Bill Gross: "Credit Supernova!"

Tyler Durden's picture

First Seth Klarman, then Paul Singer, and now Bill Gross: the respected voices speaking up against the lunatics in the Marriner Eccles asylum is getting louder and louder.

From PIMCO's Bill Gross

Credit Supernova!

This is the way the world ends…
Not with a bang but a whimper.
T.S. Eliot
They say that time is money.* What they don’t say is that money may be running out of time.
There may be a natural evolution to our fractionally reserved credit system which 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 don’t 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 finance’s 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 – 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 towards 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.
Minsky’s 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 which acknowledged recession and then rejuvenation once the system’s 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 four dollars 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. Minsky’s 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, today’s 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.


Investment Strategy
If so then the legitimate question is: how much time does money/credit have left and what are the investment consequences between now and then? Well, first I will admit that my supernova metaphor is more instructive than literal. The end of the global monetary system is not nigh. But the entropic characterization is most illustrative. Credit is now funneled increasingly into market speculation as opposed to productive innovation. Asset price appreciation as opposed to simple yield or “carry” is now critical to maintain the system’s momentum and longevity. Investment banking, which only a decade ago promoted small business development and transition to public markets, now is dominated by leveraged speculation and the Ponzi finance Minsky once warned against.
So our credit-based financial markets and the economy it supports are levered, fragile and increasingly entropic – it is running out of energy and time. When does money run out of time? The countdown begins when investable assets pose too much risk for too little return; when lenders desert credit markets for other alternatives such as cash or real assets.
Visible first signs for creditors would logically be 1) long-term bond yields too low relative to duration risk, 2) credit spreads too tight relative to default risk and 3) PE ratios too high relative to growth risks. Not immediately, but over time, credit is exchanged figuratively or sometimes literally for cash in a mattress or conversely for real assets (gold, diamonds) in a vault. It also may move to other credit markets denominated in alternative currencies. As it does, domestic systems delever as credit and its supernova heat is abandoned for alternative assets. Unless central banks and credit extending private banks can generate real or at second best, nominal growth with their trillions of dollars, euros, and yen, then the risk of credit market entropy will increase.
The element of time is critical because investors and speculators that support the system may not necessarily fully participate in it for perpetuity. We ask ourselves frequently at PIMCO, what else could we do, what else could we invest in to avoid the consequences of financial repression and negative real interest rates approaching minus 2%? The choices are varied: cash to help protect against an inflationary expansion or just the opposite – long Treasuries to take advantage of a deflationary bust; real assets; emerging market equities, etc. One of our Investment Committee members swears he would buy land in New Zealand and set sail. Most of us can’t do that, nor can you. The fact is that PIMCO and almost all professional investors are in many cases index constrained, and thus duration and risk constrained. We operate in a world that is primarily credit based and as credit loses energy we and our clients should acknowledge its entropy, which means accepting lower returns on bonds, stocks, real estate and derivative strategies that likely will produce less than double-digit returns.
Still, investors cannot simply surrender to their entropic destiny. Time may be running out, but time is still money as the original saying goes. How can you make some?
(1) Position for eventual inflation: the end stage of a supernova credit explosion is likely to produce more inflation than growth, and more chances of inflation as opposed to deflation. In bonds, buy inflation protection via TIPS; shorten maturities and durations; don’t fight central banks – anticipate them by buying what they buy first; look as well for offshore sovereign bonds with positive real interest rates (Mexico, Italy, Brazil, for example).
(2) Get used to slower real growth: QEs and zero-based interest rates have negative consequences. Move money to currencies and asset markets in countries with less debt and less hyperbolic credit systems. Australia, Brazil, Mexico and Canada are candidates.
(3) Invest in global equities with stable cash flows that should provide historically lower but relatively attractive returns.
(4) Transition from financial to real assets if possible at the margin: buy something you can sink your teeth into – gold, other commodities, anything that can’t be reproduced as fast as credit. Think of PIMCO in this transition. We hope to be “Your Global Investment Authority.” We have a product menu to assist.
(5) Be cognizant of property rights and confiscatory policies in all governments.
(6) Appreciate the supernova characterization of our current credit system. At some point it will transition to something else.
We may be running out of time, but time will always be money.
Speed Read for Credit Supernova
1) Why is our credit market running out of heat or fuel?
a) As it expands at a rate of trillions per year, real growth in the economy has failed to respond. More credit goes to pay interest than future investment.
b) Zero-based interest rates, which are the result of QE and credit creation, have negative as well as positive effects. Historic business models may be negatively affected and investment spending may be dampened.
c)  Look to the Japanese historical example.
2) What options should an investor consider?
a) Seek inflation protection in credit market assets/ shorten durations.
b) Increase real assets/commodities/stable cash flow equities at the margin.
c) Accept lower future returns in portfolio planning.
William H. Gross
Managing Director
* The terms “money” and “credit” are used interchangeably in this IO.  Purists would dispute the usage and I would agree with them, arguing for the usage for simplicity’s sake and the evolving homogeneity of the two.

