Gross: "Without QE From ECB And BOJ, The U.S. Economy Would Sink Into Recession"

Tyler Durden's picture

Back in November, when describing the perverse global fund flows in which record money creation out of the BOJ and ECB amounting to roughly $200 billion per month was being used indirectly, via spread differentials, to create demand for US Treasuries by foreign official and private investors - an observation first made by Deutsche Bank - we dubbed it "global helicopter money", and were surprised that "nobody has noticed" what is going on. Three months Bill Gross has made this phenomenon the topic of his latest letter titled "happiness runs" in which he writes that central banks remain stuck in a "QE-forever cycle", and explains that "a client asked me recently when the Fed or other central banks would ever be able to sell their assets back into the market. My answer was "NEVER". A $12 trillion global central bank balance sheet is PERMANENT - and growing at over $1 trillion a year, thanks to the ECB and the BOJ."

He then observes something we have pounded the table on repeatedly in recent years, namely that without the Trasury backstop bid from central banks, there would be a sharp sell off in rates, which would eventually catalyze a sharp contraction in financial conditions, leading to a recession, to wit:

A 2.45%, 10-year U.S.Treasury rests at 2.45% because the ECB and BOJ are buying $150 billion a month of their own bonds and much of that money then flows from 10 basis points JGB's and 45 basis point Bunds into 2.45% U.S. Treasuries. Without that financial methadone, both bond and stock markets worldwide would sink and produce a tantrum of significant proportions. I would venture a guess that without QE from the ECB and BOJ that 10-year U.S. Treasuries would rather quickly rise to 3.5% and the U.S. economy would sink into recession.

He calls this "global helicopter money" circular scheme "financial methadone", and writes that "the interest earned on the $12 trillion is already being flushed from central banks back to government fiscal authorities. One hand is paying the other. But the transfer in essence means that monetary and fiscal policies have joined hands and that the government, not the private sector, is financing its own spending."

This fusion of monetary and fiscal policy is the very definition of "helicopter money", however because it takes place at the global, and not national level, few are outraged.

Needless to say, in the long-run such an arrangement is unsustainable: "individual savers, pension funds, and insurance companies are now robbed of the ability to earn rates of return necessary to maintain long-term solvency. Financial Armageddon is postponed as consumption is brought forward and savings suppressed and deferred."

Gross' conclusion is that "for now, investors must go with, indeed embrace this financial methadone QE fix. Quantitative easing will continue even though the dose may be reduced in future years. But while a methadone habit is far better than a heroin fix, it has created and will continue to create an unhealthy capitalistic equilibrium that one day must be reckoned with."

Amusingly, despite the recent back and forth between Gross and Gundlach about bond "resistance levels", Gross is sticking with his bogey of 2.60% on the 10Y and said that "yields will likely gradually rise (watch 2.60% on the 10-year Treasury), yet they will stay artificially low due to the kindness of foreign central bank quantitative easing policies. But that is not a good thing. Happiness runs...Happiness runs, and so one day, will asset markets, artificially supported by quantitative easing."

The one thing we can add here is that while bond yields on the long-end may indeed spike, once the market appreciates the latest tightening "policy error", and prices in the latest deflationary outcome, long end yield will once again tumble, only this time the short-end will continue to rise on expectations of rising central bank rates, ultimately leading to the dreaded curve inversion, which will catalyze the outcome Gross fears: an economic recession.

His full note below.

Happiness Runs

Happiness is wanting what you have
And not wanting what you don't have.
— Shakyamuni Buddha, 500 B.C.

 

The three grand essentials of happiness are: something
To do, someone to love, and something to hope for.
— Alexander Chalmers

 

Happiness runs in a circular motion...
Happiness runs, happiness runs.
— Donovan, 1968

I think a lot about happiness - what makes a person happy, whether or not happiness should even be a life's priority - things like that. A good high school friend stunned me at the early age of 17 by suggesting we should not necessarily try to be happy. Sacrifice, service, devotion to a cause were higher orders, he felt, although presumably, since those were choices, their pursuit could secondarily lead to happiness.

