Olly, Olly Oxen Free——How Central Banks Will Destroy The Monetary System When They Own All The Debt

We were surprised to hear none other than legendary bond investor Bill Gross, who made billions going long bonds, admit to Bloomberg’s Erik Schatzker last night that he is starting to short credit, “a position that he said runs contrary to his instincts and training as an investor.

The reason why Gross, who called the Bund blow up last year with uncanny precision, is turning bearish on an asset classes that Mario Draghi is directly supporting – and as such Gross is fighting at least on Central Bank – is peculiar: he thinks the time of central bank dominance is almost over. Gross, who manages the $1.3 billion Janus Global Unconstrained Bond Fund, said he is moving to sell credit risk and insurance on market volatility rather than buying long-term debt, because he believes a day of reckoning will come when central banks will no longer be able to prop up asset prices and investors will withdraw from markets.

“It’s really hard to change your psychological makeup and to be a hedge manager that is comfortable with being short,” he said in an interview with Bloomberg’s Erik Schatzker. “I’m working on it, because I’m an investor that ultimately does believe in the system, but believes that the system itself is at risk.”

The underlying thesis behind Gross’ bearish take is simple: stimulus from central banks worldwide has artificially pushed up values of stocks and credit, which has made Gross cautious on such assets, he said.

Eliminating credit as an investment means “not buying stocks, not buying high-yield bonds.” Gross said. “It means going the other way, which comes at a price.”

Gross’ shift in position in odd because Janus’ unconstrained fund (up 2.6% YTD) which Gross co-manages with Kumar Palghat, invests in fixed-income and derivative instruments. It already has a rather low effective duration of 1.13 years, a short-term position that aims to reduce exposure to losses if rates rise. If Gross is indeed going net short, the duration will drop even further.

It’s becoming increasingly difficult for money managers to justify their fees or their jobs, Gross said. “I know that my investors want three, four, or five percent, or else they can keep it in the bank or stuff it in their mattress.” he said.

Which perhaps explains Gross’ transition to a Michael Burry-style investing mentality: betting on the “fat tail” event.

Gross also had some comments on Japan, and the entire central bank endgame.

He said that the only way for Japan to eventually cut its debt burden is for the central bank to acquire it and forgo repayment, a scenario that may play out in similar ways in other countries.

“I think that’s where they’re headed. I’m not endorsing that. I think at some point, Japan will basically buy up all its debt and the central bank will forgive the treasury and try to move forward with that. I see no other way out for Japan.

“Ultimately, they could own all the market,” he added during his Bloomberg interview. “At that point they could say to the fiscal side, ‘Olly olly oxen free. You don’t have to pay us back. Or we’ll extend your debt to 50 years with a zero percent coupon and at that point we’ll essentially eliminate the entire obligation.’”

Gross said such a move would have dramatic and damaging consequences for Japan’s currency, savings rate and private sector. Japan has unique demographic factors that exacerbate its economic dilemma, but other nations will face similar choices, he said.

He believes it is also the endgame.

“Japan’s a pretty good picture for the rest of the world, maybe five or 10 years ahead. I have a sense that that’s the route central banks will pursue. They’ll keep on buying debt, keep interest rates low and then ultimately the treasury doesn’t owe them anything.

What should central banks do?

Central banks, he said, need to start raising rates to restore the right incentives for investors. Gross said the Federal Reserve needs a leader similar to Paul Volcker, who raised interest rates in the 1980s despite popular opposition.


“We need another Volcker,” Gross said.

Unfortunately that won’t happen.