† Outstanding credit includes all government debt as well as corporate, household and personal debt. Does not include “shadow” debt estimated at $20-30 trillion. [ZH: emphasis ours]


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kliguy38's picture

CONfidence is the only thing backing this paper fiat and that left town a long time ago

Say What Again's picture

When all this paper "money" really hits the street the result will be hyper-inflation.  Let's see, what should I buy in preparation for this inflation?

Pladizow's picture


As Jim Grant has said, "Return Free Risk."

Say What Again's picture


But wait, Mandy just told me they're the only place to get any return at all! 

I feel so conflicted!

Say What Again's picture

There is no way the Bernank will allow RUT, INDU, etc. to be down for two days in a row.  Therefore, we can conclude that we should buy early today and sell on the close.
That was easy.

Dr. Richard Head's picture

I guess that is the "productivity" that Bill was referring to when he wrote "Banking and central banks were and remain essential elements of a productive global economy."  I love how these money managers mix in truth with non.

trav777's picture

Bill Gross:  "waah waah waah waaah waaaaah"

Somebody call the fkin waahmbulance for this idiot.  He made ALL OF HIS MONEY on this credit boom, by having AUM and being able to just BUY STUFF and get paid a free yield for doing NOTHING.

He's lived his whole life off of OTHER people's efforts!  That's what bonds ARE.  The money Gross plays with came from thin air- all of it.  And NOW he's complaining??  Why?  Because he's not getting his EASY YIELD anymore.

In Gross's mind there should BE NO RISK to his money.  He should get paid yield just to sit there.  Mansions, moats, jets...all his entitlements for having "AUM" and some insider tips.

Dr. Richard Head's picture

God Trav, I love a non-gay kind of way.

Spirit Of Truth's picture

In other words, addiction to debt is like addiction to crystal meth.  Someone should do a before and after meth addict portrayal of Bernanke.  This would be a good image to use:

EnslavethechildrenforBen's picture

The Dollar is not backed by confidence, it's backed by stupidity.

GOLD bitchez

THX 1178's picture

This is the way the world ends. Not with a bang but a whimper. Hmm. I disagree.

TPTB_r_TBTF's picture

The World is not ending.


high-tech civilization is ending.


The few survivors will go back to the basics.

The World will still be here...

Jack Napier's picture

The new world will begin with a bang. The old world will fizzle out as it becomes obsolete with only the ignorant and bloodsuckers clinging to its cold comfortability. Get with the times or get out of the way bitchez. Buy gold and silver if you don't want to be a broke beggar or a thief on the next page. If you live by sword, you'll die by it.

derek_vineyard's picture

Trav is right on the money.  Interest in real terms used to be near risk-less.  The world has changed.  Money is not easy to make. Its survival of the fittest.  I suspect the younger generation won't tolerate this crony fucking bullshit.  I'm thinking the internet will be their weapon.  But, then, there are Zucken-fuckers amongst their group.  They may become more savage than even our generation to aquire money.  Or many may just not reproduce  and detach.

trav777's picture

Gross is facing the very ugly possibility of having to actually DO something productive to earn a yield and that means getting dirty and it means RISK.

