Bill Gross: "The Financial System As We Know It Can Be At Risk"

In his latest monthly investment outlook, Janus Henderson's Bill Gross takes a trip to the dark side of monetary machinations and examines the signals (from credit, yield curves, and bitcoin) to comprehend how long this 'dance' can continue, "until the system itself breaks down."

1. Prior market tops (1987, 2000, 2007, etc.) allowed asset managers to partially “insure” their risk assets by purchasing Treasuries that could appreciate in price as the Fed lowered policy rates. Today, that “insurance” is limited with interest rates so low.

Risk assets, therefore, have a less “insurable” left tail that should be priced into higher risk premiums. Should a crisis arise because of policy mistakes, geopolitical crises, or other currently unforeseen risks, the ability to protect principal will be impaired relative to history. That in turn argues for a more cautious and easier Fed than otherwise assumed.


Economists prior to Keynes viewed “modeled” as well as “real time” economies as self-balancing, but subject to imbalances from external shocks like oil prices. Rarely did theory incorporate finance and credit as one of those potential earthquakes.


It took Hyman Minsky to change how economists view the world by introducing the concept of financial stability that leads to leverage and ultimate instability. He alerted economists to the fact that an economy is a delicate balance between production and finance. Both must be balanced internally and then the interplay between them balanced as well.

2. Credit creation begins at the central bank level, but in reality is predominantly expanded via fractional reserve banking and near zero reserved shadow banks.

This model allows substantial leverage and can overprice AAA assets at the core then expand outward until it reaches the periphery of financial markets. At that point or even before, credit usually leaks out into the real economy via purchases of real assets, plant and equipment, commodities and other factors of production. It is this process that has become the operating model for 20th and 21st century capitalism – a system which ultimately depends on asset prices for its eventual success.


This model, however, is leverage dependent and – 1) debt levels, 2) the availability, and 3) cost of that leverage are critical variables upon which its success depends. When one or more of these factors deteriorates, the probability of the model’s success and stability go down.

3. Our entire financed-based system – anchored and captained by banks – is based upon carry and the ability to earn it.

When credit is priced such that carry can no longer be profitable (or at least grow profits) at an acceptable amount of leverage/risk, then the system will stall or perhaps even tip. Until that point, however (or soon before), investors should stress an acceptable level of carry over and above their index bogies. The carry may not necessarily be credit based – it could be duration, curve, volatility, equity, or even currency related.


But it must out carry its bogey until the system itself breaks down. Timing that exit is obviously difficult and perilous, but critical for surviving in a new epoch. We may be approaching such a turning point, so invest more cautiously.

4. Money/cash is different than credit.

High-quality credit can at times take the place of money when its liquidity, perceived return, and safety of principal allow for its substitution.


When the possibility of default increases and/or the real return on credit or liquidity decreases and persuades creditors to hold classical “money” (cash, gold, bitcoin), then the financial system as we know it can be at risk (insurance companies, banks, mutual funds, etc.) as credit shrinks and “money” increases, creating liquidity concerns.

5. Someone asked me recently what would happen if the Fed could just tell the Treasury that they ripped up their $4 trillion of T-bonds and mortgages.

Just Fugetaboutit! I responded that that is what they are effectively doing. “Just pay us the interest”, the Fed says, “and oh, by the way, we’ll remit all of that interest to you at the end of the year”.


Money for nothing – The Treasury issuing debt for free. No need to pay down debt unless it creates inflation. For now, it is not. Probably later.

Have a great December.

Be careful in 2018.


vofreason MonetaryApostate Thu, 12/07/2017 - 11:19 Permalink

Maybe but when?!?!?.......seems we've all known this for so long yet nothing happens.  The dummies in the public that just think if the economy does well the stock market will go up and pay no attention to price think all is well.  Everyone should have bought gold up to $10,000 while fleeing treasuries and stocks after QE began .....but they didn't.  I don't have any faith in the average person "waking up" until the market crashes and then there will be more printing and more excuses just like last time so I just don't see how this doesn't continue for a long time.  I really wish people would realize that a legitimately gold backed crypto would be an amazing fix to all this ..... but they won't.  

In reply to by MonetaryApostate

LawsofPhysics Thu, 12/07/2017 - 09:14 Permalink

Retire already Bill!  It was a good run and you have a nice spread in Corona Del Mar.  Just shut the fuck up already.  You know the Fed will buy all your paper, gloating at this point just makes you look like an arrogant ass. You must be on the Fed's payroll because you know damn well that it is The Fed that has been issuing debt for FREE (ZIRP) to the bankers and financiers, NOT the treasury.

wmbz Thu, 12/07/2017 - 09:13 Permalink

"Our entire financed-based system"Correction... "debt-based" system.  Every "dollar" that enters into the system is borrowed.

bshirley1968 Thu, 12/07/2017 - 09:17 Permalink

"Can be"?  "As we know it"?WTF!?  Get out of here!  Who is this guy?  Where has he been?  And who is he talking to?500 "experts" parroting the same thing.......pointing out the obvious.  Kudos!  Lmao

buzzsaw99 Thu, 12/07/2017 - 09:37 Permalink

bill has lost his mind.  he's a blithering fool now.  he talks like some of the biggest idiots ever in the history of the zh comments section.  divorced from reality entirely.

myopinion Thu, 12/07/2017 - 11:24 Permalink

Right or wrong; rational or irrational Bitcoin and the digital currency space has become a voting machine.  A statement to the loss of faith and trust in governments worldwide. 

Roger Ramjet Thu, 12/07/2017 - 12:39 Permalink

Just one problem with point #5, the Fed isn't just remitting the interest back to the U.S. Treasury, first they are paying out interest to the large member banks on the Excess Reserve Balanaces held at the Fed. Currently there are over $2.7 trillion in excess reserves, currently earning interest at an annualized rate of 1.25%.  That means that the big banks are receiving over $27 billion annually for essentially doing nothing (after all the Fed simply created these reserves out of thin air).  That's why Goldman Sachs all of the sudden converted into a depository bank back in 2008, remember that.  They weren't going to miss out on this gravy train!The bailouts continue to this day!In fact, this is the Fed's biggest balancing act, between raising the rate paid on these excess reserves and reducing the size of excess reserves.  If you push rates up too far, somebody may notice how much is being paid to these banks (and how much is not being remitted back to the Treasury).  Reduce excess reserves too far and you will hurt bank earnings.  Delicate balancing act indeed.Of course the Fed is simply looking out for the interest of the common man.  Right?

Captain Nemo d… Thu, 12/07/2017 - 15:58 Permalink

The solar system as we know it can be an alien reality game. The financial market as we know it can be at risk. Just keep kicking the can down the road and you will go far as a pundit.