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Too Much Risk, Too Little Return

June 6, 2012

Now, with dollar reserves widely dispersed in Chinese, Japanese, Brazilian and other surplus nations, it is likely to assume that there will come a point where 2% negative real interest rates fail to compensate for the advantages heretofore gained in buying sovereign bonds.

—William H. Gross, Managing Director, PIMCO

June 6, 2012

While monetary systems are a balance between debtors and creditors, abset voluntary defaults, it is usually creditors that establish the rules for transitions to new regimes. Such was the case in the late 1960s as France's de Gaulle threatened to empty Ft. Knox unless a new standard was imposed. Now, with dollar reserves widely dispersed in Chinese, Japanese, Brazilian and other surplus nations, it is likely to assume that there will come a point where 2% negative real interest rates fail to compensate for the advantages heretofore gained in buying sovereign bonds. China, for instance, may at the margin shift incremental Treasury holdings to higher returning commodity/real assets which might usher in a gradual or somewhat sudden reconfiguration of our current dollar-based credit system. Having a reduced incentive to purchase Treasuries and curtail Yuan appreciation, the Chinese and their act-alikes may look elsewhere for returns. In addition, previously feared but now tamed private market bond vigilantes like PIMCO have similar choices, if clients with their index-bounded holdings begin to broaden their guidelines.

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