"When this bubble bursts, 2008 will look like a picnic."

January 21, 2015

The Biggest Bubble In Financial History is Bursting

The mainstream financial media likes to focus on stocks because:

1)   The stories are a lot sexier than bonds or currencies

2)   They make for better hype jobs than bonds or currencies

If your job is to sit in front of a camera selling the notion of getting rich from investing, you’re not going to talk about bonds or currencies (maybe the latter is of interest but only with insane amounts of leverage which usually bankrupts a trader in his or her first trade).

However, today stocks are in fact a very minor story. They are, in a sense, the investing equivalent of picking up pennies in front of a steamroller.

That steamroller is the $100 trillion bond bubble.

For 30+ years, Western countries have been papering over the decline in living standards by issuing debt. In its simplest rendering, sovereign nations spent more than they could collect in taxes, so they issued debt (borrowed money) to fund their various welfare schemes.

This was usually sold as a “temporary” issue. But as politicians have shown us time and again, overspending is never a temporary issue. This is compounded by the fact that the political process largely consists of promising various social spending programs/ entitlements to incentivize voters.

This type of social spending is not temporary… this is endemic.

The US is not alone… Most major Western nations are completely bankrupt due to excessive social spending. And ALL of this spending has been fueled by bonds.

This is why Central Banks have done everything they can to stop any and all defaults from occurring in the sovereign bonds space. Indeed, when you consider the bond bubble everything Central Banks have done begins to make sense.

1)   Central banks cut interest rates to make these gargantuan debts more serviceable.

2)   Central banks want/target inflation because it makes the debts more serviceable and puts off the inevitable debt restructuring.

3)   Central banks are terrified of debt deflation (Fed Chair Janet Yellen herself admitted that oil’s recent deflation was an economic positive) because it would burst the bond bubble and bankrupt sovereign nations.

The bond bubble, like all bubbles, will burst. When it does, everything about investing will change.
Bonds have been in bull market since the early ‘80s. Thus, an entire generation of investors and money managers (anyone under the age of 55) has been investing in an era in which risk has generally gotten cheaper and cheaper.

This, in turn, has driven the rise in leverage in the financial system. As the risk-free rate fell, so did all other rates of return. Thus investors turned to leverage or using borrowed money to try to gain greater rates of return on their capital.

Today, that leverage has resulted in $100 trillion in bonds with over $555 trillion in derivatives based on bonds.

This bubble, literally dwarfs all other bubbles. To put this into perspective, the Credit Default Swap  (CDS) market that nearly took down the financial system in 2008 was only a tenth of this ($50-$60 trillion).

When this bubble bursts, 2008 will look like a picnic."

(Source: Graham Summers, Phoenix Capital Research)