The only decent alpha yields are in tobacco stocks and some pipeline LPs and stuff like that.  The days of earning 5% off of a risk-free sovereign are gone.

Gross will have to get off his @ss and deal with some geopol risks and all of the other risks that us little people have to navigate whenever we deploy money to this or that "investment."

CrashisOptimistic's picture

A yes, the moat.

Maybe it should be built around an oil well, or a gasoline truck.

eclectic syncretist's picture

Bubble, then turmoil, uncertainty, confusion, and plunge.

mightycluck's picture

Is this guy right?

Worst economic recovery since 1882? If so, Gross may be right.

smlbizman's picture

am i the only one who thinks these tip bonds are not worth a an inflation protected bond where the inflation is rigged....

redpill's picture

Of course they are a scam, the government figures if you are going to try to "stick it to them" by investing in something indexed to inflation, they'll just fudge the numbers on the measurement and "share" your profit with you.  Make no mistake, manipulated inflation statistics represent deliberate and calculated fraud and theft by our government.  Bill Gross is a bond man so it's hard to tear him away from the notion of buying them in some form,

ATM's picture

(5) Be cognizant of property rights and confiscatory policies in all governments.


Seems to be a warning to avoid all government issued or manipulated markets. Really doesn't that mean everythng and anything that is in your personal possession? Real Estate can be confiscated and stock certificates, bonds, savings accounts, checking accounts, insurance contracts are all claims made against someone or something else.

PMs, art, collectibles, etc..... I can pack them up and leave wherever I am for somewhere else. I may get robbed on the way but I know that I will get robed with these others eventually.

I will take my chances....

redpill's picture

And truly getting your money out of the country has a price. The feds are getting savvy on financial accounts, leaning on different countries to tell them whatever they want to know. An offshore banking account is no longer out of reach, and if they can get to it, you really haven't gotten it out of the country. If I had to make a quick move I'd probably take the cash and get a nice watch to resell at my destination. Sure you'll take a hit on it since you'll have to sell it to another dealer below retail, but once you conduct that transaction the money will be out of the reach of the us gov't. And obviously the TSA goons don't know a Patek Phillipe from a Seiko, so there should be no probs there.

DeadFred's picture

You're implying that the gov. won't be honest and pay you the full amount of inflation? That it might just fudge the numbers to keep its payments lower than they should be? You must be paranoid (doesn't mean you're wrong). A double major in Econ and Creative Writing is a guaranteed job with the BLS.

Groundhog Day's picture

Gross says look to Japan on expansion of credit and the outcomes and at the same time he says expect more inflation? Japan is in a deflationary death spiral.  Sounds contradictory to me

Say What Again's picture

There goes a supernova  

What a pushover-yeah  

There goes a supernova

What a pushover


We're a long way from home.

Welcome to the Pleasuredome!

mcl2177's picture


Bad Attitude's picture

Yup, beans, bullets, and bandages. Too bad Dear Leader created a run on guns and ammunition.

For what it's worth, shotguns and their ammunition are still relatively plentiful.

Theosebes Goodfellow's picture


(5) Be cognizant of property rights and confiscatory policies in all governments.

(6) Appreciate the supernova characterization of our current credit system. At some point it will transition to something else.


(7) Understand that anything you own that you do not posess may not be yours or does not exist.



Thomas's picture

Holy shit! It's like Bill Gross is channelling Doug Noland.

Say What Again's picture

I was thinking more like Carl Sagan.

"Billions and Billions of stars"

Or should I say; "Trillions and Trillions of FRNs."


viahj's picture

more FRNs in existence than the combined stars in 10 Milky Way sized galaxies?

we're fucked

fomcy's picture

Looks like Mr. Market logic is More they Print lower Metal prices go.
Gold again manipulated this morning and dropped like a rock. Few cents up daily
then Thursday/Friday all gains wiped out in 2 hours. Miners at 5 years low.
I see Bernanke fingerprints all over the chart. When they stop this BS already?
It's been going on for months now.

ATM's picture


Bad place to be. They will all be know, for the public good. Fuck the shareholders. They're nothing but greedy capitalists and hoarders.

