Much of the credit-crunch can of course be laid firmly at the feet at too-easy credit for so-called sub-prime borrowers in the United States. The worry of the rest of the world is that if the US tips into recession, it could get pulled along for the ride. There are good arguments that new economic powerhouses such as China and India would blunt the impact, but it's not at all clear this is actually the case. It's also worth noting that the situati
on in the UK shares some broad similarities with the US--high asset prices being fuelled by easy credit among them.
In his just issued investment outlook for February, Gross makes very clear what he thinks of the Federal Reserve Bank's attempt to deal with the situation thus far. It's not encouraging: "My point is that Chairman [Ben] Bernanke must recognize the reduced benefits and obvious dangers of a déjà vu trek to 1% short rates . . .bubble creating, inflation inducing damage to the U.S. dollar would be the likely result now."
Gross points out that the first trip down the road to low rates, housing prices were rising and down payment requirements were low. In other words, it was an easy decision to lever up and buy a house on easy credit. In a falling market, however, the case isn't so clear, or as Gross puts it: ". . . what motivates a future homeowner to pay 6%+ interest for an asset that is going down in price?"
So, if not in rate cuts, where does Gross think the answer lies? Channelling Keynes, he argues that fiscal stimulus, and plenty of it, on a much more sustained basis than anything proposed thus far is the answer. "The U.S. needs a . . . 'demand-based' fiscal package alright, but a $300 - $500 billion permanent one, in addition to the proposed temporary package . . . To provide a stable recovery path, government spending needs to fill the gap - not consumption." In short, Gross thinks the current proposal of a $150 billion temporary package is too little to make a difference.
Gross can't help but take a shot at past Fed policy: "1% short rates were so effective 5 years ago that they not only bolstered demand, but created a housing bubble of Frankensteinian proportions." The credit ratings agencies also come in for a drubbing as he characterises their contribution to the credit bubble as ". . . the naïve endorsement of their [Wall Street's] black magic by rating services willing to sell AAAs for a fee."
We don't pretend to know if Gross is correct or not, but the idea that pouring more cheap money onto a problem that was created by easy credit in the first place will solve things strikes us as reasonably open to question.
