'Bond King' shorts US debt on default fears

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The Independent Online

The world's most famous bond investor, Pimco founder Bill Gross, is actively betting against US government debt, in a move that underscores gathering concern in the financial markets about budget deficits and runaway healthcare spending by the US federal government.

Although Congress and the White House reached a last-minute deal on Friday night to cut $38.5bn (£23.6bn) from the current year's budget, overall government debt is many hundreds of times larger than that, and the difficulties of reaching consensus on even small cuts appeared yesterday to have disheartened bond investors.

In March, Pimco created a sensation by revealing it had cut its holdings of US federal government debt – traditionally the safest investment in the world and a staple of most investment portfolios – to zero. But now it has emerged that the firm did not stop there. By the end of March, US Treasuries accounted for minus 3 per cent of the holdings in its main fund, the Total Return Fund. It can have a negative position by using derivatives or by short-selling the bonds, both ways to profit if the value of the bonds falls.

Mr Gross, who co-founded Pimco in 1971 and earned the nickname "the Bond King" for his expertise, has been issuing increasingly shrill warnings that the US is on course towards in effect defaulting on its debts. In his latest monthly letter to investors, posted on 1 April, he explained that Pimco was selling US Treasuries "because they have little value within the context of a $75 trillion total debt burden".

He wrote: "Unless entitlements are substantially reformed, I am confident that this country will default on its debt; not in conventional ways, but by picking the pocket of savers via a combination of less observable, yet historically verifiable policies – inflation, currency devaluation and low to negative real interest rates. Our clients do not want to be short-changed or have their pockets picked."

In early trading in the US yesterday, demand for Treasuries was indeed receding. As well as long-term questions over the sustainability of US budget deficits, traders are anticipating an uptick in US inflation in figures due later this week.

The official ceiling on US federal government's debt, currently $14.3 trillion, does not include promises that have been made to pay pensions and healthcare costs for a growing numbers of retired people. Adding in the costs of meeting those obligations takes the debt to $75trn, according to Pimco's rough-and-ready estimate.

Congress is expected to approve the 2011 budget in the next couple of days. The political fight now turns to the 2012 budget, and to reforms aimed at tackling longer-term problems. President Barack Obama is set to propose reform of these entitlement programmes with a speech on the country's long-term fiscal problems tomorrow, and he is also going to propose raising taxes on the wealthy. Republicans last week proposed cuts to Medicare and Medicaid government health spending.