or unions, would overall economic output increase or decrease?