Damages

Bill Gross

America’s fiscal cliff looms even though it is still considered the world’s “cleanest dirty shirt.” It has federal debt to GDP of less than 100%, Aaa/AA+ credit ratings and it issues the world’s reserve currency.

Yet studies by the IMF, the BIS and the CBO suggest that the US needs to cut spending or raise taxes by 11% of GDP – and quickly, over the next 5 to 10 years.

Gross has compiled a chart, using the data gathered by the above agencies, which illustrates the trouble America faces (PIMCO’s “Ring of Fire”). The only conclusion to be drawn is that the US balance sheet is in flames and the fire department is apparently asleep in the station house.

If the US continues to ignore 8% of GDP deficits that, when including Social Security, Medicaid and Medicare liabilities, compose an average estimated 11% annual “fiscal gap,” it will begin to resemble Greece before the turn of the next decade. Unless the gap is closed, the debt to GDP ratio will continue rising, the Fed will print dollars to pay for the deficiency, inflation will follow and the dollar will decline. Bonds would be burned to a crisp and stocks would certainly be singed; only gold and real assets will thrive within the “Ring of Fire.”

If that be the case, there would be damage aplenty, not just to the US but to the global financial system itself, a system that for 40 years has depended on the US economy as the world’s consummate consumer and the dollar as the global medium of exchange. If the fiscal gap isn’t closed over the next few years, then rating services, dollar-reserve-holding nations and bond managers may together force a resolution that ends in tears. It would be a scenario for the storybooks, one which investors would want to forget. The damage would likely be beyond repair.

source: pimco