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Bill Gross: “Our Financial System Is A Truckload Of Nitroglycerin On A Bumpy Road”

Bill Gross: “Our Financial System Is A Truckload Of Nitroglycerin On A Bumpy Road”

Courtesy of Bill Gross’ latest monthly letter “Show Me The Money“, here are some perspectives on the only thing that has kept the global economy going since the financial crisis: debt, and lost of it.
in 2017, the global economy has created more credit relative to GDP than that at the beginning of 2008’s disaster. In the U.S., credit of $65 trillion is roughly 350% of annual GDP and the ratio is rising. In China, the ratio has more than doubled in the past decade to nearly 300%. Since 2007, China has added $24 trillion worth of debt to its collective balance sheet. Over the same period, the U.S. and Europe only added $12 trillion each. Capitalism, with its adopted fractional reserve banking system, depends on credit expansion and the printing of additional reserves by central banks, which in turn are re-lent by private banks to create pizza stores, cell phones and a myriad of other products and business enterprises. But the credit creation has limits and the cost of credit (interest rates) must be carefully monitored so that borrowers (think subprime) can pay back the monthly servicing costs. If rates are too high (and credit as a % of GDP too high as well), then potential Lehman black swans can occur. On the other hand, if rates are too low (and credit as a % of GDP declines), then the system breaks down, as savers, pension funds and insurance companies become unable to earn a rate of return high enough to match and service their liabilities. 

U.S. Total Credit Market Debt as a Percent of GDP

Chart: U.S. Total Credit Market Debt as a Percent of GDP

Central banks attempt to walk this fine line – generating mild credit growth that matches nominal GDP growth – and keeping the cost of the credit at a yield that is not too high, nor too low, but just right. Janet Yellen is a modern day Goldilocks.

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Canada’s debt-to-income ratio sets new record high at 165%

Canadians now owe $1.65 for every dollar of income they have at their disposal.

Canadians now owe $1.65 for every dollar of income they have at their disposal. (Joe Raedle/Getty Images)

The ratio of household debt to disposable income hit a new record in the fourth quarter of last year.

Statistics Canada says the ratio rose to 165.4 per cent in the fourth quarter, up from 164.5 per cent in the third quarter.

That means Canadian households on average held $1.65 in debt for every dollar of disposable income.

Much of that new debt came in the form of mortgages. “Most of the growth was in mortgage credit, up 6.3 per cent, which has accelerated considerably since 2014 and is now increasing at the fastest pace since late 2012,”  TD Bank economist Diana Petramala said.

The increase came as disposable income increased 0.6 per cent.

However, total household credit market debt, which includes consumer credit and mortgage and non-mortgage loans, increased 1.2 per cent to $1.923 trillion at the end of last year.

The total included $573.6 million in consumer credit debt and $1.262 trillion in mortgage debt.

HOUSEHOLD DEBT RATIO

That 70s show – episode 4

That 70s show – episode 4

Total credit market debt 1840 - present

We have shown in the previous three episodes (episode 12 and 3) how the US economy structurally changed after Nixon took the US off gold, letting the Federal Reserve do what it does best. Obviously, with the “hard” anchor of the US dollar cut loose, the rest followed suit. It is telling that the so-called post-Bretton Wood “gold standard” of all currencies, the Deutsche mark lost 65 per cent of its purchasing power from 1971 to 1990.

Also note that the French, with its inferior Franc lost 84 per cent of its purchasing power over the same, time hated the Germans for it. As a “victorious” nation of the Second World War, the French had a right to veto German unification, and would only agree to re-merge east and west if the Germans would give up their coveted mark and join the euro.

But we digress, in the this episode we will focus on debt levels within the context of unrestrained central banking.

Throughout history the US economy used to be leveraged, on average, 1.5 times GDP; total credit market debt fluctuated more or less within a tight range of maximum one standard deviation from its long term mean. Prior to 1971 the only time debt levels really got out of hand was during the Great Depression on back of a 45 per cent decline in nominal GDP. Total outstanding debt, in dollar terms actually fell by 12 per cent over the same time span.

So, the US economy was leveraged 1.5 times its annual output from 1840 to 1971 before fundamentally changing its trajectory. Needless to say, this low debt period  was also when the US economy became the world’s largest and most sophisticated (see here) and ultimately a global hegemon.Total credit market debt 1840 - present

Source: History of the United States from Colonial times to 1970, Federal Reserve, Bureau of Economic Analysis, Bawerk.net

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