Thursday, April 27, 2006

Is GM the canary in the economic coal mine?

Excellent article from Bill Gross, head of PIMCO compares the fate of the GM with that of the US economy.

"How are we to pay for this future burden of healthcare and social security expenses? Aside from contractual legislative changes to both areas (which are surely just around the corner), the way a reserve currency nation gets out from under the burden of excessive liabilities is to inflate, devalue, and tax."

"Another way the U.S. could escape the burden of its future liabilities is to “grow” its way out, much in the same manner GM is attempting to make its models more attractive and relevant to current car buyers. We could do that by accelerating relative productivity gains, by emphasizing innovation, and upscaling education. Other nations however, understand the same rules and it will be difficult to “grow” assets and/or reduce liabilities via increased savings if we have a reduced “product line.” With our manufacturing and service base being increasingly hollowed out by foreign competitors, the primary export we have that can be made more attractive are our Treasury bonds in the form of higher relative yields. It will be an easier task, in fact for GM to renovate its product line than for the U.S. to revamp its. "

"Owners of these liabilities (either existing/future debt holders, or tax paying corporations/citizens) will likely be the sacrificial lambs of the future. Investors, therefore, should factor in an increasing propensity for higher inflation in future years as debt principal is eroded much like the shaved edges of a Roman coin. Higher taxes, as well, are just around the corner. Finally, currency devaluation effected through a low Fed Funds policy vs. competitor nations and/or global policy coordination should apply the coup de grace for foreign holders of U.S. liabilities. Chinese, Japanese, OPEC, and other substantive holders of U.S. Treasuries will have two ways to lose in future years: they will watch U.S. inflation erode their principal and on top of that the real dollar value of their global purchasing power will decline as the dollar sinks. Actually, the same applies to U.S. citizens although the decline in global purchasing power can be masked by domestic asset appreciation in the short-term (houses, stocks)."

"If the U.S. chooses to pursue many or most of the above policies, the investment implications are significant, although it must be recognized that I am not speaking to “overnight” developments but instead to changes that should occur in future years. Higher inflation, higher personal and corporate taxes, and a lower dollar point U.S. and global investors away from U.S. assets and toward more competitive economies less burdened by health and pension liabilities – those personified by higher savings rates and investment as a percentage of GDP. Need I say more than to sell U.S. assets and buy Asian ones denominated in their local currencies; or if necessary to hire a global asset manager with sufficient flexibility and proper foresight to thrive in an increasing difficult investment environment?"

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