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Gross: Better Sovereign Debt Opportunities Outside U.S.

Eric Jacobson

Eric Jacobson: As you and your colleagues have talked for years and the market understands a lot a better now than they once did, I think a lot of that, that buying from Asia is mercantilist-based, as you said the recirculation of currency. There has been a lot of talk in the last year or two speculating what if this goes away? What if suddenly they have a large enough domestic market that they don't need to sell to us as much?

There has been very little, at least in the public sphere perhaps more so in the institutional world, there's a lot less understanding and discussion of what the pace of that might look like. I'm wondering if you have a view that you could share in terms of how either concerned or not concerned you are about the pace of those changes over the next several years and what it might mean for less demand for U.S.-dollar assets.

Bill Gross: I think ultimately the market has to be concerned about the gradual disappearance of the Chinese and others. Actually China hasn't been buying very many Treasuries in the last 12 months, and the pace has been picked up by Japan and some other countries. So the circumstance that you cite in terms of the internal growth of China and perhaps using money for internal development as opposed to purchasing U.S. Treasuries I think is a legitimate concern. 

The Chinese must know that they are artificially suppressing yields and that at some point their trillion dollars' worth of Treasuries that they own are vulnerable from a price standpoint. And so we have a situation much like quantitative easing with the Fed. Not only might we reach a point where the Chinese don't buy as much or, at some point stop buying, but the trillion dollars that they own might be up for sale much like the Fed might be selling their Treasuries over the next several years.

So we've sort have been in a sweet spot here in terms of demand from central banks foreign and central banks domestic, both of which have beginning to express a lack of enthusiasm going forward. And that might mean higher real interest rates and higher nominal interest rates depending upon the outlook for inflation, which itself is sort of moving higher.

Jacobson: So in terms of framing the time span on the China/non-U.S. acquisition of those assets, how much of that risk is a big part of your current thinking, your current positioning and so forth, and how its affecting what you are doing today versus how much of it is something you are monitoring for the next few years?

Gross: I think it's a monitoring situation. I mean, we have no inside connection to the Chinese and rarely do they discuss their intentions. Going forward we only have a presumption over the next three to five years that at the margin the situation will continue to change for the negative. But it's not a current determining factor.

What it really is, Eric, is the fact that in many cases--and starting with the Treasury market with the federal-funds rate at 25 basis points--that bond investors, depositors, and savers are not being rewarded relative to historical terms. I mean, historically a saver over the past century in the United States and the U.K. globally in developed financial markets has been able to earn 1% more than the inflation rate by putting their money in the bank. I mean it's been an incentive to save; yes, you do receive something relative to inflation.

Today, obviously with money market funds at 25 basis points or less--and as I said at the fed-funds level at the same rate and inflation at 2 to 2.5 and moving higher--the savers are getting pick-pocketed as I express it by 2% and in some cases 3%. So, it's a huge reversal, and you start from that valuation point and then you can move to two-year Treasuries and five-year Treasuries and it becomes a little more difficult because obviously the yields are higher but the risk is greater, too. In any context, the valuation of nonrisk, pure-duration investments as typified by Treasuries is historically at a very low level. And so PIMCO has chosen not to play that game and to basically move money into countries like Canada and like Mexico to cite North American examples or to Germany or to Brazil.

In all cases these are countries with much more pristine balance sheets and lower deficits than the United States and higher yields. So, on a globalized type of market and with no intention to the negative toward the United States as a credit--the United States is AAA credit; the United States will not default, that's unthinkable--there are simply more attractive sovereign alternatives with better balance sheets and higher yields. So, we move money there as opposed to here.