Skip to comments.We Are All Going To Die From Inflation Says Bill Gross
Posted on 02/04/2013 3:56:29 PM PST by lbryce
They say that time is money. What they dont say is that money may be running out of time.
There may be a natural evolution to our fractionally reserved credit system that characterizes modern global finance. Much like the universe, which began with a big bang nearly 14 billion years ago, but is expanding so rapidly that scientists predict it will all end in a big freeze trillions of years from now, our current monetary system seems to require perpetual expansion to maintain its existence. And too, the advancing entropy in the physical universe may in fact portend a similar decline of energy and heat within the credit markets. If so, then the legitimate response of creditors, debtors and investors inextricably intertwined within it, should logically be to ask about the economic and investment implications of its ongoing transition.
But before mimicking T.S. Eliot on the way our monetary system might evolve, let me first describe the big bang beginning of credit markets, so that you can more closely recognize its transition. The creation of credit in our modern day fractional reserve banking system began with a deposit and the profitable expansion of that deposit via leverage. Banks and other lenders dont always keep 100% of their deposits in the vault at any one time in fact they keep very little thus the term fractional reserves. That first deposit then, and the explosion outward of 10x and more of levered lending, is modern day finances equivalent of the big bang. When it began is actually harder to determine than the birth of the physical universe but it certainly accelerated with the invention of central banking the U.S. in 1913 and with it the increased confidence that these newly licensed lenders of last resort would provide support to financial and real economies. Banking and central banks were and remain essential elements of a productive global economy.
But they carried within them an inherent instability that required the perpetual creation of more and more credit to stay alive. Those initial loans from that first deposit? They were made most certainly at yields close to the rate of real growth and creation of real wealth in the economy. Lenders demanded that yield because of their risk, and borrowers were speculating that the profit on their fledgling enterprises would exceed the interest expense on those loans. In many cases, they succeeded. But the economy as a whole could not logically grow faster than the real interest rates required to pay creditors, in combination with the near double-digit returns that equity holders demanded to support the initial leverage unless it was supplied with additional credit to pay the tab. In a sense this was a Sixteen Tons metaphor: Another day older and deeper in debt, except few within the credit system itself understood the implications.
Economist Hyman Minsky did. With credit now expanding, the sophisticated economic model provided by Minsky was working its way toward what he called Ponzi finance. First, he claimed the system would borrow in low amounts and be relatively self-sustaining what he termed Hedge finance. Then the system would gain courage, lever more into a Speculative finance mode which required more credit to pay back previous borrowings at maturity. Finally, the end phase of Ponzi finance would appear when additional credit would be required just to cover increasingly burdensome interest payments, with accelerating inflation the end result.
Minskys concept, developed nearly a half century ago shortly after the explosive decoupling of the dollar from gold in 1971, was primarily a cyclically contained model that acknowledged recession and then rejuvenation once the systems leverage had been reduced. That was then. He perhaps could not have imagined the hyperbolic, as opposed to linear, secular rise in U.S. credit creation that has occurred since as shown in Chart 1. (Patterns for other developed economies are similar.) While there has been cyclical delevering, it has always been mild even during the Volcker era of 1979-81. When Minsky formulated his theory in the early 70s, credit outstanding in the U.S. totaled $3 trillion. 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 $4 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. Minskys Ponzi finance at the 2013 stage goes more and more to creditors and market speculators and less and less to the real economy. This Credit New Normal is entropic much like the physical universe and the heat or real growth that new credit now generates becomes less and less each year: 2% real growth now instead of an historical 3.5% over the past 50 years; likely even less as the future unfolds.
Not only is more and more anemic credit created by lenders as its sixteen tons becomes thirty-two, then sixty-four, but in the process, todays near zero bound interest rates cripple savers and business models previously constructed on the basis of positive real yields and wider margins for loans. 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. 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. In effect, the initial magic of credit creation turns less magical, in some cases even destructive and begins to consume credit markets at the margin as well as portions of the real economy it has created. For readers demanding a more model-driven, historical example of the negative impact of zero based interest rates, they have only to witness the modern day example of Japan. With interest rates close to zero for the last decade or more, a sharply declining rate of investment in productive plants and equipment, shown in Chart 2, is the best evidence. A Japanese credit market supernova, exploding and then contracting onto itself. Money and credit may be losing heat and running out of time in other developed economies as well, including the U.S
In other words, just sit back and watch?
