Pimco's Gross: Welcome to 'Financial Repression'

CHICAGO -- It's great to be Bill Gross, founder of Pimco, a manager of $1.2 trillion in assets. Even when you're wrong, you're right. Gross has gotten heat about his bearish call on treasury bonds.

Bonds did nothing but go up in the past few months since his call, and yields have declined (treasury prices move inversely to yield). He recently told the media he was still able to make money, even though his fund has underperformed. So does he still feel the same way about bonds? "Actually I don't agree with myself over the last three months," he jokes.

Gross, speaking here at the Morningstar Investment Conference, actually repeated his mantra, saying that yields have declined to "staggering" levels. He called the decline a long strategic program by the federal government to "pick people's pockets" by offering a lower rate of return than inflation, in order to inflate away excessive debt.

What does it mean for you? Gross repeated his now-famous "slowly cooked frog" metaphor: What's ahead is "a relatively low return relative to inflation...Your pocket is being picked. Relative to inflation, you're a frog that's getting cooked in a pot."

Gross points out that if you take an average treasury duration, the average yield of US Treasury bonds is not that much higher than interest rates in Japan, the country with the much publicized lost economic decade. "We're only 80 basis points away from Japan," says Gross. He argues that yields can't go much lower, unless, of course, we are Japan.

This is "financial repression," says Gross, a process whereby the government penalizes savers and investors by keeping rates artificially low relative to inflation to lower debt levels relative to gross domestic product (GDP)."This country and other countries with debt problems...the developed world basically has used and will use a tactic called 'financial repression.' "

Gross says this means that investors looking for yield will have to go outside the country and look at riskier fixed-income assets, including emerging market bonds and dividend-paying stocks. "I can say with greater than 50% certainty your pocket will be picked if you stay here. You don't want to be one of those frogs...You want to get out of the pot."

Brazil offers real interest rates at 6% to 7%, Gross points out. He admits the country has more risk but at least its economy is going well. "There's a country that's really got it going, for investors at least. You need to get outside of the United States...You don't have to go far afield to find a less repressive atmosphere. The United States is close to Japan in terms of its interest rates."

This dynamic means that the developed G7 economies will transition to a different sort of economy than we've experienced since 1981, a period Gross says was driven by increasing asset prices. "The asset-based economy is over," he asserts.

"If real interest rates can't be driven down any further, what total return is available to me going forward? Can I expect double-digit returns that I've had since 1981? The dramatic influence of interest rates aren't there any more."

So what will the Federal Reserve do to find buyers of treasuries once Quantitative Easing II -- a program in which the government buys its own bonds to keep rates low --ends? Gross says in order to reassure treasury buyers, it will start with the message that the Fed funds rate will "stay low for a very long time."

In other words: The Fed will continue to try to pick your pocket. Be wary, says Gross. Stay away from treasury bonds and low-yielding, dollar-based instruments. Otherwise, your frog may be cooked.