Allow me to attempt an explanation: Bill Gross's main issue with current monetary policy is that it's preventing Fixed Income from being as profitable as it has been in the past (which is contrary to his own interests as well as those of many other franchises in the financial sector).

A financial investor will only make an investment at the far end of the yield curve if he thinks he can make a capital gain on that investment (he thinks yields will fall even further), or if he can make install some kind of carry trade (i.e. buy longer dated maturities, short shorter-dated ones and take advantage in the yield-differential).

While Gross admits that the yield curve isn't flat, he also repeatedly makes the point that yields on US Treasuries are at all time lows making the prospect of capital gains on investments on 5/10y or even 30y treasuries quite remote and the risk/reward profile unattractive.
Also, while the curve isn't entirely flat, the curve isn't steep enough for a carry trade to be profitable enough (precisely because yields on long-dated debt are at all-time lows while short dated debt has a floor at 0% and therefore hasn't been able to reach the -3/-4% that a Taylor rule implied would be optimal during the crisis). This has been a major issue for brokerage firms since 2007 (whose business model relied heavily on doing exactly these types of investments), and is one of the reasons why a lot of them have been bought for next to nothing (evolution), closed down (citadel securities), or tried to diversify their revenues by going into investment banking (MF Global).

In situation of global ZIRP, Broker-dealers (and Fixed Income Funds for that matter) end up not being able to make money from the yield curve_ and that's problematic for them because they aren't able either to invest in the equity space which would theoretically be much more attractive (unlike PE & VC Funds)

I thought it was confusing as well. But this is what I think he means.

The lower the discount rate you use in valuing an asset, the higher the price will be. Interest rates drive rates of return and discount rates and they now can't go any lower. Smart money (and a lot of dumb money at this point) know that the stock market gains were just a result of interest rates going lower over the last 30 years.

If you believe that, then you want to get into cash or short term Treasuries as financial assets (especially long term Treasuries) have almost no upside and a good deal of downside. Once you realize this, you won't exit cash/short term Treasuries until rates go up and lessen this risk/reward tradeoff. To get people out of cash, you have to raise rates which would kill asset values.

But if you don't raise rates, then you get everyone not wanting to take any risk, staying in cash and not investing in anything real that has risk (buildings, houses, businesses, etc.).

This is the hole in Keynes' General Theory. Brad Delong had a post where he excerpted the part from the General Theory about lowering interest rates is the solution and we should try to have permanent quasi booms versus quasi slumps. That works until you get to zero interest rates, can't lower them, and then you run out of the ability to have the boom.

The solution IMO is higher taxes, lower trade deficits,higher interest rates, lower financial asset values, complete recap of the system. You don't do that until you prove out that there is in fact no alternative. We ain't there yet.

I would think that Brad Delong/Matt Yglesias type thinkers would say inflation is the solution. That actually may be correct. The problem is that we are in a democracy and people are like Dan and economics doesn't make sense ( I think that's because economists haven't done a good job whether thats salt or fresh water). So the things they would advocate are hard to get the public to support so you get the alternative that I outlined.

I also think that what there model is really saying is they need inflation in incomes, but I'm not convinced the levers they are pulling will increase inflation but not in incomes. So it will just be more of the same with us being in a bad situation of quasi slump for as long as the eye can see.

To extend the analysis of the other posters, I would also suggest that the Fed believes that lowering interest rates should encourage investors to purchase risk assets, as returns on bonds are unattractive for the reasons both Gross and the other commenters mention.

However, because investors are truly afraid of capital loss, they will accept low rates of real return in order to ensure that the capital is still available to them. Thus, they will park their money in demand-deposit accounts, rather than purchase stocks, commodities or real estate.

