We are to the point of fearing fear itself. America in all its resplendent free market capitalistic glory is on the auction block with few bidders. How this came to be is obvious in retrospect: too much exuberant leverage, not enough regulation; too strong a belief in asset-based prosperity, too little common sense that prices could go down as well as up; excessive “me first” greed, too little concern for the burden of future generations; a political morass unworthy of our Founding Fathers. You may have more to add to the list, but frankly there isn’t enough time. Historians can sit back and reflect, but at this very moment, America is for sale and there is fear and trembling in the auctioneer’s voice.
...PIMCO’s Investment Committee to a man (no women yet) believes that capitalism is the best and most effective economic system ever devised, but it has a flaw: it is inherently unstable. Every economy, capitalist, socialist, or communist requires long-term capital assets to allow it to function: buildings, roads, factories, homes, all of which have expected lives of 30 years or more. A classic communist system would build these things and it would be done – no financing, no debt coming due, and no worries. Capitalism, however introduces an instability because it uses short-term profit maximization via the buying and selling of debt and equity that finance these same capital projects. Because capitalism has a dynamic of profit maximization at its core, companies and households take on more debt or less, issue more stock or less, and then trade these obligations amongst each other, creating the possibility of bubbles and bankruptcy, faux prosperity and instability.
...Future economic textbooks will likely teach that while capitalism is the most dynamic and productive system ever conceived, it is most efficient when there is a delicate balance between private incentive and government oversight (my italics). The benevolent fist of government will now join hands with Adam Smith in a most visible manner. Because it will, expect a lengthy recession but not depression, accelerating government deficits approaching a trillion dollars as forecast here in this Outlook several months ago, and the eventual rise of inflation and longer dated bond yields. For now however, it is best to focus on the potential unfreezing of commercial paper and a globally coordinated policy rate cut. Own the front ends of Treasury/LIBOR yield curves. Agency mortgage-backed securities will also benefit from Treasury buybacks. Stay liquid, remain in high quality.
-- October Newsletter