We don’t “die” of inflation. At worse, inflation is highly uncomfortable, but as has been shown all over the world, people deal with it on many different levels, beginning with simply dispensing with trying to use the currency in circulation. The first step is to try to find a substitute form of exchange, say some kind of precious goods that have a recognized exchange value, or common goods that have high utility. If neither of these two approaches are available, then the individual is only able to offer his (or her) personal expertise or talents in exchange for the basic necessities of life, i.e., food, shelter and personal care.
Money, as such, is actually a highly artificial construct, based entirely on trust and a common belief that it is somehow a storehouse of value. But a fistful of cruzeiros or pesos is mostly not recognized as that far from the place of its origin, and there has been a concerted effort to strip the US dollar of its value as a representation for wealth.
Even with rampant inflation, people still keep on going.
We're all going to die of old age. Because we're old, the younger generations (our kids) will kill us to get our money. If we don't have any money, then they'll kill us so they won't have to spend it on us.
Is this the same Bill Gross who shorted government debt in 2011 and lost a bundle for Pimco?
Sure. If you trust the planners. :-)
One thing FDR said I agree with: “Nothing in politics happens by accident. If it happens, you can bet it was planned that way.”
Those who think all this is happening by accident are as big fools as those who think a big bang created the universe (and digital computers and iphones and grand skyscrapers and the Mona Lisa and Operation Overlord and so on.)
Perhaps one of the unintentional side effects of Darwinism is that people readily accept happenstance as an explanation for everything they don’t understand. Since history (when it’s taught) is taught only on a superficial level, most people are unable to fathom the plotting and planning that men have done throughout history. (It’s easier to believe Julius Caesar was lucky, for instance, than it is to read and digest his “Gallic Wars”.)
The only real "victims" of inflation are those who own large cash holdings, or those who hold debt instruments valued in dollars that will not change in value over time. Anyone who owns "real" assets -- and by this I mean assets that produce income and/or growth potential that is tied to underlying economic realities and has nothing to do with the nominal value of the asset at any given time -- is not likely to be impacted nearly as much by inflation, since the income and growth tied to that asset will change as currency value changes.
Japan's decades-long problem is its deflationary quagmire, not inflation.
My favorite quote from “Heavy Metal”.......”You die, she dies, everybody dies!”
Deflation is the game played today. We are exporting our inflation to other countries but they are catching on to Ben trickery. Now it’s a race to see who can devalue the fastest. Then one day the worm will turn and inflation will run rampant.
Currently, The stock market is over heated and uncle Ben appears to be pulling out liquidity. He can’t afford inflation to speed up so he uses his tool
box behind the curtain. He knows the risk of raising interest rates and will do anything to avoid higher rates.
Uncle Ben is gambling that the market will strengthen enough to claw back all the QE money floating around as credit. If he is wrong there will be what I call “The Big Reset”. Nothing we can do about it but hold on and watch it happen.
Yes, but in my view, the only thing wrong was his timing, not the end result.
Talk to someone with white hair who lived through the inflation generated by the oil shock under Carter. Ask them about house mortgages that ran 20%. Ask them about the silliness of the politicians, especially (acting) President Ford and his “Whip Inflation Now” buttons.
The coming inflation will screw the low information voters out of all of their disposable income, and the Dems will still find a way to blame it on the Republicans, especially the Tea Party folks.
It may be the same BG, but he is a highly regarded sage.
Helpless? No, not entirely. If you can see that somebody is controlling things, and you understand something of what their goals are, you’re in a better position to adjust and survive than the fellow who subscibes to the “accidental theory of history”.
The American Revolution was a revolution against determinism. The idea that some are born to rule and others born to be ruled was rejected, and a war was fought to settle the argument.
But the idea didn’t go away - and never will. Where King George III failed to convince, Darwin (et al.) would try again. And today those who pull the strings are shrewd enough not to rub our faces in it and thereby risk an uprising.
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