This is a good description of what has happened in Japan, where despite ZIRP interest rates for ages, no one wants to purchase Nikkei 225 stocks. There is simply no demand for risk assets in Japan whatsoever, and so investors accept low rates of return and minimal income, and adjust spending accordingly, creating less final demand, and less economic activity, fewer attractive investment opportunities, and yet lower prices - and therefore higher propsensity to save, even as rates decline! Indeed as yields on investments decline, the need to accumulate a larger pool of assets to provide a given level of income INCREASES the propensity to save, rather than to borrow.

This is further complicated by the existence of the transfer state, in which savings are expropriated from younger (more risk-seeking) workers to subsidize highly risk-averse retirees and near retirees, who fear that their savings could be annihilated in another stock / real estate / bond bubble. Cash, then is being funnelled from the people for whom lower rates might be an incentive to borrow and invest to the people for whom lower rates are an incentive to save.

This, unfortunately, is what happens when people try and price credit from a diktat rather than from the risk/reward profiles of the credit market's participants - the market itself freezes.

As you said, you have not a clue; his point is simple; at a price, in this case a low price, it is no longer economic (as in can't make enough profit to cover costs) for banks to extend credit (lend); banks have other costs beside funding, like head count, benefits, real estate, systems, on and on; so if it's not econmic to lend, the fed's policy's will have the unintended consequence of discouraging lending due to too thin a margin to make it economic; you really ought to stop writing if you know so little...

Another issue with the current Fed policy is that while banks were able to finance themselves on an unsecured basis until the crisis, they are now heavily reliant on the repo markets and therefore constantly require quality collateral to finance themselves.

Unfortunately, since the beginning of the crisis, the Fed has been buying up safe assets (AAA rated securities, or T-Bills/T-Bonds) through operations such as QE/QE2 in order to force financial institutions to invest in riskier assets, thereby reducing even more the stock of 'safe' assets available for repos, which had already been declining as a result of the depression (H/T FT Alphaville http://ftalphaville.ft.com/blog/2011/12/05/778301/the-decline-of-safe-assets/)

This has reduced the financial institutions' ability to finance themselves and is therefore exacerbating the credit crunch

And btw PMG, you're not being helpful...

Gross is saying that the fed is fixing the price of debt at a price that won't clear the market. People will not lend for multi-year terms at the zero interest bound.

But the only way the fed can "fix" this price is by manipulating the supply of credit. There is no sign that the market is not clearing. People and firms with good credit have no trouble borrowing. For the most part they don't need to borrow because they do not want to invest (or consume) at a level they can't finance out of their own cash balances.

Another thing Gross has said is that a flat yield curve at the zero bound squeezes the profit out of financial intermediation. Should we be concerned about this? There are better ways to deal with insolvency in the banking system than by manipulating the price of credit to keep the banks profitable. If there is no profit in banking then there is more banking than the economy requires. Let the bloated banking sector shrink.

There is justified anger about concentration of income at the top stagnant or declining wage growth for the rest of Americans. Yet it seems that those most bothered by this state of affairs also seem to be the most vocal that rates need to stay near zero and that more Quantitative Easing is necessary. To me this is a contradictory position.

The Fed has a dual mandate of stable prices and full employment. However, Fed studies (SF I believe) as well as Bernanke's own testimony essentially admit that there is little the Fed can do to drive full employment. The stated goals of QE are to raise asset prices (especially riskier ones) and by extension cause a wealth effect in the economy. This wealth effect accrues to the wealthiest 10%. Meanwhile, the average American experiences higher food and energy prices and lower real wages.

Ironically, the rationale for why QE is OK (i.e., non-inflationary) is because it is not flowing through to wages. In other words, the stated purpose of QE is to drive wealth to owners of assets (financial institutions and the upper class) by driving asset prices higher. Real wages are thus left to decline or stagnate. It is almost a supply-side argument, with the hope being that the wealth effect will trickle down through confidence and hiring.

Why is it that those most in favor of indefinitely low rates cannot see that the policy they support is so at odds with their core economic beliefs about fairness.

