Introduction

In the landscape of economic foresight, few concepts have captured the hierarchy of financial risk as elegantly as Exter’s Inverted Pyramid.

Created by economist John Exter in the 1970s, this visual framework has proven remarkably prescient in predicting financial crises and understanding how capital flows during economic cycles. Today, as we navigate an era of unprecedented monetary expansion and debt accumulation, Exter’s insights are more relevant than ever.

A Visual Guide To Understanding Financial Risk

Exter’s Inverted Pyramid stands on its apex – a small point of gold that supports an enormous superstructure of increasingly risky assets. This design brilliantly illustrates both the hierarchy of financial assets and their relative sizes in the global economy, providing a framework for recognizing where we are in the credit cycle and how capital flows during different economic phases.

John Exter’s original pyramid of assets is shown in image below.

The Foundation Is Gold

At the pyramid’s base (the narrow bottom of the inverted pyramid) sits gold. Exter chose gold not out of tradition but because it uniquely combines several critical characteristics:

• No counterparty risk (doesn’t depend on anyone’s promise to pay)
• No credit risk (can’t default or go bankrupt)
• Highly liquid (accepted worldwide)
• Historically proven store of value

Moving Up The Pyramid Of Risk

As we ascend the inverted pyramid, each layer represents assets that are progressively:

• Less liquid
• More dependent on counterparty performance
• Larger in total market size
• Riskier during financial stress

Reading Economic Cycles

Credit Expansion

• Confidence is high
• Credit is expanding
• Capital flows UP the pyramid
• Investors seek higher returns in riskier assets
• The same capital gets reused multiple times (fractional reserve banking, margin trading)
• The pyramid broadens as derivatives and securitized products multiply
• Gold and safe assets are shunned as “barbarous relics“

Credit Contraction

• Confidence wanes
• Credit contracts
• Capital flows DOWN the pyramid
• Investors flee to safety and liquidity
• Risky assets become illiquid (hard to sell at any price)
• The pyramid “pancakes” as values collapse
• Gold and government bonds outperform stocks

The Pyramid’s Crucial Insight

Exter’s Inverted Pyramid remains remarkably relevant today because it captures timeless truths about human nature, confidence, and the structure of financial systems, teaching us that:

• All paper assets ultimately depend on confidence
• In crises, liquidity becomes paramount
• The door to real safety (gold) is narrow
• Debt pyramids built on thin foundations eventually collapse
• Central banks enable but cannot prevent these cycles

The inverted shape of Exter’s Pyramid reveals a disturbing truth: the narrowest part (gold) must support an enormously wide superstructure of paper claims. This works during expansions when confidence is high, but becomes catastrophic when confidence fails and everyone tries to move down the pyramid simultaneously.

Final Thoughts

For investors, the lesson is clear: understand where your assets sit on Exter’s Pyramid, recognize the signs of credit cycle transitions, and never forget that when confidence fails, everyone rushes for the same narrow exit. In Exter’s words, “When they go to gold instead of currency or Treasury bills, the price of gold will take off. It will be a bandwagon everyone will want to get on.”

The pyramid stands as both warning and guide, a testament to one man’s intellectual independence and a roadmap for navigating the recurring cycles of credit expansion and collapse that define our modern financial system.

Thanks for reading!