Weak credit creation poses a risk to US growth: Pimco

NEW YORK: Pacific Investment Management Co’s (Pimco) Bill Gross, manager of the world’s biggest bond fund, said insufficient credit creation with economic growth of only about 2% jeopardises the US expansion.

"A credit-based financial economy, as opposed to pure cash, depends on an ever-expanding outstanding level of credit for its survival," Gross wrote in his monthly investment outlook on Pimco’s website.

"Credit creation is essential for economic growth in a finance-based economy such as ours. Without it, growth stagnates or withers." If the credit growth is more than 4.5% a year, then private and public sectors must create about $2.5 trillion of new debt per year to pay for outstanding interest, Gross estimates.

This failure to generate the required credit to fuel growth is keeping output since the recession capped, he said.

The biggest gain in US business investment in over two years helped the world’s largest economy expand more than previous forecast in the second quarter. Gross domesticproduct rose at a 4.2% annualised rate, following a firstquarter contraction.

In July, the Federal Open Market Committee changed the language of its policy statement to highlight "significant underutilisation of labour resources" as a justification for continued easy- money policies, even though the jobless rate has fallen faster than Fed officials had forecast.

The velocity, or turnover of credit, is also a factor and is related to the level of interest rates offered in the economy, Gross wrote. Low levels of rates on longer-term debt make holding short-term, near cash, securities more attractive.

"Today’s levels of interest rates and stock prices offer a historically unacceptable level of risk relative to return unless the policy rate is kept low — now and in the future," Gross wrote.

"That is the basis for the New Neutral, Pimco’s assumption that the Fed funds rate peaks at 2% or less in 2017 versus others’ assumptions," which forecast it will be much higher.

"Existing asset prices in the US, while artificially high and bond yields artificially low, may continue to be so unless the Fed oversteps its interest rate line,” Gross said.

Fed funds futures contracts show an over 50% chance the central bank will increase its benchmark to at least 0.5% in July 2015.