There have been a number of phrases that have grown out of our current economic malaise. The housing bust. Black Swans. The Mancession. Financial Contagion. The growth recession. QE2. But above all else the phrase that most people seem to agree has capture best the essence of the post financial crisis economy is “The New Normal.” Nonetheless, Bill Gross, the prominent bond fund manager who is credited with popularizing the phrase a little more than two years ago, says he may be done using the term. What phrase does Gross prefer to describe the current state of our money affairs? The Paranormal economy.
In a letter to investors that came out this week, Gross says we may be leaving The New Normal behind. Gross, who is the c0-chief investment officer and founder of money management firm PIMCO, credits the coining of the phrase to his colleague and PIMCO CEO Mohamed El-Erian. Gross says he used The New Normal to describe the deleveraging, i.e. getting rid of our debts, that needed to go on in the aftermath of the financial crisis, and everything that went with it. For consumers, money that was going toward buying a new car or second house was now going to be used to pay down debt. So more frugal customers. Banks would make fewer loans, and less profit, because no one was going to trust borrowers again. Houses would lose their value, due to a lack of mortgages and a pile up of foreclosures as borrowers walked away from their home loans. Renting, too, would become part of The New Normal.
It didn’t all play out as Gross expected. For example, he thought, as banks and investors lost faith in borrowers, interest rates for everyone, including the United States government, would go up. That didn’t happen. Instead, U.S. bond rates continued to fall, and so did mortgage rates. Gross’s bond portfolio suffered because of that bad call. No worry, that may all be over now. The bad news is what comes next might be worse.
So what makes Gross believe we are entering The Paranormal economy? Basically the fact that interest rates have remained low for such a long period of time, and it appears may stay that way for some time. And here comes the paranormal: Typically, low-interest rates spur more borrowing. But Gross says not so this time around. That’s because banks won’t want to make loans. Low-interest rates, not just for short-term loans but for ones that don’t have to be paid back for 5 or 10 years, will make lending unprofitable. It might make investing not all that attractive either. Why risk your money in the market when it’s not going to go anywhere.
Worse, Gross thinks all the central bank intervention, both here in the U.S. and in Europe, will soon cause inflation. The result may push consumers to ditch thrift and higher saving rates for a spend it while you have it attitude. That might turn out alright in the short-term, but Gross doesn’t think it will boost the economy for long. Gross says economies need lending to survive. And Gross ends the letter to his investors on a real downer: “The financial markets and global economies are at great risk.”
So how scared should we be? I’m not quite sure. First of all, at least so far, the things that the Federal Reserve have done to boost the economy – QE 1 and 2, the Twist – have done little to increase inflation. Here’s a great chart from Business Insider to prove that. Second, I think deleveraging may be over, or at least stalled. That seems particularly true in Europe where the rescue plan appears to involve more borrowing, not less. U.S. consumers, too, seem willing again to reach for their credit cards. (I’m not quite sure they ever really stopped.) Gross has been saying for sometime that the Fed’s policies were going to hurt the economy instead of help it. And this just seems like more of the same, just in a new scenario. So I guess when it comes to the paranormal economy, count me as a non-believer.