February, 2013 Archives
by Riaan Nel in News
Bill Gross from PIMCO wrote an excellent article recently titled “Credit Supernova!”. It is a great, but at times a little technical, read. Bill posits that the current global financial system is fragile due to its structure based on fractional reserve banking. He explains how the system evolves toward crisis, and he shares some thoughts on what investors potentially could do.
The global financial system is based on a fractionally reserved credit system. A “fractional reserve system” refers to monetary policy requiring banks to hold only a fraction (typically 10%) of depositors’ funds as cash reserves. The remaining 90% of deposits can be loaned out to create new deposits which in turns create new loans, and so forth. This is known as the multiplier effect. In other words, what Bill is saying is we are living in a world where money is “created” through credit creation – or a little more precise, the money supply is expanded when more and more credit is created.
Bill compares the global fractional reserve financial system to the force of entropy in the universe. The universe is expanding so rapidly that everything will end with a “big freeze” (luckily for us a few trillion years from now.) According to Gross:
“…the advancing entropy in the physical universe may in fact portend a similar decline of “energy” and “heat” within the credit markets.”
Bill references the political economist Hyman Minsky’s financial instability hypothesis (which serves as the theoretical framework of my Master’s thesis examining the 2008 global financial crisis.) Minsky’s main argument was that our current capitalist system was inherently unstable. “Good” economic times eventually produce financial crises.
Bill describes some implications for investors with regard to this fragile financial system. I cannot agree more that credit is currently funneled increasingly into market speculation as opposed to productive innovation. Asset price appreciation is now critical to maintain the system’s momentum and longevity. Again let me quote:
“…our credit-based financial markets and the economy it supports are levered, fragile and increasingly entropic – it is running out of energy and time.”
Bill has the following suggestions for how savings should be positioned:
- Position for eventual inflation.
- Move money to currencies and asset markets in countries with less debt and less hyperbolic credit systems.
- Consider global equities with stable cash flow.
- Start transitioning from financial asset to real assets.
Click here to read the entire article: http://www.pimco.com/EN/Insights/Pages/Credit-Supernova.aspx.
by admin in Global Investments
Here is a link to LPL Financial’s Outlook 2013. I don’t know how their research department came up with the percentage probabilities, but I would say there is a bigger chance of the bear path than what they predict. Maybe 35-40 percent. I agree that the most probable outcome is the compromise path.
http://www.sanddollarinvest.com/pdfs/Outlook2013.pdf. Here is a link to the Youtube summary video of the report: http://www.youtube.com/watch?feature=player_embedded&v=7BEXH3MzquI.