Many investors believe that the 2008 Crisis was THE Crisis of their lifetimes. They look at the stock market’s levels, and investor complacency and they believe that the Central Banks have fixed the financial system.
They are mistaken.
The 2008 Crisis was a stock and investment bank crisis. But it was not THE Crisis. It was just Round One.
Round Two, or THE Crisis, concerns the biggest bubble in financial history: the massive Bond bubble, which, as it stands, is north of $100 trillion.
To put this into perspective, the Tech Bubble was about $15 trillion in size. The Housing Bubble, which triggered the 2008 Crisis, was about $30 trillion in size.
The bond bubble today is over $100 trillion. And if you include derivatives that trade based on the prices of bonds, it’s $555 trillion.
So we are talking about a problem that is exponentially larger than anything you or I have seen before.
How is this possible?
By way of explanation, let’s consider how the current monetary system works…
The current global monetary system is based on debt. Governments issue sovereign bonds, which a select group of large banks and financial institutions (e.g. the Primary Dealers in the US) buy/sell/ and control via auctions.
These financial institutions list the bonds on their balance sheets as “assets,” indeed, the senior-most assets that the banks own.
The banks then issue their own debt-based money via inter-bank loans, mortgages, credit cards, auto loans, and the like into the system. Thus, “money” enters the economy through loans or debt. In this sense, money is not actually capital but legal debt contracts.
Because of this, the system is inherently leveraged (uses borrowed money).
Consider the following:
1) Total currency (actual cash in the form of bills and coins) in the US financial system is a little over $1.2 trillion.
2) If you want to include money sitting in short-term accounts and long-term accounts the amount of “Money” in the system is about $10 trillion.
3) In contrast, the US bond market is well over $38 trillion.
4) If you include derivatives based on these bonds, the US financial system is north of $191 trillion.
Bear in mind, this is just for the US.
Indeed, globally there roughly $100 trillion in bonds in existence.
A little over a third of this is in the US. About half comes from developed nations outside of the US (Germany, Japan, etc.). And finally, emerging markets make up the remaining 14%.
The size of the bond bubble alone should be enough to give pause.
However, when you consider that these bonds are pledged as collateral for other securities (usually over-the-counter derivatives), the full impact of the bond bubble explodes higher to $555 TRILLION.
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).
Moreover, you have to consider the political significance of this bubble.
For 30+ years, Western Governments 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.
In the US today, a whopping 47% of American households receive some kind of Government benefit. 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 bond space. Indeed, when you consider the bond bubble everything Central Banks have done since 2008 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 because it would burst the bond bubble and bankrupt sovereign nations.
So how will the bond bubble play out?
The next round has already begun. Europe, Japan, and the US are all lurching back towards debt deflation with inflation expectations flat-lining if not in outright deflationary territory.
There will be QE programs and other strategies implemented, but at this point the Central Banks are beginning to lose control. In the next few months the financial system will begin to fracture, resulting in the next leg down of a cyclical bear market begun in August-September.
Smart investors are preparing now. The August-September correction was just a warm up. The REAL drop is coming shortly.
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Best Regards
Graham Summers
Chief Market Strategist
Phoenix Capital Research