In his latest Investment Outlook, PIMCO’s Bill Gross says that the U.S. is heading toward a “credit supernova”, with exponentially rising amounts of credit leading to an eventual implosion of deleveraging.
Gross says that over the years, the U.S. has used more and more credit to produce less and less growth. In the early 1970s, credit outstanding in the U.S. totaled $3 trillion, he says. “Today, at $56 trillion and counting, 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. 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 zero-bound interest rates of the past few years, Gross says, are making the “magic” of credit creation turn destructive. “Net interest margins at banks compress; liabilities at insurance companies threaten their levered equity; and underfunded pension plans require greater contributions from their corporate funders unless regulatory agencies intervene,” he says. “What has followed has been a gradual erosion of real growth as layoffs, bank branch closings and business consolidations create less of a need for labor and physical plant expansion.”
Gross acknowledges that his supernova analogy is “more instructive than literal. The end of the global monetary system is not nigh.” But the point, he says, is that more and more credit is being put into speculation instead of productive innovation. He says a time may well come when “investable assets pose too much risk for too little return”, which would lead to major credit contraction.
That doesn’t mean investors should throw in the towel, Gross says. But he thinks they should plan accordingly. His advice: “Seek inflation protection in credit market assets/ shorten durations; increase real assets/commodities/stable cash flow equities at the margin; accept lower future returns in portfolio planning.”