Through the years I've accumulated a short list of quotes that express a personal view of what makes people happy. You, I'm sure, have your own candidates, but most of them probably resemble some of the ones listed above: Stay busy doing something you enjoy; be mindful of other people and the world in, around, and above you; don't let your reach exceed your grasp; find someone to share your happiness with. My favorite of all of these is the one above by Donovan - that somewhat kooky "love generation" folk singer of the late 1960s. "Happiness runs in a circular motion...happiness runs, happiness runs." There may be more to this refrain, however, than appears at first glance, the entirety of which I've tried to encapsulate artistically in my open-ended smiley face that wasn't ever-popular when Donovan crooned the tune. For years I thought that the gist of Donovan's phrase was the obvious - the "pay it forward" allusion that suggests what goes around, comes around - and it undoubtedly is. But there are hidden nuances, at least to me. The "running in a circular motion" also connotes a self-contained, inward-looking, self-satisfaction that equates happiness to being content with yourself as a person. And the last phrase - "happiness runs, happiness runs" may speak to the Buddhist philosophy of impermanence and the priority of the moment. Donovan might not rank up there with Kant and Spinoza, but his little song packs a powerful message. Rock on, flower child, wherever you are.

And while happiness may run in a circular motion, it seems history may too - or at least it may rhyme, as Mark Twain once said. Pictured below are two of my notes written not recently, but in 2003. They are as relevant today as they were then. "Financial repression" runs...in a circular motion, it seems. In 2003, though, central bankers had rarely contemplated the monetary policy instruments that could lower and then artificially cap interest rates. Although my notes correctly allude to "all means including 'ceilings' " to keep the cost of financing low, the expansion of central bank balance sheets from perhaps $2 trillion in 2003 to a now gargantuan $12 trillion at the end of 2016 is remarkable. Not only did central banks buy $10trillion of bonds, but they lowered policy rates to near 0% and in some cases, negative yields. All of this took place to save our "finance-based economy" and to raise asset prices upon which that model depends. As any investor would admit, these now ongoing policy panaceas have done just that - promoted higher asset prices and engendered a modicum of real growth. In the process however, as I have frequently written, capitalism has been distorted: savings/investment has been discouraged by yields/returns too low to replicate historic productivity gains; zombie corporations have been kept alive in contrast to Schumpeter's "creative destruction"; debt has continued to rise relative to GDP; the financial system has not been cleansed and restored to a balance where risk and reward are on a level plane; disequilibrium has replaced equilibrium, although it is difficult to recognize this economic phantom as long as volatility is contained.

But in order to control volatility, and keep a floor under asset prices, central bankers may be trapped in a QE-forever cycle, (in order to keep the global system functioning). Withdrawal of stimulus, as has happened with the Fed in the past few years, seemingly must be replaced by an increased flow of asset purchases (bonds and stocks) from other central banks, as shown in Chart I. A client asked me recently when the Fed or other central banks would ever be able to sell their assets back into the market. My answer was "NEVER". A $12 trillion global central bank balance sheet is PERMANENT - and growing at over $1 trillion a year, thanks to the ECB and the BOJ.

An investor must know that it is this money that now keeps the system functioning. Without it, even 0% policy rates are like methadone - cancelling the craving but not overcoming the addiction. The relevant point of all this for today's financial markets? A 2.45%, 10-year U.S.Treasury rests at 2.45% because the ECB and BOJ are buying $150 billion a month of their own bonds and much of that money then flows from 10 basis points JGB's and 45 basis point Bunds into 2.45% U.S. Treasuries. Without that financial methadone, both bond and stock markets worldwide would sink and produce a tantrum of significant proportions. I would venture a guess that without QE from the ECB and BOJ that 10-year U.S. Treasuries would rather quickly rise to 3.5% and the U.S. economy would sink into recession.

So what's wrong with financial methadone? What's wrong with a continuing program of QE's or even a rejuvenated U.S. QE if needed? Well conceptually at first blush, not much. The interest earned on the $12 trillion is already being flushed from central banks back to government fiscal authorities. One hand is paying the other. But the transfer in essence means that monetary and fiscal policies have joined hands and that the government, not the private sector, is financing its own spending. At an expanding margin, this allows the private sector to finance its own spending and fails to discriminate between risk and reward. $600 billion in the U.S. for instance goes into the repurchase of company stock, whereas before, investment in the real economy might have been a more lucrative choice. In addition, individual savers, pension funds, and insurance companies are now robbed of the ability to earn rates of return necessary to maintain long-term solvency. Financial Armageddon is postponed as consumption is brought forward and savings suppressed and deferred.

