Policy responses to the global economic crisis: Too little, too late?

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Presentation by Andrew Bosomworth, Managing Director, PIMCO, at the Bank of Latvia conference "Economic Adjustment under Sovereign Debt Crisis: Can Experience of the Baltics Be Applied to Others?"
Riga, November 2, 2012.

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Policy responses to the global economic crisis: Too little, too late?

  1. 1. Your Global Investment Authority Policy responses to the global economic crisis: Too little, too late? Andrew Bosomworth, Managing Director 2 November 2012, Riga, LatviaThis publication is distributed foreducational purposes only. Informationcontained herein has been obtained fromsources believed to be reliable, but notguaranteed. No part of this publicationmay be reproduced in any form, orreferred to in any other publication,without express written permission.PIMCO Europe Ltd (Registered in Englandand Wales, Company No. 2604517)Registered Office, 11 Baker Street, London,W1U 3AH, United Kingdom. Tel:+44.20.3640.1000. Authorised andRegulated by the Financial ServicesAuthority (25 The North Colonnade,Canary Wharf, London, E14 5HS).(Presented in Latvia) Your Global Investment Authority For investment professional use only Pg 0
  2. 2. Its not the quantity, its the mix that matters Too much reliance on monetary policy and automatic stabilisers Too few structural reforms: – Government efficiency – Quality of education Unintended consequences Incomplete fiscal governance structure in Europe Your Global Investment Authority For investment professional use only Pg 1
  3. 3. Too much reliance on monetary policy Balance sheet as % of GDP ECB BOJ BOE FED 35% 30% 25% 20% 15% 10% 5% 0% 07 08 09 10 11 12As of 30 September 2012SOURCE: PIMCO, Eurostat, ONS, BoE, ECB, Bloomberg Your Global Investment Authority For investment professional use only Pg 2
  4. 4. The biggest banks in the world Central bank balance sheets BoE ECB Fed 35% 30% 25% Percent of GDP 20% 15% 10% 5% 0% 1830 1850 1870 1890 1910 1930 1950 1970 1990 2010As of September 2012SOURCE: Haldane AG (2009), Deutsche Bank calculations (from 2007), PIMCO Your Global Investment Authority For investment professional use only Pg 3
  5. 5. No counter factual evidence, but difficult to believe this is purely cyclical Duration and share of long-term Duration of unemployment (weeks) unemployment (U.S. % of unemployed longer than 27 weeks 50 45 40 35 Weeks and % 30 25 20 15 10 5 0 50 55 60 65 70 75 80 85 90 95 00 05 10As of 26 October 2012SOURCE: Bureau of Labor Statistics, Haver Analytics Your Global Investment Authority For investment professional use only Pg 4
  6. 6. Unconventional monetary and fiscal policies force investorsto take more illiquidity and credit risk Quantitative Easings trickle-down theory  Large scale asset purchases (quantity exogenous)  Lower bond yields/higher discount factors (price endogenous)  Higher net present value of cash flows  Increased wealth  Higher investment and consumptionRefer to Appendix for additional risk information. Your Global Investment Authority For investment professional use only Pg 5
  7. 7. Unconventional policies drive a wedge between valuationof financial assets and real economy Fed balance sheet programs and the S&P 500 1,500 +26% +24% 1,400 S&P 500 Index level 1,300 1,200 +36% 1,100 1,000 -41% -14% 900 -10% Operation Twist 800 700 QE1 QE2 QE3 600 2008 2009 2010 2011 2012As of 19 September 2012SOURCE: BloombergRefer to Appendix for additional index information. Your Global Investment Authority For investment professional use only Pg 6
  8. 8. Persistent current account imbalances are unsustainable inside a monetary union Current account balances 8 6 Surplus countries: Belgium, Finland, Germany, 4 Luxembourg, Netherlands 2 Broadly balanced countries:% GDP 0 Austria, France, Ireland, Italy -2 Deficit countries: -4 Cyprus, Estonia, Greece, -6 Malta, Portugal, Slovakia, Slovenia, Spain -8 -10 -12 99 00 01 02 03 04 05 06 07 08 09 10 11 12 As of September 2012 SOURCE: Eurostat, PIMCO Your Global Investment Authority For investment professional use only Pg 7
  9. 9. Thank you, ECB: Other EU countries with fixed exchange ratesadjusted much faster Current account balances: EMU outs with fixed exchange rates Bulgaria, Latvia, Lithuania, Romania 0 -2 -4 -6 % GDP -8 -10 -12 -14 -16 -18 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012As of September 2012SOURCE: Eurostat, PIMCO Your Global Investment Authority For investment professional use only Pg 8
