Severe Storm Warning – Bill Gross Warns on Global Debt Bubble
Investment guru Bill Gross has warned that a global debt bubble may lead to an economic collapse.
If you have been following the markets this year, you are probably aware that investors and banks are treading into unknown territory. A series of unconventional monetary policies, strange yield curves, and rapid technological growth have inspired experts from the fields of economics and finance to be skeptical about health of financial markets.
According to Bill Gross of Janus Investment Group, modern financial markets have a tendency to compress risk while elevating the potential returns of assets. This often results in high asset prices. The current markets suggest that asset prices do not reflect fundamental values. Instead, they are likely being artificially risen by optimism and social contagion. This condition is normal, and it is a result of investors purchasing hot stocks after so-called smart money has already adjusted prices prior to announcements.
This irrational exuberance can cause a bubble in stock markets, but the world may soon experience an extreme shock caused by the bursting of a different kind of bubble. Bill Gross suggests that the prices of assets backed by debt may also be artificially high. He states that it has not been detected because it has been steadily growing over a 40-year period. Since it has not yet popped, many finance experts are unaware of its existence.
Data for Total Returns Suggests an End to Stability
Bonds and debt-backed assets are often viewed as the more stable cousins of stocks. Many investors buy bonds with the expectation that they will earn their returns without experiencing much risk. Unfortunately, this is not always true. Throughout the last 40 years, both bonds and stocks have been impacted by sudden changes in financial markets. The collapse of the NASDAQ 500, the Savings and Loans Crisis, and the Subprime Mortgage Crisis show that holders of bonds and stocks are vulnerable.
Stocks and bonds have generally moved together since 1976, but the returns for stocks have always been about 3 percent higher than the returns for corporate bonds. During this time, the prices of both stocks and debt assets have climbed. In 2016, stocks and bonds are at their highest prices in nearly 500 years. According to Janus Investment Group, this ideal situation does not reflect the reality of markets. This trend may have been viewed as positive for over 40 years, but the state of the current global economy changes everything. With negative and low interest rates in most of the developed world, high returns are a thing of the past.
For further convincing, consider the Barclays Capital US Aggregate portfolio. Prior to the implementation of unconventional monetary policy by central banks, this portfolio offered investors a yield of nearly 7.5 percent. In 2016, this portfolio yields no greater than 2.9 percent. Quantitative easing and other post-Global Financial Crisis policies helped shrink returns.
The Debt Bubble is a Direct Result of Monetary Policies
Bill Gross has stated that the global debt bubble’s growth is a result of the monetary policies that have gained popularity in Japan, China, the United States, and the European Union. Due to very low interest rates, the prices of bonds and other asset prices have risen to unusually high levels. In Japan, negative interest rates have also caused asset prices to spike. This risky policy implementation is more appropriate for the realm of experimental economics, so it should come as no surprise that such measures have caused unexpected results for the economy. The quantitative easing of Ben Bernanke from the US Federal Reserve also contributed to the rapid growth of debt-backed asset prices.
While monetary policies have played a major role in the creation of a debt bubble, the expansion of credit is also relevant. With the expansion of credit, more people apply for loans to buy homes, vehicles, and other high-value products. This increased demand drives up the price of the products, and debt-backed securities become more valued. This isn’t always a problem, but it can cause a financial crisis when credit is issued to individuals who cannot afford to pay off the loans. The Global Financial Crisis of 2008 is a prime example of what happens when the issuing of credit spirals out of control.
These factors have decreased returns for assets while increasing prices. Bill Gross suggests that the current returns do not offer sufficient compensation for the elevated level of risk. To make matters worse for investors and middle-class consumers, illiquid asset spreads are at historic lows. This reduces options for alternative assets, and investors are exposed to greater risk.
Bill Gross isn’t the only investor to suggest that financial woes are on the horizon for global markets. Warren Buffet and George Soros have both suggested that hard times are ahead for the middle-class. Unfortunately, the short-run considerations of central bankers may have caused this massive risk.
For more information about the global debt bubble, go to Personal Money Store.