Treasuries are most brazen Ponzi scheme ever, says Gross

American treasuries are the most brazen Ponzi scheme of all time, according to Bill Gross, the managing director of Pimco, the world’s largest private bond investor.

In a note released ahead of the American mid-term elections on Tuesday, Gross says the Federal Reserve is helping to fuel a gigantic bubble in the asset class, which in his words has turned into a “Sammy scheme”.

The Fed will most likely continue to inflate the bubble on Wednesday by announcing a second round of quantitative easing (QE2), Gross says.

The new round will exchange government bonds on institutions’ balance sheets for cash, increasing demand for treasuries and freeing up money for lending.

In theory, this should help create growth, 2% inflation and jobs if it is lent out to the real economy, but Gross says it may not, given that America is deleveraging, not demanding more credit. (article continues below)

“We are, as even some Fed governors now publically admit, in a “liquidity trip”, where interest rates or trillions in QE2 asset purchases may not stimulate borrowing or lending because consumer demand is just not there. Escaping from a liquidity trap may be impossible, much like light trapped in a black hole,” he says.

“Ben Bernanke, however, will try – it is, to be honest, all he can do. He can’t raise or lower taxes, he can’t direct a fiscal thrust of infrastructure spending, he can’t change our educational system, he can’t force the Chinese to revalue their currency – it is all he can do, and as he proceeds, the dual questions of “will it work” and “will it create a bond market bubble” will be answered.”

Gross says QE2 may stimulate bonds in the short term, but eventually it may stoke higher inflation somewhere in the financial system, which would harm the bond markets.

“Bondholders, while immediate beneficiaries, will likely eventually be delivered on a platter to more fortunate celebrants, be they financial asset classes more adaptable to inflation such as stocks or commodities, or perhaps the average American on Main Street who might benefit from a hoped-for rise in job growth or simply a boost in nominal wages, however deceptive the illusion,” he says.