  10. 10. The rationale for federalism  Monetary unions have never worked before without federal fiscal policies  War and peace  Limited adjustment tools in the absence of exchange rate flexibility and presence of heterogeneous nations: – Cultural and economic differences – Low labour mobility – High capital mobility – Defaulting on contractual obligations is not an option  Globalisation and demographics: – Europe will be a much small player on the global field by 2050 – Better equip Europe to maintain and grow its standard of living and to play a constructive, influential role in global politics Your Global Investment Authority For investment professional use only Pg 9
  11. 11. Nation building: ECB is compensating for deficiencies in fiscal policy Banks net borrowing from the ECB Federal government expenditure 1,000 (2011, as % of GDP) Surplus countries: 800 Australia 25% Belgium, Finland, Germany, 600 Luxembourg, Netherlands United States 24% 400 Broadly balanced countries: Canada 15%EUR billion Austria, France, Ireland, Italy Spain 14% 200 Deficit countries: Germany 13% 0 Cyprus, Estonia, Greece, Switzerland 11% -200 Malta, Portugal, Slovakia, European Union 1% -400 Slovenia, Spain -600 Monetary policy is over-compensating -800 for deficiencies in the 07 08 09 10 11 12 distribution of fiscal policy As of September 2012 SOURCE: Eurosystem National Central Banks, ECB, Haver PIMCO Your Global Investment Authority For investment professional use only Pg 10
  12. 12. Nation building: A democratic fiscal authority is needed to complete EMU Liquidity Firewall Goals Goals  Unblock transmission mechanism  Eliminate convertibility risk   Direct recapitalization of banks (via ESM) Constraints   Single Supervisory Mechanism (SSM)  Can only buy time, cannot address ×  Common deposit insurance scheme insolvency ×  Resolution Authority  Democratic legitimacy Constraints  Creditor-debtor burden sharing Structural reforms Goals ×Political and fiscal union  Deliver fiscal savings and economic growth Goals  Improved competitiveness, labour market  Common fiscal capacity with fiscal flexibility and reduce barriers to entry agency empowered to override Constraints deviations in national budgets  Social costs of reforms (high  Common legislature unemployment) Constraints  Tolerance for above-target  Democratic legitimacy and inflation in core popular acceptance SOURCE: PIMCO  Agreed in principle but partially or not yet implemented  Implemented ×Not started Sample for illustrative purposes only Your Global Investment Authority For investment professional use only Pg 11
  13. 13. Your Global Investment Authority For investment professional use only Pg 12
  14. 14. AppendixPast performance is not a guarantee or a reliable indicator of future results.CORRELATIONThe correlation of various indices or securities against one another or against inflation is based upon data over a certain time period. These correlations may vary substantially in the future or over different timeperiods that can result in greater volatility.CREDIT QUALITYThe credit quality of a particular security or group of securities does not ensure the stability or safety of an overall portfolio. The Quality ratings of individual issues/issuers are provided to indicate the creditworthiness of such issues/issuer and generally range from AAA, Aaa, or AAA (highest) to D, C, or D (lowest) for S&P, Moodys, and Fitch respectively.FORECASTForecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy orinvestment product. There is no guarantee that results will be achieved.HYPOTHETICAL EXAMPLEHypothetical and simulated examples have many inherent limitations and are generally prepared with the benefit of hindsight. There are frequently sharp differences between simulated results and the actualresults. There are numerous factors related to the markets in general or the implementation of any specific investment strategy, which cannot be fully accounted for in the preparation of simulated results and allof which can adversely affect actual results. No guarantee is being made that the stated results will be achieved.INVESTMENT STRATEGYThere is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially duringperiods of downturn in the market.OASThe Option Adjusted Spread (OAS) measures the spread over a variety of possible interest rate paths. A securitys OAS is the average return an investor will earn over Treasury returns, taking all possible futureinterest rate scenarios into account.OUTLOOKStatements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions, and eachinvestor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.PORTFOLIO STRUCTUREPortfolio structure is subject to change without notice and may not be representative of current or future allocations. Your Global Investment Authority For investment professional use only Pg 13
