In the preceding part of this series, we discussed how Bill Gross is worried about the rising global credit level. Gross also believes that the rising credit level in the United States (QQQ) (SPY) should remind us of the bankruptcy of the Lehman Brothers in 2008.
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Gross believes that credit creation and the cost of credit should be monitored more properly. Gross has stated the following: “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.”
Both higher credit costs and lower credit cost affect the economy. Gross pointed out that if the cost of credit is too high, or if the credit level is too high in the financial system (IVV), (VFINX), it can create an asset bubble in the economy (IWM) (IWF).
Higher costs of credit will be too expensive for borrowers to pay service costs. Gross pointed out that “if rates are too high (and credit as a percentage of GDP too high as well), then potential Lehman black swans can occur.”
On the other hand, if the cost of credit is too low, a huge problem to the entire financial system can occur. Gross explains this problem the following way: “If rates are too low (and credit as a percentage 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.”
In the next part of this series, we’ll analyze Gross’s view of the Trump administration.