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Pimco’s Gross: US Has No Way Out of Debt Trap

Tuesday, 08 Mar 2011 01:19 PM

Americans should brace for big changes in their lives in the coming years, warns Pimco founder and co-CIO Bill Gross. There is simply no exit from the significant decline in U.S. living standards to come.

Borrowing to finance huge deficits will eventually come home to roost on the U.S. taxpayer, either in the form of higher interest rates or a radical reduction in entitlement spending, Gross tells Yahoo Finance in an interview.

U.S. debt is now at $14.195 trillion, just $99 billion below the current limit. The Treasury Department has been taking money from an emergency reserve to avoid hitting the limit as Congress debates raising the debt ceiling, Reuters reports.

The White House projects the deficit – or how much we borrow each year to pay for just the federal government, not counting state and local borrowing — will hit $1.6 trillion this fiscal year, or 10.9 percent of GDP.

Pimco's Bill Gross
“We do have advantages. We are the reserve currency, although that privilege is being abused,” says Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co.

“If we continue to abuse and continue spend money, with trillion-and-a-half dollar deficits, then ultimately what it means is that the dollar goes down, that foreign goods become more expensive, and our standard of living is eroded,” says Gross, Pimco’s co-chief investment officer.

As borrowers demand compensation for the risk, interest rates will move higher. Gross points out that higher interest rates mean higher mortgage rates and higher credit-card rates will follow.

In addition, borrowing rates have stayed at a generational low in part thanks to the Federal Reserve’s highly unusual purchases of roughly $2 trillion worth of U.S. Treasurys. The latest version of that program is set to end in June, if the Fed doesn’t cancel it beforehand.

“There is really no way out of this trap and this conundrum at this point,” says Gross. “If we refuse to go along, and we refuse to attack entitlements, then the world itself will impose restrictions and lower our standard of living through the dollar and through higher interest rates.”

The answer, he suggests, is to have a serious discussion in Washington about Social Security and Medicare, not just the discretionary spending around the edges. But doing that in a serious way implies a major change in the American way of life, too.

“If we do decide to reduce our deficits, then of course our standard of living will not be what it was because we are simply not allowing enough, or as much, money as we’ve become used to in terms of those entitlement-spending programs,” he says.

A failure to rein in spending and rising interest rates could cause that to spike to “Greek-like” levels if not addressed, Gross warns.

“When a country reaches a certain debt level, confidence in that country’s ability to repay that debt becomes jeopardized,” Gross says.

As for Washington, Gross says, don’t get your hopes up.

“Perhaps in 2012 it will be addressed,” Gross says. However, ultimately, history has proven that both Democrats and Republicans have been big spenders and low taxers, he warns.

“Both are equally at fault here, and to suggest otherwise, I think, is not being realistic,” he says. “I don’t have too much faith and hope.”

Billionaire real-estate magnate Sam Zell, meanwhile, warns that Americans should brace for a "disastrous" 25 percent decline in the standard of living if the U.S. dollar’s reign as the global reserve currency ever ends.

He says that there are signs in the market that it could eventually happen. As it is now, a Korean manufacturer who wants to sell to Brazil must first buy dollars to complete the deal. If countries decide to bypass the dollar, the effect would be a disaster, Zell says.

“Frankly, I think we’re at a tipping point. What’s my biggest single financial concern is the loss of the dollar as the reserve currency,” he told CNBC in an interview. “I can’t imagine anything being more disastrous to our country than if the dollar lost its reserve-currency status.”

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