Advertisement
by Chris Becker
The always interesting Bill Gross has released his latest investment outlook, and like a lot of the top advisors and investment gurus out there recently is steering away from stocks, bonds and even private equity. Gold and other “unusuals”, although not quite full “prepper” seem to be the solution, although they are difficult for the individual investor to acquire without derivatives or outside risk.
He has five questions and evocative answers to make here, with my responses in bold after:
- When does our credit-based financial system sputter/break down? When investable assets pose too much risk for too little return. Not immediately, but at the margin, low/negative yielding credit is exchanged for figurative and sometimes literal gold or cash in a mattress. When it does, the system delevers as cash at the core, or real assets like gold at the risk exterior, become the more desirable assets. Deleveraging and deflation is what worries central bankers, not inflation. Negative interest rates on bonds indicate we’re almost there…
- Can capitalism function efficiently at the zero bound? No. Low interest rates may raise asset prices, but they destroy savings and liability based business models in the process. Banks, insurance companies, pension funds and Mom and Pop on Main Street are stripped of their ability to pay for future debts and retirement benefits. Thus requiring either a re-invention of capitalism, or a reboot following a wave of hyperinflation. Both outcomes are also terrifying to central bankers…
- Can $180 billion of monthly quantitative easing by the ECB, BOJ, and the BOE keep on going? How might it end? Yes, it can, although the supply of high quality assets eventually shrinks and causes significant technical problems involving repo, and of course negative interest rates. Remarkably, central banks rebate almost all interest payments to their respective treasuries, creating a situation of money for nothing — issuing debt for free. Central bank “promises” of eventually selling the debt back into the private market are just that — promises/promises that can never be kept. The ultimate end for QE is a maturity extension or perpetual rolling of debt. The Fed is doing that now but the BOJ will be the petri dish example for others to follow, if/ when they extend maturities to perhaps 50 years. This is where a lot of bears get tripped up – this situation can continue, and indeed be “inflated” for a long time – over 8 years now since the GFC and over 20 for the Japanese – and calling the end requires a crystal ball. Or does it?
- When will investors know if current global monetary policies will succeed? Almost all assets are a bet on growth and inflation (hopefully real growth) but in its absence at least nominal growth with some inflation. The reason nominal growth is critical is that it allows a country, company or individual to service their debts with increasing income, allocating a portion to interest expense and another portion to theoretical or practical principal repayment via a sinking fund. Without the latter, a credit-based economy ultimately devolves into Ponzi finance, and at some point implodes. Watch nominal GDP growth. In the U.S. 4-% is necessary, in Euroland 3-4%, in Japan 2-3%. I take issue with Gross’ language here – this is not a credit based system, its a debt-based. Credit does not require “nominal growth with some inflation” because credit can be destroyed once used. A debt based system MUST have inflation to work, because the debt is never destroyed – it is financialised and made an asset.
As for nominal growth, the US is at 3.5%, EU at 2.8% (Germany a little higher) and Japan at 2.5%… - What should an investor do? In this high risk/low return world, the obvious answer is to reduce risk and accept lower than historical returns. But don’t you have to put your money somewhere? Yes, of course, except markets offer little in the way of double digit returns. Negative returns and principal losses in many asset categories are increasingly possible unless nominal growth rates reach acceptable levels.
Advertisement
The full text of this article is available to MacroBusiness subscribers
Cancel at any time through our billing provider, Stripe
Advertisement