(1) I recently moved all of my cash out of money market funds and into a treasury only fund. Why should I take a small risk when there is not any meaningful additional return for doing so? So rather than a money market fund using my assets to fund banks in overnight lending or corporations in the commercial paper market, my funds are funding the 10% annual US government deficit.

(2) I recently moved investment funds from a margin account to a non-marginable segregated account. I didn't trust the bank, which was using my funds as collateral to fund its own borrowing in the overnight money markets. When rates were higher, it was worth my while to use the margin account. Now that money can no longer be used by the bank for funding. It is no longer available to the financial and corporate sectors.

(3) Bank of New York last year started charging large commercial depositors for the "right" to deposit money at its bank. With rates so low, the bank could not earn a return on those assets (by investing in safe short-term securities) and therefore needed to charge depositors to make it a sound business.

A major issue in the market that Gross is alluding to (and which #1-3 above exemplify) is that there are not enough safe/risk-free assets in the market today. The subprime debacle killed off large amounts of AAA-rated structured products. Now the wave of sovereign downgrades has further diminished the supply of AAA assets. And as a previous poster stated, the Fed is buying up a large portion of the risk-free assets that are available.

Our economy has increasingly moved from borrowing via bank loans and bonds to secured funding. With available returns so low, most investors do not want to lend on an unsecured basis at low rates. Hence, they demand collateral. Given near-zero rates going out several years, there is little incentive to take additional risk. Thus my decision to move from a money market to a treasury only fund. Similarly, many large institutions are no longer letting their cash be used by financial institutions for repos and re-hypothecation.

But as I described above, the financial system has become addicted to this kind of funding. Removal of these assets from circulation (due to low rates and a lack of trust) are curtailing lending--especially in Europe. Investors like Gross would rather send their assets overseas to emerging markets, funding foreign companies at higher yields with similar risks. This is decidedly not good for the US private sector.

Lastly, permanently low rates punish savers and investors. But the savers are the ones I worry about most. After stagnant wages for a decade, two stock market crashes, and a real estate bust, the average middle-aged American is not prepared to retire. Thus, they are spending less, saving more, and staying in the workforce longer (to the detriment of younger workers who cannot find jobs). There is no way to depend on interest income as a supplement to Social Security. Moreover, the government forgoes significant interest income tax revenue due to ZIRP.

While low rates help an over-indebted country, the tradeoff is not as simple as it seems. The people we need to be spending are being forced to save dollar for dollar and government tax revenue is probably lower. In my opinion, if a business cannot survive 4 years after the bust with a Fed Funds rate of 1.5%, then they should not be in business. By remaining in business, they undermine the prospects or the more deserving companies and you end up with a corporate backdrop resembling Japan's.

If the US is afraid of higher rates in terms of its cost of funds, then it should be extending the duration of its debt sales out toward 30 years. But it isn't doing so in any meaningful way. How short-sighted does one have to be to try to constantly roll over debt at short duration when long rates are near all-time lows? By not terming out US government debt, the Treasury is virtually guaranteeing that rates can NEVER be raised, as doing so would drive up interest expense and overwhelm tax revenues. As long as the Treasury maintains its current term structure, the US will continue running high deficits without the ability to raise rates. At some point in the future (3-5yrs in my estimation), the markets will likely force up rates and the US will be forced to refinance at rates high enough to destroy our budget even more. What will we do then?

Bill's point is

1) He didn't expect the Fed to do what it did, and the Fed is wrong

2) The current term structure means best case his investors make a very little return, and worst case they lose quite a bit of money, and it's the Fed's fault, not his

3) It's on the Fed if they create a banking crisis by eliminating the yield curve arb and reducing banks' net interest margin

(not a great argument, it helps banks on the funding side, they can make some of the spread back on credit spreads, the whole point is to force everyone to not just buy Treasuries, make loans, buy stocks, get investors to risk on. The only thing I will grant is it is uncharted territory, sometimes things work in reverse logic, people say, I'm not being paid to invest longer term, if the Fed thinks things are that bad, I should just hold cash)

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