Bill Gross on Central Banks: They're 'Casinos'

While European Central Bank President Mario Draghi expounds on the latest tweaks and twists to ECB policy, Bill Gross has a far less wordy explanation for what the banks are doing.

"Central banks are casinos." That is the curt definition the Janus Capital money manager gives them in his monthly outlook letter. "They print money as if they were manufacturing endless numbers of chips that they’ll never have to redeem."

The banks in these post-crisis years have been essentially relying on two old gambler strategies, Mr. Gross says: the bluff and the "Martingale." Everybody knows what a bluff if, but the Martingale is a little more obscure (hey, we had to look it up, too). It's a strategy of doubling down on the previous bet, no matter whether the previous bet was a winner or a loser. The idea is that eventually, the odds are that you will win a pot big enough to cover all your bets. Whether or not it actually works is debatable.

This, however, is what the world's big central banks are all doing, Mr. Gross says. Bluffing and doubling down. It's worked so far because the banks, being the ones creating the chips, have an endless supply of them. Mr. Draghi's famous "whatever it takes" statement from 2012 "is a Martingale promise in disguise," Mr. Goss says. "It vows to get the Euroland economy back to “even” and inflation up to 2% by increasing QE and the collateral it buys until the Euro currency declines, the EZ economy improves, and inflation approaches target."

He noted - the letter was apparently written before the ECB unveiled its latest policy proposals - that the ECB was expected to add fresh stimulus measures on Thursday. "Martingale or bust!"

This game can go on for as long as the citizenry retains faith in the bank and the currency, he wrote. If they lose faith in the practical value of the currency, the game will unravel quickly. "Venezuela, Argentina, and Zimbabwe are modern-day examples. Germany's Weimar Republic is a great historical one."

It may look like a success, but it's mainly a successful bluff, he argues.

Martingale QE’s and resultant artificially low interest rates carry distinctive white blood cells,not oxygenated red ones, as they wind their way through the economy’s corpus: they keep alive zombie corporations that are unproductive; they destroy business models such as insurance companies and pension funds because yields are too low to pay promised benefits; they turn savers into financial eunuchs, unable to reproduce and grow their retirement funds to maintain expected future lifestyles. More sophisticated economists such as Kenneth Rogoff and Carmen Reinhart label this “financial repression”. Euthanasia of the saver is the result if it continues too long.

How this all plays out, of course, can't be known, but he warns that "as gambler know there isn't an endless stream of Martingale chips, even for central bankers acting in unison. One day the negative feedback loop on the real economy will halt the ascent of stock and bond prices and investors will look around like Wile E. Coyote wondering how far is down."