PIMCO's Bill Gross: "U.S. Treasuries Are One Giant PIK Bond"

Source: PIMCO
Bill Gross, co-founder of PIMCO and manager of the $260 billion PIMCO Total Return Fund, wrote in his July Investment Outlook that the global debt crisis, which is currently flaring up in the euro area, still hasn't been cured, and will eventually end up in the United States if debt/GDP and other government liabilities (some unfunded) keep trending higher. He provided a chart of U.S. Gross Federal Debt/GDP. And we have an economy that can't survive without stimulus, right? Markets will be interesting to watch during the fiscal cliff fiasco at the end of the year. Can't LIBOR fraud at the TBTF banks get us out of this mess?

"But when debt as a percentage of GDP, or debt service as a percentage of household income, or the appropriateness of the term structure (short vs. long) on both borrower and lender balance sheets becomes imbalanced, then the well-oiled capitalistic engine may sputter and in some cases – as in Greece – freeze up. That’s when a debt crisis can’t be cured with more debt, be it in the form of QEs or LTROs, or implicit firewalls created or to be created by Eurobonds, ESMs, the IMF or any other agency that presumably is money good. The fact is that the current burden of global debt is only being lightly alleviated via zero-bound interest rates. None of it, other than Greek PSI or minor amounts of private U.S. mortgage debt has been extinguished over the post-Lehman era; it has only been transferred from one pocket to another. Banks, insurance companies and mutual funds have passed the peripheral Old Maid from their hands to that of the ECB, or to Spanish and Italian banks, and ultimately on to the German core. Does it matter that Greece decides to stay with the Euro or that the Southern peripherals move towards austerity, or that the U.S. in November decides to go Red or Blue? Not much. Solutions for real growth matter only at the margin. An authentic debt crisis – which the world is now experiencing – can only be ultimately cured in two ways: 1) default on it, or 2) print more money in order to inflate it away. Both 1 and 2 are poison for bond and stock holders, which is why 7% returns – guaranteed or not – are so comical."

On U.S. Treasuries being one giant PIK bond:

"The chart below shows America’s debt/GDP which at close to 100% is not near-term threatening, but if continued upward on trend could be absolutely debilitating. 7-8% annual deficits while alleviated and tempered by the financing of them with negative real interest rates, promise to raise that 100% number to 125% within five years if nothing is done. Yet as stunning and as Greek-like as that percentage is, it comes nowhere close to the actual liabilities of the U.S. government that represent promises nearly as sacrosanct as the interest and principal on a 30-year Treasury. Social Security, Medicare and Medicaid liabilities when measured on the same present value basis as our current $15 trillion of outstanding debt, total four times as much: $66 trillion according to unbiased, non-political, Office of Management and Budget (OMB) estimates of future liabilities. In addition, studies estimated the unfunded liabilities of state and local governments at an additional $38 trillion. All together they would accelerate the line in chart 1 to 800% of GDP. And we look down on the Greeks?"

"Think of the U.S. balance sheet with its $66 trillion dollars of liabilities as one giant PIK bond – Payment In Kind. The corporate bond market has PIKs although they tend to be junk market rated. Instead of paying actual current interest they promise to pay future bills with more and more bonds – payment in kind. That’s what Social Security ($8 trillion) is; that’s what Medicare is ($23 trillion); and that’s essentially what Medicaid is ($35 trillion) although the latter is appropriated annually and therefore disguised as an actual debt. U.S. Treasuries are one giant PIK bond that can only partially be paid off under assumptions of Old Normal 3% real growth rates, or check writing by the Federal Reserve that inflates away the debt and a bondholder’s real principal at the same time."

Source: http://www.pimco.com/EN/Insights/Pages/Whats-In-A-Name.aspx
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