  15. 15. AppendixRISKEach sector of the bond market entails risk. Municipals may realize gains and may incur a tax liability from time to time. The guarantee on Treasuries, TIPS and Government Bonds is to the timely repayment ofprincipal and interest, shares of a portfolio that invest in them are not guaranteed. Mortgage and asset-backed securities are subject to prepayment risk and may be sensitive to changes in prevailing interestrates, when they rise the value generally declines. With corporate bonds there is no assurance that issuers will meet their obligations. An investment in high-yield securities generally involves greater risk toprincipal than an investment in higher-rated bonds. Investing in non-Euro securities may entail risk as a result of non-Euro economic and political developments, which may be enhanced when investing inemerging markets.INDEX DESCRIPTIONSBarclays Capital Global Aggregate Index provides a broad-based measure of the global investment-grade fixed income markets. The three major components of this index are the U.S. Aggregate, the Pan-European Aggregate, and the Asian-Pacific Aggregate Indices. The index also includes Eurodollar and Euro-Yen corporate bonds, Canadian Government securities, and USD investment grade 144A securities.The Barclays Capital Global Corporate Index covers investment-grade, fixed-rate, taxable securities sold by industrial, utility and financial issuers.The Barclays Capital Global Treasury Index tracks fixed-rate local currency sovereign debt of investment-grade countries. The index represents the Treasury sector of the Global Aggregate Index.The Citigroup World Government Bond Index (WGBI) is a market capitalization weighted index of the global government bond markets. To join WGBI, countries must satisfy market size, credit and barriers-to-entry requirements.JPMorgan Corporate Emerging Markets Bond Index (CEMBI) Diversified is a uniquely-weighted version of the CEMBI index. It limits weights of those index countries with larger corporate debt stocks by onlyincluding a specified portion of these countries’ eligible current face amounts of debt outstanding. The CEMBI Diversified results in well-distributed, more balanced weightings for countries included in the index.The countries covered in the CEMBI Diversified are identical to those in the CEMBI, which is a global, liquid corporate emerging markets benchmark that tracks U.S.-denominated corporate bonds issued byemerging markets entities.The JPMorgan Emerging Markets Bond Index Global is an unmanaged index which tracks the total return of U.S.-dollar-denominated debt instruments issued by emerging market sovereign and quasi-sovereignentities: Brady Bonds, loans, Eurobonds, and local market instruments.The JPMorgan Emerging Markets Bond Index Plus is a total return index that tracks the traded market for U.S. dollar-denominated Brady and other similar sovereign restructured bonds traded in the emergingmarkets.JPMorgan Government Bond Index-Emerging Markets Global Diversified Index (Unhedged) is a comprehensive global local emerging markets index, and consists of regularly traded, liquid fixed-rate, domesticcurrency government bonds to which international investors can gain exposure.The Morgan Stanley Capital International Emerging Markets Index is an unmanaged index that measures equity market performance in the global emerging markets. As of May 2005, the Emerging Markets Index(float-adjusted market capitalization index) consisted of indices in 26 emerging countries: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia,Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, Turkey, and Venezuela.The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets. Since June 2007 the MSCI World Indexconsisted of the following 23 developed market country indices: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, Netherlands, New Zealand,Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom, and the United States. The index represents the unhedged performance of the constituent stocks, in US dollars. Your Global Investment Authority For investment professional use only Pg 14
  16. 16. AppendixINDEX DESCRIPTIONS (continued)It is not possible to invest directly in an unmanaged index.This presentation contains the current opinions of the manager and such opinions are subject to change without notice. This presentation has been distributed for informational purposes only and should not beconsidered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but notguaranteed. No part of this presentation may be reproduced in any form, or referred to in any other publication, without express written permission of PIMCO Europe Ltd (Registered in England and Wales,Company No. 2604517), Registered Office 11 Baker Street London, W1U 3AH. Authorised and Regulated by the Financial Services Authority (25 The North Colonnade, Canary Wharf, London, E14 5HS). PIMCO andYOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Allianz Asset Management of America L.P. and Pacific Investment Management Company Your Global Investment Authority For investment professional use only Pg 15

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