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Some very big hitters are talking about deflation and are buying bonds and dumping equities. Foremost among them are Pimco’s Bill Gross and Mohamed El Erian, David Tepper of Appaloosa Management, a $15 billion hedge fund, and “… the $42 billion Fortress Investment Group LLC, the $1.2 billion New York hedge fund Argonaut Capital Management, and the $107 billion Boston investment firm GMO LLC, founded by [Jeremy] Grantham, are warning clients about possible deflation.”

I am glad they are finally seeing things as they are, not as they wish things to be:

“Deflation isn’t just a topic of intellectual curiosity, it’s happening,” says Mr. Gross, who runs the $239 billion mutual fund Pimco Total Return Fund, citing an annualized 0.1% decline over the past two years in the U.S. consumer-price index. “It’s an uncertain world that’s tipping toward deflation.” …

Mr. Gross has been aggressively buying U.S. government debt in recent weeks. Treasurys now account for about 51% of the portfolio of his Pimco Total Return fund, up from less than 33% at the end of March. It is as high an allocation to government securities for the fund as at any time in the past six years, according to Morningstar Inc. The fund has risen 7% this year. …

Mr. Gross was much more skeptical of Treasurys as recently as about three months ago. Mr. Gross says he is paying particular attention to deterioration in an index produced by the Economic Cycle Research Institute [ECRI] that attempts to predict future economic health. In addition, he says, a drop in money supply and fiscal tightening in much of the world are reasons for Pimco’s investment shift.

I wonder if he’s been reading The Daily Capitalist, because those are comments very similar to what I have saying (here, here. and especially here). The difference is that government spending has little to do with deflation or inflation. It’s all about money supply and that has been declining since December, 2009. The other difference is that these folks weren’t saying this until very recently when they got spooked by a declining CPI. As readers here know, a decline in prices is a result of deflation, but not the cause of deflation.

The reporter in the Wall Street Journal article says:

Indeed, many of these star investors don’t see extended deflation as a sure bet and predict that, as deflation becomes more likely, the Federal Reserve and other government officials will take radical steps to arrest the decline, such as buying bonds or introducing spending programs.

Jeez, are there any sure bets? Of course not. But, his faith in the Fed and our government is misplaced. They haven’t been very effective impacting inflation, deflation, money supply, or credit lately, so I don’t know why we should expect them to be effective now. The Fed bought bonds and $1.25 trillion of RMBS and yet money supply still declines.


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