by Richard Newell
“The global story is about Asian supply and US demand. In the US we have seen an explosion of debt and an increasing reliance on China and Japan to fund our budget deficit.”
The key players are China, Japan and the US consumer. Each is operating in their own self-interest, says Hodge. “In the case of Japan, they want to retain export strength and keep their currency cheap, while the Chinese want to keep jobs growth high and wages low. China represents only 5% of world GDP but accounts for 13% of world GDP growth. It is a huge importer of commodities, oil and iron ore. And currently, with industrial output at record levels, it is showing signs of overheating. The rising cost of commodities will only pressurise this situation.”
Meanwhile, the US economy has moved from a substantial surplus to a $500 billion deficit in the space of five years. About 80% of China and Japan’s foreign reserves are held in US dollars. Hodge says, “We are relying on the good grace of foreigners to buy our treasuries. In fact, foreign buying of US bonds is currently financing the entire US deficit.”
PIMCO’s conclusion is that this ‘unstable equilibrium’ is not a sustainable condition.
“The cheapness of money around the world will not last,” says Hodge.
“The world is not a safe place, politically or macro-economically. And as an investor, you are not being rewarded for this. The risk premium is too narrow, credit spreads are too tight and interest rates are too low.
"We do not believe that you are being paid to underwrite the default risk of corporates around the world. As a firm, we are taking less risk and as an investor, you need to pay an investment manager to know not only what markets to trade, but when to trade them; timing is everything.”
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