For now, investors must go with, indeed embrace this financial methadone QE fix. Quantitative easing will continue even though the dose may be reduced in future years. But while a methadone habit is far better than a heroin fix, it has created and will continue to create an unhealthy capitalistic equilibrium that one day must be reckoned with. Yields will likely gradually rise (watch 2.60% on the 10-year Treasury), yet they will stay artificially low due to the kindness of foreign central bank quantitative easing policies. But that is not a good thing. Happiness runs...Happiness runs, and so one day, will asset markets, artificially supported by quantitative easing.

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Muad'Grumps's picture

I think we are at the point where QE won't help. The real economy has divorced itself from the financial sphere. That's what Trump's rise signified. Faction B of the Deep State has gone its own way.

ArkansasAngie's picture

Yup because all the Euro banks would collapse.

Darktarra's picture

What they want and need is one of those good old fashion Global World Wars to iron things out! That is why they wanted Hillary i the White House! 

hotrod's picture

Stealth QE.  Monetizing the USA debt never stopped

Seasmoke's picture

I call it the biggest fraud in the history of man. 

gatorengineer's picture

well what happened 2000 years or so ago in the mid east was pretty special too.

King Tut's picture
King Tut (not verified) gatorengineer Feb 6, 2017 10:18 AM

jew?

29.5 hours's picture

Perhaps the central banks can find a way to eat, burn or disappear sovereign bonds. But what about other paper? The Fed alone has 2 Trillion in mortgage backed securities. Thirty-year stuff. That's a long time to hold the entire U.S. housing market in suspension. Won't work out, even on paper...

TheytookERjobs's picture

I'm happy with my silver, cryptocurrencies and hot Asian girlfriends

gatorengineer's picture

two out of three are imaginary... which two?

TheytookERjobs's picture

Definitely not the bitcoin or the Asian hookers.. I'm a young stud and I have watched 'The Secret' so there you go

gatorengineer's picture

Problem when you bang an an asian chick you are horny a half hour later

Secret Weapon's picture

I could never get used to the squeaking sound they make.    Kind of like having sex with Flipper.

Inzidious's picture

I kinda like it. Encourages me to go harder :)

GunnerySgtHartman's picture

Gross' conclusion is that "for now, investors must go with, indeed embrace this financial methadone QE fix.

Or investors could move into PMs.  Yeah, they may not provide immediate returns, but they will over the longer term - AND they are never worth zero.

FreeShitter's picture

We are already in a recession, w/o QE we would be in greatest of all depressions.

silverer's picture

If you adjust for inflation, it sure looks that way to me.

nati's picture

Don't worry, none of this will matter when the aliens emerge from their underground base in Antarctica. Just keep holding on until then.

wisebastard's picture

i guess way back in 2008 we could have had actual reform to the system......maybe instead of bombing mother fuckers in Iraq looking for WMDs we should have been focusing on the WMDs used on Wall St.....

wisebastard's picture

American Appearl just closed 110 stores so its to late for them to get a forien bailout.....but hey at least the US has not hit up the IMF so we can still drain some more forgien creditors and then go to the IMF before shit hits the fan again....

nmewn's picture

Because nothing says "Roaring Keynesian Ekonomeee!" like counterfeiting your own currency to buy into your own indebtedness! ;-)

new game's picture

circular flow at the top with trickle down in the form slave labor wages for 99 percent of usefull eaters.

 a system of control and power over almost everybody. throw in some propaganda for good measure.

orangegeek's picture

No mention of Chinese juan and China's own debt.

 

Chinese juan could devalue ( not tied to the USD, just a converting currency ) and that would be curtains for much of the global economy.

silverer's picture

"Monetary heroin" is a good description. I've heard it used a number of times.

Kina's picture

Yeh but they all have to keep pumping that water lesst the ship sink.

hotrod's picture

There was no taper just international QE5.

