NEW YORK (CNN/Money) - Bill Gross, who oversees more than $250 billion for Pimco, has once again stepped up to his bully pulpit. Although in his case it's more of a beary one.
Even though its economy is surging, worries Gross in his latest monthly missive, the United States is in a sorry state, overly dependent on creditors for its growth. The budget deficit is swelling, the trade deficit is reaching toward 5 percent of gross domestic product, and the only thing that doesn't keep the whole thing from going kaplooey is that other countries keep on buying up U.S. assets -- particularly Treasury securities.
It's akin, Gross writes in his note for September, to a family that is living far beyond its means. Perhaps the head of the household makes a good salary, the family is healthy, the kids are getting good grades. But somehow the cash coming in isn't quite enough to keep up with the family's bills, or its desires (Gross suggests a Hummer). So the family borrows, and its bankers are happy to keep extending it credit since the family's prospects are so good.
But what if something happens? The marriage sours, maybe, a job is lost, somebody gets sick. Then everything goes awry. Paying down the debt becomes a strain, banks view the household as a credit risk, and suddenly the family must make do with much less.
The United States, Gross worries, is demonstrating a similar lack of fiscal discipline, running up a huge deficit for "Hummers in L.A. and Hummvees in IRAQ."
The whole thing is going to come apart at the seams eventually, and Gross thinks the mechanism for that will be China. In order to keep its currency, the yuan, from gaining in value against the U.S. dollar China has been steadily adding to its U.S. assets.
It has to buy them at a fairly heady clip, because it has a monthly trade surplus with the United States of more than $10 billion which it can't convert into yuan because that would make the yuan run higher. But eventually, China will look at its Treasury holdings and decide it has far more than it needs. The People's Bank of China had $346.5 billion in foreign currency reserves at the end of June -- more than twice what it had at the beginning of 2001.
When the day of reckoning comes, the Chinese may sell their Treasurys, other Asian creditors, like Japan, will join in, and yields will run higher. Or perhaps, thinks Gross, China will revalue the yuan.
"Either way," writes Gross, "we pay the price: higher import costs, a cutback in spending on cheap foreign goods, rising inflation, perhaps chaotic financial markets, a lower standard of living."
Scary stuff, no? Take this one grain of salt. The scenario that Gross envisions wouldn't be good for bonds and it wouldn't be good for stocks, but it could be good for Treasury inflation-protected securities, or TIPS, which have yields that rise and fall with the rate of inflation. And Pimco has been an admitted buyer of TIPS lately.