Big bubble bonds

August 29, 2015 01:00 PM

Following up on the turmoil between Greece and its creditors and the crash in Chinese equities, let’s ponder the upcoming crisis that we are facing that specifically involves bonds. 

Bonds are the bedrock of the financial system: Every asset class in the world trades based on the pricing of bonds. So the fact that bonds are in a bubble (perhaps the biggest bubble in financial history) means that every asset class is in a bubble; everything from real estate to stocks to the buying of cars (see “When will this end?”). Ever wonder why car loans in America exceed the value of the cars in question?

Depending on who you speak with, globally there are $75 trillion to $100 trillion in bonds in existence today. A little over a third of this is in the United States. About half comes from developed nations outside of the United States. And finally, emerging markets make up the remaining 14%.

So whatever the real number is, 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 something like $500 trillion. This affects both banks and the shadow banking industry. No wonder the Bank of England is perplexed as to the shrinking liquidity—it is a problem to which they have no solution.

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 trillion-$60 trillion).

And this was at a time when there was QE and other means to throw at the problem which are now spent. So what will be used this round?

This is why the shrinking bond liquidity causes folks to wonder what will happen as confidence in government wanes and the shrinking liquidity affects all markets at the same time in different degrees. 

The bottom line is this: Nearly everything you think of as “value” is either inflated or will not be there when the time comes for you to call on it. Do you have a retirement plan? Whether it is an old defined plan or a 401K, bonds, specifically 10-year U.S. Treasury notes are at the root of your account value. Pension plans of all sorts use bonds as the vehicle to provide income. Your bank holds bonds on their balance sheet as an asset. The same for all insurance companies. 

So there you have it. We are living in the greatest credit bubble of all time, and it is bursting. It is bursting because liquidity is drying up. 

To wrap this up, credit is everything. We have come to view credit as an asset; it is not. On the contrary, it is a liability, someone else’s liability. It has come to be used as the foundation to our entire system. It is used in the real economy to make it hum. Credit is what puts a price on anything and everything we believe has value. The problem is this: There is a limit to the use of credit and we as a world have now run right up against that limit. Every Ponzi scheme in history must have new investors to continue. The use of credit is how unlimited new investors kept showing up, until now. Now, even sovereign nations are awakening to the fact there are limits to how much credit may be taken on.

A rude awakening indeed!

Jim Sinclair spent many years on Wall Street as a trader and market maker and is known as Mr. Gold. Bill Holter was a retail stockbroker for 23 years and contributes to many alternative investment websites. The two have recently partnered in a new venture, The Holter-Sinclair collaboration. 

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About the Author

Jim Sinclair spent many years on Wall Street as a trader and market maker and is known as Mr. Gold. Bill Holter was a retail stockbroker for 23 years and contributes to many alternative investment websites. The two have recently partnered in a new venture, The Holter-Sinclair collaboration.