In his January letter, entitled "Money for Nothing, Checks for Free," Gross tells investors to avoid long-term U.S. government debt, writing that "ultimately government financing schemes such as today’s QEs or England’s early 1700s South Sea Bubble end badly."
Gross takes aim at a speech given by now-Fed Chairman Ben Bernanke back in 2002, in which Bernanke says the Fed can increase the monetary base "at essentially no cost."
Gross says that Bernanke may have been referring to the fact that through quantitative easing, the Fed buys government bonds issued by the U.S. Treasury on the open market and then sends the interest income on its holdings back to the Treasury at the end of every year.
In other words, the Treasury can not only issue debt on the cheap right now due to very low interest rates, but it also makes back a lot of the interest it has to pay out on the debt it issues every year because the Fed, which owns a significant portion of the bonds that make up the Treasury market, sends those payments right back to the Treasury.
Gross writes (emphasis his): "When the Fed buys $1 trillion worth of Treasuries and mortgages annually, as it is now doing, it effectively is financing 80% of the deficit for free...This is about as good as it can get folks. Money for nothing. Debt for free."
However, Gross warns that inflation is the real "cost" of the Fed's easing, and investors should avoid long-dated U.S. Treasuries because of it (emphasis his):
While they are not likely to breathe fire in 2013, the inflationary dragons lurk in the “out” years towards which long-term bond yields are measured. You should avoid them and confine your maturities and bond durations to short/intermediate targets supported by Fed policies. ..Bernanke’s dreams of economic revival, which would then lead to the day that investors can earn higher returns, may be an unattainable theoretical hope, in contrast to a future reality. Japan we are not, nor is Euroland or the U.K. – just yet. But “costless” check writing does indeed have a cost and checks cannot perpetually be written for free.
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