The Vigilante: Why the man who runs the world's largest mutual fund sold all his Treasury bonds

In February 1993, as the fledgling Clinton administration grappled with the nation’s budget woes, campaign adviser James Carville groused to The Wall Street Journal: “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everyone.” If Carville were serving in the Obama administration today, he’d be seeking reincarnation as Bill Gross. The founder and co–chief investment officer of PIMCO, Gross runs his firm’s Total Return Fund—the world’s largest mutual fund, with holdings entirely in bonds. And for some time, he has been an outspoken critic of U.S. economic policy.

Gross demurred when I suggested that James Carville might want to be him. “I thought the remark was striking at the time,” he said, “but no, I didn’t feel that they were catering to us at every turn.”

But Democrats wrestling with the legacy of Ronald Reagan’s deficits resented the influence of what the analyst Ed Yardeni had dubbed “the bond vigilantes”: the investors who enforce fiscal and monetary discipline when governments won’t. If your political system inflates its currency, or fails to align its spending with its tax revenues, the bond vigilantes will raise your interest rates until you either get it together … or catapult into a crisis.

In the 1990s, we chose to get it together; thanks to tax hikes under both Bush I and Clinton, and a massive influx of capital-gains-tax revenue from the stock-market bubble, we even enjoyed a brief surplus. The bond vigilantes retreated over the horizon. But now deficits are back—and bigger than ever. In 2010, the United States spent $1.3 trillion more than it took in.

This year, the Congressional Budget Office expects us to borrow another $1.5 trillion. In just two years, we will have borrowed almost 20 percent of gross domestic product, or more than $9,000 for every person in the United States. But we won’t be borrowing it from Bill Gross. For some time, he’d been selling his Treasury holdings, and by early March, he had reportedly dumped all of them. Then in mid-April, Gross upped the ante by placing bets against U.S. bonds in the market, a move that pushed the Total Return Fund’s holdings of U.S. debt to the equivalent of minus 3 percent. If the bond vigilantes really are getting the gang back together, then the size of Gross’s funds—and his recent divestment—would seem to make him their leader. With economists and politicians warning about the dire consequences of out-of-control deficits, it seemed like a good time to sit down and ask Gross how dire the situation was. Is the United States really heading for an epic showdown with the debt markets? And if it comes, how badly will we be hurt?

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