Gundlach: Dollar Rally Coming

Lawrence Jones: Another area I want to touch upon, because it's something you've written quite a lot about and spoken about in the past, is the large, unfunded obligations that the U.S. government has in front of it. Both formally in a contractual basis through U.S. Treasury obligations, but also through policy prerogatives such as Medicare/Medicaid, Social Security, programs like this. Can you talk a little bit about some of your concerns and thoughts on the debt boom that we've seen at the governmental level?

Jeffrey Gundlach: Yeah, there's been a $7 trillion increase in various promises to pay at the federal level plus state-level over the past 12 months, and now it's up at $65 trillion pushing $70 trillion when you add it all up. Rough numbers, you have $10 trillion dollars of government bonds, you have $10 trillion of guarantees of state and local bonds, and then you have about $45 trillion of Medicare and Social Security.

Medicare and Social Security are going to go from a net inflow, which is still the case. In spite of how bad the deficit looks at the government level, we are still actually understating it, because we're taking the surplus from Social Security on an in-vs.-out calendar basis. That's going to flip over in probably four or five years or so. And when it does, it really blows the lid off of the deficit problem.

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So the real issue for investors to think about is, how are you going to pay $65 trillion going to $70 going to $80, on the baseline, of promises to pay, with a $14 trillion economy? One way to do it would be to actually pay it, which would mean to start running a government surplus. Think about that, taking a $1½ trillion dollar deficit, which is supporting GDP by about 10%, and turning that into $1½ trillion of savings, you would have a drop in GDP of 20%, there's no political wherewithal, or societal will for that.

So what you're left with is, you have to print the money to make these promises to pay honored, or else you have to default various ones of them. Most people think there will be a Social Security default, they don't call it default, they just say raising the eligibility age and things like that, but it's a default. People are promised that money, they've paid into the system, and they are expecting and counting on that money.

I think where we run into trouble is that part of the population needs that money and thinks that they're going to get it, and I think some slice there is going to be alarmed when they hear that they're not going to get it. That could lead to broader ideas of default to foreign creditors, by factoring them down.

We don't have to call it default, again, we can call it a maturity tax. Foreigners now have a maturity tax, so in essence they get factored down on their payments. All of these are forms of default. The other possibility, would be--the good one--would be that you would actually grow the economy enough, and have a moderate inflation rate, that would have enough job creation and business formation that would actually make it payable through economic growth and some moderate inflation.

To me, that's a possible outcome. Seems low probability, and even if you got there on an on-average way over 10 to 15 years, the volatility around that inflation rate would be very high and cause financial market disruptions.

The bottom line is, you have financial market disruption coming. Either through some high inflation rates, which I don't think are coming soon, but are a possibility if the government succumbs to the temptation to print money; or a very ugly disruption through partial defaults through the system; or else volatility around the very good case because you can't engineer this nirvana outcome of inflation and growth, you have so much volatility around it.

Because of all of this, I think we're looking at a turning point in markets in the very near term. I really think that the dollar is bottoming out and will start to rally. On the flipside, since we have basically all one market going on when the dollar goes up, stocks and credit go down and vice versa, I think we're going to see that continue in the credit markets and the equity market dropping with the dollar rally.

I know that's a strongly contrarian opinion, but I really am quite convinced that the dollar is imminently going to rally for us, in a significant way, in the intermediate term. Similar to what I said in March, this is going to be a rally that's too big to look through. I think we have a dollar rally coming that is too big for investors to look past and investors need to sell out of non-dollar currency investments in real time right now.

Jones: Thank you very much for giving us your thoughts, we always appreciate it.

Gundlach: Thanks, Larry, and good luck to you.

Jones: Thank you.