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This is the trillion-dollar question. From a common sense perspective, the simple answer is “absolutely!”
Since 1998, the markets have been in serial bubbles and busts, each one bigger than the last. A long-term chart of the S&P 500 shows us just how obvious this is (and yet the Fed argues it cannot see bubbles in advance?).
Moreover, we’ve been moving up the food chain in terms of the assets involved in each respective bubble and bust.
The Tech bubble was a stock bubble.
The 2007 bust was a housing bubble.
This next bust will be the sovereign bond bubble.
Why does this matter?
Because of the dreaded “C word” COLLATERAL.
In 2008, the world got a taste of what happens when a major collateral shortage hits the derivatives market. In very simple terms, the mispricing of several trillion (if not more) dollars’ worth of illiquid securities suddenly became obvious to the financial system.
This induced a collateral shortfall in the Credit Default Swap market ($50-$60 trillion) as everyone went scrambling to raise capital or demanded new, higher quality collateral on trillions of trades that turned out to be garbage.
This is why US Treasuries posted such an enormous rally in the 2008 bust (US Treasuries are the highest grade collateral out there).
Please note that Treasuries actually spiked in OCTOBER-NOVEMBER 2008… well before stocks bottomed in March 2009.
The scrambling for collateral, NOT the alleged “flight to safety trade” that CNBC proclaims.
WHAT DOES THIS HAVE TO DO WITH TODAY?
The senior most assets backstopping the $600 trillion derivatives market are SOVEREIGN BONDS: US Treasuries, Japanese Government Bonds, German Bunds.
By keeping interest rates near zero, and pumping over $10 trillion into the financial system since 2007, the world’s Central Banks have forced investors to misprice the most prized collateral backstopping the entire derivatives system: SOVEREIGN BONDS.
SO what happens when the current bond bubble bursts and we begin to see bonds falling and yields rising?
Another collateral scramble begins… this time with a significant portion of the interest rate derivative market (over 80% of the $600 TRILLION derivative market) blowing up.
At that point, rising yields is the last thing we need to worry about. The assets backstopping a $600 trillion market themselves will be falling in value… which means that the real crisis… the crisis to which 2008 was the warm up, will be upon us.
This is why Central Banks are so committed to keeping rates low. This is also why all Central Bank policy has largely benefitted the large financial institutions (the Too Big To Fails) at the expense of Main Street…
THE CENTRAL BANKS AREN’T TRYING TO GROW THE ECONOMY, THEY’RE TRYING TO PROP UP THE FINANCIAL INSTITUTIONS’ DERIVATIVE TRADES.
They will fail eventually. When they do, the markets will experience yet another terrible collapse even worse than that of 2008.
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