Oh My, Bill [Gross] — ‘Ya Getting Nervous?
Hoh hoh hoh hoh hoh…. (in my best “Jabba The Hut” imitation)
A credit-based financial economy (as opposed to pure cash) depends on an ever-expanding outstanding level of credit for its survival. Without additional credit, interest on previously issued liabilities cannot be paid absent the sale of existing assets, which in turn would lead to a vicious cycle of debt deflation, recession and ultimately depression.
You forgot the word compounded, which is another word for exponential.
The unmodeled (for lack of historical example) experiment that all major central banks are now engaged in is to ask and then answer: What growth rate of credit is enough to pay prior bills, and what policy rate/amount of Quantitative Easing (QE) is necessary to generate that growth rate? Assuming that the interest rate on outstanding debt in the U.S. is approximately 4.5% (admittedly a slight stab in the dark because of shadow debt obligations), a Fed governor using this template would want credit to expand by at least 4.5% per year in order to prevent the necessary sale of existing assets (debt and equity) to cover annual interest costs.
Oh now that’s kind of an ugly thought, isn’t it?
You probably didn’t catch the “why” intuitively, but you should have. If this is the amount of credit expansion necessary then the depreciation in fixed terms of the same currency must be 4.5%. This in turn means that your earned income must rise by at least that amount or your purchasing power, that is, what you can buy, will decrease.
This, if it occurs, will cause you to try to access even more credit in order to make up the difference. That appears to be ok, except that every dollar of said credit you access depreciates your net worth and creates an additional forward demand on your cash flow into the future to pay both the principal and interest due.
In other words it raises the amount of your income expansion that must take place to stay “even” into the future by more than the 4.5%!
This is a problem because, as I discuss early on in my book Leverage, two compound functions where one has a higher growth rate than the other inevitably run away from one another over time.
They don’t track one another, they accelerate away from each other. That in turn means that eventually you cannot pay your bills — the exactly crash that Bill puts forward!
This is an inherent mathematical property that cannot be changed!
This global monetary experiment may in the short/intermediate term calm markets, support asset prices and promote economic growth, although at lower than historical levels. Over the long term, however, economic growth depends on investment and a rejuvenation of capitalistic animal spirits – a condition which currently does not exist. Central bankers are hopeful that fiscal policy (which includes deficit spending and/or tax reform) may ultimately lead to higher investment, but to date there has been little progress, as seen in Chart 2. The U.S. and global economy ultimately cannot be safely delevered with artificially low interest rates, unless they lead to higher levels of productive investment.
BILL! The premise upon which their expectation rests is impossible for the above reason!
What’s even worse is that we know this doesn’t work because we have more than 30 years of history that proves it on an empirical level.
The ugly part of said empirical evidence is that there was never any reason to believe this “grand experiment” that began around 1980 would work because the desired outcome over the intermediate and longer term was and is mathematically impossible.
The 1987 stock market crash followed the “boomlet” of credit expansion about two years earlier; when it folded back you got the market collapse. The 2000 Nasdaq crash followed the “boomlet” of the 1998-1999 credit expansion relative to GDP. And the 2008 collapse came, as was utterly predictable, from the 2003-2007 credit explosion — an explosion that reached seven times that of GDP expansion.
We’re back at it again, by the way — since 2011. And, as has been the case previously, we are once again whistling along ignoring arithmetic, believing it will all be ok.
It’s rather amusing to read what Bill has to say in this letter, because it is a raw admission that for the last 30 years, on the data, that the so-called “policy” has failed. Not that it might fail in the future, or that the future is uncertain, but that his entire thesis is bankrupt not only as I have asserted must be the case on the math, but it has also been demonstrated to be bankrupt through the last 30 years of actual experience.
Buckle up folks.