Gundlach on the Key Threat to Global Economies

by Robert Huebscher, 12/20/11

If class warfare is to be the dominant theme in next year’s presidential campaign, it will revive the premise of Ernest Hemingway’s 1937 novel, To Have and Have Not, which he wrote in the midst of the second downturn of the Great Depression.  That was also the title Jeffrey Gundlach gave his conference call with investors last week, during which he warned that wealth inequality will threaten European and domestic economies.

In Hemingway’s novel, the protagonist, Harry Morgan, is forced into criminal activity in order to care for his family.  The wealth polarization of the 1920s and 1930s – which Gundlach said the discourse of the Occupy movement recalls – figures prominently in the story.

Gundlach is the founder and chief investment officer of Doubleline Capital, where he manages its flagship Total Return Fund.  The slides from his presentation are available here.

“When you have wealth polarization, not only do you get a big share of wealth going to the top one percent, but you get a lot more people showing up at the bottom,” Gundlach said. “Clearly, that is problematic; it is difficult for the budget, and it is difficult for a happy society.”

Last week also saw Morningstar pass over Gundlach as a candidate for its fixed-income manager of the year award, so we’ll look at whether that decision made sense.  I’ll also review a few of Gundlach’s more provocative forecasts from last week’s call, but first let’s look at what Gundlach said were the problems posed by wealth inequality. 

The haves and have-nots

Wealth inequality can be traced to growing fiscal deficits, Gundlach said.  Federal debt began to escalate around 1980, he said, and since that time the top fifth of the population got almost all of the wage gains.

“One could make a very simplistic but somewhat convincing argument that this debt-based scheme looks like the country took on a bunch of money and gave it to the top 20% of the population,” he said.
Although he acknowledged that the underlying causes of wealth inequality are much more nuanced, he said that message may resonate with a significant fraction of the population.

Meanwhile, he said, the bottom fifth of the population slightly lost income over that time period.

Societal awareness of phenomena lags actual changes by a number of years, he said. The peak of income inequality was in 2007, according to Gundlach, and wealth has actually been more evenly distributed since then.

But it is a dominant theme today, affecting governments across the globe.

Gundlach said that 2011 will be remembered for the fight over the debt ceiling and the growing awareness of the need to deal with the budget deficit.   He warned, however, that confronting the deficit would cause the US economy to “go sharply into the negative, just like it has in the austerity-program-ridden sections of peripheral Europe.”

Income inequality is not unique to the US, he said.  Most of the countries in the world are experiencing more polarized wealth, he said, but nowhere is that tension as extreme as it is in Europe.

In Europe, the “haves,” like Germany and France, are distinguished from the “have-nots” (which include virtually every other country) by the strength of their public sectors, he said.

Unfavorable demographics are exacerbating wealth inequality in Europe.  Gundlach said that in Italy there are three workers per retiree and in 20 years there will be two and in 30 years there will be 1.5 per retiree.  “If you have stress at three workers per retiree, how much worse is it going to be at one-and-a-half workers per retiree? This is a really big problem,” he said.