Legendary bond investor Bill Gross, co-founder of PIMCO which manages nearly $2 trillion, believes that our credit-based economy’s days are numbered. Our banking system is based on fractional reserves, whereby a bank with $10 in deposits can loan out $100 and in effect “create” an extra $90 of capital that can be put to productive use. The depositor wins because they earn interest, the bank wins because it makes a profit on the spread between what it pays depositors and what it earns in interest and the borrower wins because they believe they can earn more than the borrowing cost on the money.
This model now is being pushed to its limit. In the 1980s, it took $4 in new credit to create $1 in of GDP growth. Now it takes over $20 in new credit to create that same dollar in growth. Total U.S. credit outstanding surpasses $56 trillion and much of today’s borrowing is done simply to cover interest payments which isn’t a productive use of the money. Borrowing to pay interest on borrowed money doesn’t make anything, doesn’t create jobs and doesn’t add value to our economy.
When credit is no longer put to productive use and investors no longer believe that the measly interest rates earned on lending money are worth the risk, our economy will freeze, leading to high rates of inflation and low growth.
Gross believes investors should consider: putting their money into assets which offer protection against inflation, investing in countries with less debt and more conservative credit systems and transitioning from financial assets to real assets at the margin like gold and commodities.
Read the full article at PIMCO Investment Insights.
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