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February 01, 2013 at 08:52 AM
In what may be his most apocalyptic monthly letter in a series that for years now has been explicating the “new normal,” PIMCO bond manager Bill Gross is warning investors that America’s money economy is like a supernova—a bright shining star that suddenly burns out.
Titled “Credit Supernova!,” Gross’ February shareholder letter relies on the pioneering work of economist Hyman Minsky, who is credited nowadays for a model thought to have foreseen the recent financial crisis. Nearly 40 years ago, Minsky wrote about “Ponzi finance” that occurs when rapidly accelerating credit is needed just to finance interest payments on debt.
But Gross (left) notes that Minsky formulated his theory at a time when U.S. credit outstanding totaled $3 trillion.
“Today, at $56 trillion and counting,” Gross writes, “it is a monster that requires perpetually increasing amounts of fuel, a supernova star that expands and expands, yet, in the process begins to consume itself.”
As evidence that our credit supernova is burning out, Gross notes that “each additional dollar of credit seems to create less and less heat. In the 1980s, it took four dollars of new credit to generate $1 of real GDP. Over the last decade, it has taken $10, and since 2006, $20 to produce the same result.”
The result is a new normal in which GDP growth has averaged around 2% annually rather than the 3.5% growth Americans have enjoyed over the previous 50 years.
A byproduct of the Ponzi-fueled financial instability of America’s rapid credit creation is the near-zero rate policy, which Gross says “cripple savers and business models previously constructed on the basis of positive real yields and wider margins for loans.”
Because bank lending is less profitable, there is less investment in the economy and an erosion of real growth. Gross cites the case of Japan as a laboratory example of what the U.S. is currently facing. Japan had a decade-long head start on near-zero interest rates, and Japanese investment as a percentage of GDP declined steadily. Gross shows that the same is currently taking place more precipitously in the U.S.
The investment implications of all this are quite ominous. In the current environment, Gross says “credit is now funneled increasingly into market speculation as opposed to productive innovation.” The credit supernova is on track to burn out and he writes that “the countdown begins when investable assets pose too much risk for too little return.”
