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Your Global Investment Authority

Policy responses to the global economic crisis: Too little, too late? Andrew Bosomworth, Managing Director 2 November 2012, Riga, Latvia

This publication is distributed for educational purposes only. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission.

PIMCO Europe Ltd (Registered in England and Wales, Company No. 2604517) Registered Office, 11 Baker Street, London, W1U 3AH, United Kingdom. Tel: +44.20.3640.1000. Authorised and Regulated by the Financial Services Authority (25 The North Colonnade, Canary Wharf, London, E14 5HS). (Presented in Latvia)

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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

It's not the quantity, it's the mix that matters

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Too much reliance on monetary policy

As of 30 September 2012 SOURCE: PIMCO, Eurostat, ONS, BoE, ECB, Bloomberg

0%

5%

10%

15%

20%

25%

30%

35%

'07 '08 '09 '10 '11 '12

Balance sheet as % of GDP ECB BOJ BOE FED

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The biggest banks in the world

As of September 2012 SOURCE: Haldane AG (2009), Deutsche Bank calculations (from 2007), PIMCO

0%

5%

10%

15%

20%

25%

30%

35%

1830 1850 1870 1890 1910 1930 1950 1970 1990 2010

Perc

ent o

f GD

PCentral bank balance sheets BoE ECB Fed

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No counter factual evidence, but difficult to believe this is purely cyclical

As of 26 October 2012 SOURCE: Bureau of Labor Statistics, Haver Analytics

05

101520253035404550

'50 '55 '60 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10

Wee

ks a

nd %

Duration and share of long-term unemployment (U.S.

Duration of unemployment (weeks)% of unemployed longer than 27 weeks

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Unconventional monetary and fiscal policies force investors to take more illiquidity and credit risk

Refer to Appendix for additional risk information.

Quantitative Easing's 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 consumption

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Unconventional policies drive a wedge between valuation of financial assets and real economy

As of 19 September 2012 SOURCE: Bloomberg Refer to Appendix for additional index information.

600

700

800

900

1,000

1,100

1,200

1,300

1,400

1,500

2008 2009 2010 2011 2012

S&P

500

Inde

x le

vel

Fed balance sheet programs and the S&P 500

-41%

+36%

-10%

+26%

-14%

+24%

QE1 QE2

Operation Twist

QE3

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Persistent current account imbalances are unsustainable inside a monetary union

As of September 2012 SOURCE: Eurostat, PIMCO

Surplus countries: Belgium, Finland, Germany, Luxembourg, Netherlands

Broadly balanced countries: Austria, France, Ireland, Italy

Deficit countries: Cyprus, Estonia, Greece, Malta, Portugal, Slovakia, Slovenia, Spain

-12-10-8-6-4-202468

'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12

% G

DP

Current account balances

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Thank you, ECB: Other EU countries with fixed exchange rates adjusted much faster

As of September 2012 SOURCE: Eurostat, PIMCO

-18

-16

-14

-12

-10

-8

-6

-4

-2

0

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

% G

DP

Current account balances:EMU outs with fixed exchange rates Bulgaria, Latvia, Lithuania, Romania

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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

The rationale for federalism

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Nation building: ECB is compensating for deficiencies in fiscal policy

As of September 2012 SOURCE: Eurosystem National Central Banks, ECB, Haver PIMCO

Federal government expenditure (2011, as % of GDP) Australia 25% United States 24% Canada 15% Spain 14% Germany 13% Switzerland 11% European Union 1%

Monetary policy is over-compensating for deficiencies in the distribution of fiscal policy

Surplus countries: Belgium, Finland, Germany, Luxembourg, Netherlands

Broadly balanced countries: Austria, France, Ireland, Italy

Deficit countries: Cyprus, Estonia, Greece, Malta, Portugal, Slovakia, Slovenia, Spain

-800

-600

-400

-200

0

200

400

600

800

1,000

'07 '08 '09 '10 '11 '12

EUR

billi

on

Banks' net borrowing from the ECB

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Nation building: A democratic fiscal authority is needed to complete EMU

SOURCE: PIMCO Sample for illustrative purposes only

Political and fiscal union Goals Common fiscal capacity with fiscal

agency empowered to override deviations in national budgets Common legislature Constraints Democratic legitimacy and

popular acceptance

× Structural reforms Goals Deliver fiscal savings and economic growth Improved competitiveness, labour market

flexibility and reduce barriers to entry Constraints Social costs of reforms (high

unemployment) Tolerance for above-target

inflation in core

Liquidity Goals Unblock transmission mechanism Eliminate convertibility risk Constraints Can only buy time, cannot address

insolvency Democratic legitimacy

Agreed in principle but partially or not yet implemented Implemented Not started ×

Firewall Goals Direct recapitalization of banks

(via ESM) Single Supervisory Mechanism (SSM) Common deposit insurance scheme Resolution Authority Constraints Creditor-debtor burden sharing

× ×

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Appendix

Past performance is not a guarantee or a reliable indicator of future results. CORRELATION The 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 time periods that can result in greater volatility. CREDIT QUALITY The 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 credit worthiness of such issues/issuer and generally range from AAA, Aaa, or AAA (highest) to D, C, or D (lowest) for S&P, Moody's, and Fitch respectively. FORECAST Forecasts, 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 or investment product. There is no guarantee that results will be achieved. HYPOTHETICAL EXAMPLE Hypothetical 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 actual results. 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 all of which can adversely affect actual results. No guarantee is being made that the stated results will be achieved. INVESTMENT STRATEGY There 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 during periods of downturn in the market. OAS The Option Adjusted Spread (OAS) measures the spread over a variety of possible interest rate paths. A security's OAS is the average return an investor will earn over Treasury returns, taking all possible future interest rate scenarios into account. OUTLOOK Statements 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 each investor 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 STRUCTURE Portfolio structure is subject to change without notice and may not be representative of current or future allocations.

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Appendix

RISK Each 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 of principal 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 interest rates, 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 to principal 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 in emerging markets. INDEX DESCRIPTIONS Barclays 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 only including 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 by emerging 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-sovereign entities: 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 emerging markets.

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, domestic currency 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 Index consisted 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.

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Appendix

INDEX 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 be considered 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 not guaranteed. 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 and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Allianz Asset Management of America L.P. and Pacific Investment Management Company