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‘Bernanke trapped in liquidity black hole’

US treasuries are the most brazen Ponzi scheme of all time, according to Bill Gross, the managing director of Pimco, the world’s biggest private bond investor.

In a note released ahead of this week’s US mid-term elections, Gross says the Federal Reserve is helping to fuel a gigantic bubble. He says: “The Fed is, in effect, telling the markets not to worry about our fiscal deficits, it will be the buyer of first and perhaps last resort. There is no need, as with Charles Ponzi, to find an increasing amount of future gullibles, they will just write the cheque themselves. I ask you, has there ever been a Ponzi scheme so brazen?

There has not. This one is so unique that it requires a new name. I call it a Sammy scheme, in honour of Uncle Sam and the politicians, as well as its citizens, who have brought us to this critical moment in time.”

Gross says a new round of quantitative easing would continue to inflate the bubble. It would exchange government bonds on institutions’ balance sheets for cash, increasing demand for treasuries and freeing money for lending.

In theory, this should help create growth, 2 per cent inflation and jobs if it is lent out to the real economy but Gross says it may not, given the US is deleveraging, not demanding more credit.

He says: “We are, as even some Fed governors now publicly admit, in ’a liquidity trap”, where low interest rates or trillions in QE2 asset purchases may not stimulate borrowing or lending because consumer demand is just not there. Escaping from a liquidity trap may be impossible, much like light trapped in a black hole.

“Ben Bernanke, however, will try – it is all he can do. He cannot raise or lower taxes, direct a fiscal thrust of infrastructure spending, change our educational system or force the Chinese to revalue their currency. It is all he can do and as he proceeds, the dual questions of will it work and will it create a bond market bubble will be answered.”

Gross says QE2 may stimulate bonds in the short term but eventually it may stoke higher inflation somewhere in the financial system, which would harm the bond markets.


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