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Bill Gross Investment Outlook (March 2017): Show Me The Money

Bill Gross Investment Outlook: Show Me The Money, March 2017

total credit market

  • Banking system can create money out of thin air; by rough estimates, banks and their shadows have turned $3 trillion of “base” credit into $65 trillion+ of “unreserved” credit in the US alone
    • It still mystifies me but fractional reserve banking has been the basis of credit and real economic growth since the system was blessed by central banks over a century ago
  • In 2017, global economy created more credit relative to GDP than that at the beginning of 2008’s disaster
    • In the US, credit of $65 trillion is roughly 350% of GDP and the ratio is rising
    • In China, the ratio has more than doubled in the past decade to nearly 300%
  • Since 2007, China added $24 trillion worth of debt and US and Europe only added $12 trillion each
  • Capitalism depends on credit expansion and the printing of additional reserves by central banks, which in turn are re-lent by private banks to create myriad of other products and business enterprises
    • Credit creation has limits and the cost of credit must be carefully monitored so that borrowers can pay back the monthly servicing costs
    • If rates are too high, then potential Lehman black swan can occur
    • If rates are too low, then the system breaks down, as savers, pension funds and insurance companies become unable to earn a rate of return high enough to match and service their liabilities
  • Central banks attempt to walk this fine line – generating mild credit growth that matches nominal GDP growth – and keeping the cost of credit at a yield that is not too high, nor too low, but just right
  • While recovery has been weak by historical standards, banks and corporations have recapitalized, job growth has been steady and importantly, markets are in record territory
    • But our highly levered financial system is like a truckload of nitro glycerin on a bumpy road
  • One mistake can set off a credit implosion where holders of stock, high yield bonds, and subprime mortgages all rush to the bank to claim its one and only dollar in the vault
    • Happened in 2008 and central banks were in a position to drastically lower yields and buy trillions of dollars via QE to prevent a run on the system
    • Today, central bank flexibility is not what it was back then: yields are near zero
    • Continuing QE programs by central banks are approaching limits as they buy up more and more existing debt, threatening repo markets and the day to day functioning of financial commerce
  • Don’t be lured by the Trump mirage of 3-4% growth and the magical benefits of tax cuts and deregulation
    • US and the global economy are walking a fine line due to increasing leverage and the potential for too high (or too low) interest rates to wreak havoc on an increasingly stressed financial system
  • Be more concerned about the return OF your money than the return ON your money in 2017 and beyond 

Bill Gross, considered the “king of bonds”, is the co-founder and former Co-CIO of PIMCO. He left PIMCO in 2014 and joined Janus Capital as Managing Director and CIO. Janus Capital is an investment firm based in Denver, CO with disciplines across fixed income, equity, global macro, and alternatives. 

Image Source: Reuters
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