Stoploss's picture

Perfect..  I like the supernova theme.  After all, the barbarous relic not known as money is created by a supernova explosion, and nothing else. Gold cannot be created with out the supernova.

daxtonbrown's picture

Wow, this article could have been written by Tyler, or many of the readers on zero hedge. It dowsn't change what I know, but it might change the thinking of some of my family and partners.

eddiebe's picture

Kliguy, I disagree. Confidence has not even begun to leave town. Do you own gold? Do you price it in fiat? How many people do?

If and when confidence in fiat finally does begin to wane in the Western world, who knows how massive the effects will be? My guess is that for the PM's the move will be spectacular and much unlike what we are witnessing as I type this.

kliguy38's picture

CONfidence in "the system" backs fiat. We only have the military levitating the system which still provides a support. CONfidence lost in the system of government, laws, an morality is a travesty to Nature's law and you can manipulate that for awhile but eventually Nature's law will dominate. "What goes up...does come down"

TideFighter's picture

What options should an investor consider?

a) buy gold

b) buy gold

c) buy gold

Fixed it for ya', Bill.

EscapeKey's picture

I had a debate with some fucking moron the other day who suggested that gold was a bad investment because "we might just discover huge new ores" and consequently "that the US Dollar was by far the safer asset".

Yes, moron, because the fact that they're printing £1tn/yea (no doubt going up anytime soon) is in no way equivalent to "discovering huge new ores" every day!

francis_sawyer's picture

On the subject of 'morons' & 'mining' [for ores]... Riddle me this...


There are what?... About $150 million dollars worth of BITCOINS out there?...


The FED is printing $85 billion A MONTH to keep the fiat ponzi going... That's what? $2.7 billion a day [or a little more than a billion an hour]... So basically, in about much time as it takes for a Bitcoin geek to drive down to 7-11, get a hotpocket, & nuke it in the microwave, the FED will have printed the entire notional value of all the Bitcoins in existence...

But they ARE LEGION!... [they'll tell you so themselves]...

Now take that argument to it's next possible step...

All the holders of 'fiat wealth' in the world... [All the Rothschilds, & dark monied interests ~ forget about Buffett & Gates, they're just piss ants]... ALL of them, COMBINED, are supposed to wake up tomorrow & say "Oh shit ~ we missed out on this BITCOIN thing, we'd better go get us some... So they proceed to exchange some fiats for some... I'll leave aside the fact that if BITCOIN owners were so enamored with their currency, why the hell would they want to sell them for FIATS in the first place?...

But let's say it happened anyway... IOW ~ I guess we're supposed to logically assume that the families who have accumulated their so-called "wealth" [& the entire power matrix that goes along with that], over CENTURIES, which required countless wars, murders, extortions, etc. & have endeavored to KEEP this money & power within tightly knitted family structures], are just going to make a few computer geeks the new POWER BROKERS in the world...

Nice try...

EscapeKey's picture

oh look, it's our resident bitcoin "expert".

fuu's picture

Naw, it's just francis.

LasVegasDave's picture

you are much more effective when you are blasting the Yids for ruling the world.

Stay with your best pitch, asshole

francis_sawyer's picture



It sems like YOU (& others like Dr. Engali) are more interested in, [your word] 'YIDS', than francis_sawyer is... I made zero mention of them above... The other day, Engali did the same thing... Brought the subject up, unattached...

So it must be YOU PEOPLE who are 'closet cases' on the subject... 


Instead of quipping about the subject [as above] ~ why don't you explain to me [in the context of my argument], how BITCOIN is going to supercede the OPERATIONAL aspects of my scenario...

Tell me what's going to happen... Is Warren Buffett going to just pull out his wallet & buy all the BITCOINS in the world tomorrow?... & even if he DOUBLED or TRIPLED his value offer (took it to, say, a half a billion)... My guess is that all you bitcoin holders would be scrambling to exchange them into fiats as fast as you could...

Or no, wait... At the point that WHALES arrive, they could just PRINT MORE bitcoins to accomodate the flow... But no wait... The CAN'T PRINT more bitcoins can they?... It goes against the principle of the whole thing...