Bill Gross Warning in Outlook Great For Gold Bugs, Over the Next Decade

Bill Gross, a.k.a. ‘The Bond King,’ was very pessimistic in his monthly PIMCO outlook for October. What is so interesting is that he was actually far less negative than what I was expecting based upon his comments a month ago. Gross took a lot of heat on his “death of the cult of equities” feature even though he was right if you read the article rather than focused on his catchy headline.

We were expecting that Bill Gross would say in his PIMCO October investment outlook that the U.S. was on an immediate path toward the demise of the U.S. and hyperinflation hated by everyone but the most extreme of the gold bugs. That did not happen. Still, Gross was full of warnings that are coming up in the years ahead.

Mr. Gross keyed on studies from the CBO, IMF and BIS suggest that when you average out these studies the United States has to cut spending or raise taxes by 11% of GDP and rather quickly over the next five to 10 years. The real issue is that if the U.S. does not begin to close this gap, then the debt/GDP ratio will continue to rise and that the Federal Reserve would print money to pay for the deficiency. When that happens, Gross asserts that inflation would follow and the dollar would inevitably decline.

It is evident that Mr. Gross did not want to have to appear in the media for ten days or so defending his story because his comments are all farther out on the timeline and far less dire for anything in the immediate future. Here are some comments showing that the situation is bad, but where Mr. Gross decided to put off the most critical predictions and observations:

• Well, Armageddon is not around the corner. I don’t believe in the imminent demise of the U.S. economy and its financial markets. But I’m afraid for them.
• What they’re saying is that when it comes to debt and to the prospects for future debt, the U.S. is no “clean dirty shirt.” The U.S., in fact, is a serial offender, an addict whose habit extends beyond weed or cocaine and who frequently pleasures itself with budgetary crystal meth. Uncle Sam’s habit, say these respected agencies, will be a hard (and dangerous) one to break.
• The fiscal gap differs from the “deficit” in that it includes future estimated entitlements such as Social Security, Medicare and Medicaid which may not show up in current expenditures.
• What the updated IMF, CBO and BIS “Ring” concludes is that the U.S. balance sheet, its deficit (y-axis) and its “fiscal gap” (x-axis), is in flames and that its fire department is apparently asleep at the station house.
• Unless we begin to close this gap, then the inevitable result will be that our debt/GDP ratio will continue to rise, the Fed would print money to pay for the deficiency, inflation would follow and the dollar would inevitably decline. Bonds would be burned to a crisp and stocks would certainly be singed; only gold and real assets would thrive within the “Ring of Fire.”

Here is the graphic used by Bill Gross to describe the Ring of Fire. This is an average of the structural fiscal gap (percentage of GDP) projections given by PIMCO, IMF, BIS, and CBO as of July 2012.

FULL OCTOBER 2012 OUTLOOK

JON C. OGG