Sonny Brakes's picture

Reminds me of games we played as children. Anyone remember playing 'hot potato, pass it on', 'musical chairs', or 'kick the can'? What's different is that the people paying the price don't realise that they are paying the price. The taxpayer, feepayer, is such a good sport. It'll be a challenge trying to get people to defend their freedoms once their freedoms have all been taken away from them. Our individual economic freedom is a commodity that's been lost and will probably never be recovered. Can I get a witness?

new game's picture

yea, i see. all i can do is vote with my wallet, actions and not comform.

King Tut's picture
King Tut (not verified) Sonny Brakes Feb 6, 2017 10:22 AM

Who cares? But did you see that awesome Stupor Bowl, Bro, it's what all the sheep will be bleating about today!

geekz_rule's picture

9 fucking years later... and they still have their schemes to kick the imaginary can down the road. smh

it's got to end eventually... but jfc.. they gone on almost a decade past where most would have thought possible.

scorched earth, as I see it. as the nightfallen in suramar say.. "an illusion! what are you hiding.."

BlueHorseShoeLovesDT's picture

They are Keynesians they are going to kick the can until we are all dead.

BlueHorseShoeLovesDT's picture

Good chance Orange Julias Ceaser pumps the debt up tp 40 trillion.

gatorengineer's picture

The Trajectory from the Obowel movement will for sure get us to 30, that's if it doesn't crash first.

Yen Cross's picture

  I think Billy[IS] probably is correct>>>  Welcome back to reality Mr. Gross,

Secret Weapon's picture

Dear Bill, without the bull shit numbers and phony accounting gimmicks used by the Fed Gov.  you would see that we are in a depression.  Pull your head out of your ass. 

buzzsaw99's picture

that's why he gets paid the big bucks, because he knows shit the rest of us don't. /s

Sonny Brakes's picture

Didn't they crucify Enron, Arthur Anderson, and Bernie Madoff for these accounting practices?

BlueHorseShoeLovesDT's picture

We need moar war with things that begin in "I"

hotrod's picture

Kill all canaries. So nothing really changed regarding debt monetizaton yet gold and silver were slaughtered.

LawsofPhysics's picture

In real terms we are still in a depression...

"Mark to fantasy" accounting is still being used!!

PoasterToaster's picture
PoasterToaster (not verified) Feb 6, 2017 10:00 AM

The Statist, Corporate "economy" would sink.  The true economy of the people would rise from the ashes.

taketheredpill's picture

 

 

When QE1 ended in 2010 US 10 year rates fell -140 basis points.

 

When QE2 ended in 2011 US 10 year rates fell -80 basis points

 

ECB and BoJ were not in the market at that time.  Rates fell because QE ended and money ran way from risk assets into safety of Treasury debt.

 

 

orangegeek's picture

Your point is that QE ends, rates drop.

 

So where did the bid on bonds come from after QE-X?

 

Right - I don't know either.

The Most Interesting Frog in the World's picture

Correct, equities will tank as speculators move from equity to fixed income which will drive rates down.  I don't see any reason why the CB's have to or will reduce their balance sheets though.  Gross is probably right on that account, this might be permanent.

orangegeek's picture

central banksters buying up everything - any questions?

TK69's picture

incoherent. The author does not understand money. The banks are flushed with cash which is why interest rates are low:lack of demand by borrowers. It is the same reason why foreign govenments are buying there own bonds too:lack of demand. This is how world governments are keeping afloat. This is the reason for the financial crises:to support bloated governments around the world.

gator gatlin's picture

This accepted and repeated idea that QE caused the buyback craze is not really correct.  it merely reduced the cost thereof.  The real cause of the buyback craze is Eddie Lampert.  He perfected it, other corp execs and controlling investors, witnessed the results and just copied what they saw work for their own benefit.  (I'm not Eddie!)

Eagle40's picture

Gross is delusional. If we did not have QE we would go into recession. Shit, we have never recovered from the last recession-depression. We are in an employment depression. In the near future things are going to get worse as I believe we will enter a hyper inflation depression. We will default and the dollar destroyed. This is a debt/credit and currency collapse. However, I believe if there is anyone who can guide and lead us through this failed globalized experiment it is Trump. Trump will be fighting the globalist, Marxist, and Deep State thugs who have tried to destroy America.

Go Trump

Threnody's picture

Cowards don't face the music.   Cowards lie til the bitter end, always hoping they will out run reality, at least, themselves.