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Bill Gross: Fed Policy Is A 'Brazen' 'Ponzi Scheme'

First Posted: 10/27/10 05:30 PM ET Updated: 05/25/11 07:10 PM ET

Of Mutual Interest
"I call it a Sammy scheme," Gross writes.

The Fed should stop meddling with the economy now, before it does more damage, say two top asset managers.

The Fed Reserve Bank's quantitative easing program, expected to begin next week, in which the central bank will go on a spending spree to inject more money into the economy, will deal untold damage to the system it attempts to support, say Pimco managing director Bill Gross and GMO chief investment strategist Jeremy Grantham. These purchasing strategies, in which the Fed will likely buy government bonds, intending to lower interest rates and stimulate demand, don't work, Gross and Grantham say in letters to investors: They actually make things worse.

"I ask you: Has there ever been a Ponzi scheme so brazen?" Gross says. "There has not."

Gross says that government debt has always operated in a Ponzi-like manner. The U.S., he says, can rely on future investments to pay for its current expenditures, in a theoretically unending chain. But in this case, Gross says, the government will be its own investor, feeding its own Ponzi machine.

"Instead of simply paying for maturing debt with receipts from financial sector creditors ... the Fed has joined the party itself. Rather than orchestrating the game from on high, it has jumped into the pond with the other swimmers," Gross writes. "There is no need -- as with Charles Ponzi -- to find an increasing amount of future gullibles, they will just write the check themselves."

Gross, it should be noted, has a huge personal stake in the matter. His company, Pimco, invests in bonds -- as Reuters notes, Pimco's bond-focused Total Return Fund, which Gross runs, has about $252 billion in assets, making it the world's largest bond fund. When Gross criticizes the Fed's anticipated quantitative easing, he complains that it will likely boost inflation, which would deal a severe blow to bonds, ultimately reducing their value (and his fortune). "Bondholders, while immediate beneficiaries, will likely eventually be delivered on a platter to more fortunate celebrants," he writes.

Grantham, whose firm manages more than $94 billion in assets, also had some choice words for the Fed. The title of his report, "Night of the Living Fed," not only conveys the danger he anticipates from quantitative easing (it's "a play on the traditional scary Halloween season," Reuters explains) but also suggests that the Fed's program will artificially -- and harmfully -- jolt the tepid economy.

"If I were a benevolent dictator, I would strip the Fed of its obligation to worry about the economy and ask it to limit its meddling to attempting to manage inflation," he writes. "I would force it to swear off manipulating asset prices through artificially low rates and asymmetric promises of help in tough times. ... It would be a better, simpler, and less dangerous world."

The Fed's powers are limited to adjusting the currency -- setting interest rates and determining how much money is in circulation. By taking that limited power to its furthest possible extreme, Gross and Grantham say, Fed chairman Ben Bernanke is making matters worse. Real stimulation, Grantham writes, will come from elsewhere.

"If you really want to worry about growth, you should be concerned about sliding education standards and an aging population," Grantham says in his letter.

Gross, in his letter, makes an argument similar to Grantham's, with a similar metaphor. He suggests that the economy might be stronger in the long run if the Fed were to allow it to grow naturally, "from admittedly lower levels."

"The Fed, on Wednesday, however, will decide that it is better to keep the patient on life support with an adrenaline injection and a following morphine drip than to risk its demise and ultimate rebirth in another form," Gross writes.

So outraged is Gross by the Fed's anticipated policy that he gives it a nickname.

"I call it a Sammy scheme, in honor of Uncle Sam and the politicians (as well as its citizens) who have brought us to this critical moment in time," Gross says. "It is not a Bernanke scheme, because this is his only alternative and he shares no responsibility for its origin. It is a Sammy scheme -- you and I, and the politicians that we elect every two years -- deserve all the blame.

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