There are many voices that have criticized the actions of the United States Federal Reserve (Fed) in trying to contain inflation, and one of them has been that of the so-called “king of bonds”, Bill Gross, with whom we agree that if the central bank raises its reference rate to the level of 5% and more, there will be not only a hard, but a prolonged recession with high prices as the main characteristic.
The Fed’s bet is that if the cost of credit goes up, there will be less demand for products and prices will start to fall. The problem is that growth will also fall and there will be a consequent setback. And it will not be smooth or soft, but a “great recession”, as we have warned here.
Fed Chairman Jerome Powell has been applying the same tactics as his predecessor Paul Volcker in the late 1970s and early 1980s, but without taking into account the fact that the economy is much more leveraged. now (a euphemism to say that the debt is at unimaginable and unpayable levels), says Gross in an interview.
Unlike in Volcker’s time, the world economy today has had to deal with the recent troubles in the UK, the cracks in China’s property-based economy, war and freezing of natural gas in Europe, and a super-strong dollar accelerating inflation in emerging market economies.
If the Fed’s reference rate stops at 4.5%, a mild recession would be expected. However, any increase that takes the rate above 5% would trigger a severe global recession. We at Top Money Report believe that will be the case.
And it is that the real rates of the federal funds are already at approximately 2%, a level that –in previous economic cycles– has induced future recessions; That’s not to mention the inversion of the Treasury yield curve, which continues to worsen.
In the current cycle, however, financial and economic leverage is much higher than before the Great Recession, suggesting even lower performance, and that means the Fed has already gone too far, Gross argues, Well-known fund manager and co-founder of the Pacific Investment Management Company (PIMCO).
Hence, investors must prepare for a new era in investment in the world economy. Given such a scenario, the dollar in cash is one of the best “investment” options along with gold.
By the way, the king of metals has had a month of bullish “rally” that does not go unnoticed.
Gross’s critique is that the Fed “knows nothing,” drawing on the past few years’ experience of zero percent yields, relentless quantitative easing (“printing”), and expanding its balance sheet from $1 trillion to $8.7. trillions (millions of millions) of dollars.
But given that the US would be self-inflicting an economic slowdown, does it need a recession to be more financially efficient in the long run? Gross points out that a recession is required to increase unemployment and reduce the purchasing power of wagesa very high cost that will make people pay in the street for the errors of rulers and monetary authorities.
Cash (in dollars) is king
Regarding investment prospects, it is difficult to say that the current bond market is “oversold”, as a crisis like the one witnessed with cryptocurrencies or potentially with the devaluation of the Japanese yen would change things quickly.
So is this the best time to buy stocks or bonds? Neither, says Bill Gross, as cash is king. And we agree!
Hence the importance of the “carry” system, which is the difference in yield rates between short-term and long-term bonds.
If there is a positive carry, companies can borrow money at a low price, lend it at a higher rate and make a profit. On the contrary, if it is negative it makes them reluctant to lend, which weighs on economic growth.
Volcker conquered double-digit inflation in the 1980s by setting a negative carry of more than 500 basis points for three years, but he did so at the cost of a severe recession. That’s where we go.
Although the Fed may not “should” be so aggressive today, because the economy is significantly more leveraged and cannot handle the same amount of negative carry, we think it will make that serious mistake. Today, a broad negative carry may kill inflation, but it will do so at the cost of a global depression.
For investors, what that means is that They should NOT rush to buy risky assets too soon (such as stocks, stock indices, weak currencies, commodities, and of course cryptocurrencies), because the bearish wave would still be a long way from over. When everything goes down, “not losing” is synonymous with winning, and the safe bet is to look for safe haven assets (false like the dollar and real like gold).
Editor’s Note: This text belongs to our Opinion section and reflects only the author’s vision, not necessarily the High Level point of view.
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William Beard Master in Economics from the Austrian School; liberal, gold market specialist and editor of investment newsletter Top Money Report