Thursday, 14 May 2015

58-trillion reasons why you should be worrried

Following weeks of relentless turmoil in the world's bond markets which saw bonds losing a collective $450 billion and yields rising rapidly, there is growing fear of a bond market implosion. Post-2008/09 government spending and the issuance of debt has led to an almost 80% increase in government obligations to over $58 trillion worldwide.

The fear is that even the safest government debt is not as safe as previously assumed, hence the wild swings in (the bluest-chip) German government 10-year  bonds  -  where yields went from 0.05% to 0.70% in less than a month, to mid-May. The situation is of course much worse in  basket-cases such as Greece, Hungary and the Ukraine, but terms of debt-to-GDP ratio, has even reached dangerous levels in Italy, Japan, Malaysia, China, Ireland, Singapore and Belgium.

According to Claus Vogt, co-author of 'The Global Debt Trap' (cited in The Globe and Mail,  14 May 2015), the massive government debt has reached bubble proportions due to money-printing and interest rates already at close to 0%. A minor black-swan event and a loss of confidence in central bankers abilities to manage unprecedented quantitative easing,  could lead to "a stampede out of stock and bonds" and presumably the collapse of financial markets. Bonds are not generally not as liquid as stocks and a sudden mass rush out of the market would be catastrophic.

Similarly, there is a huge risk in fixed-income ETFs, should such a s collapse occur. These bond ETFs are not very liquid and could be severely impacted by mass-liquidations. While large issuers of these ETFs such as Vanguard have created bank guarantees and lines of credit to provide liquidity in case of a rush to the exits by investors, it is doubtful if these facilities would be sufficient. For example Vanguard created a facility of $2.89 billion, but this is meant to cover $3 trillion of assets, i.e. less than one-tenth of one percent.

With stock markets in Europe booming and reaching new highs almost daily in the United States and following years of huge gains from bond investing, the party may be coming to an end, and it may happen much faster and with a much more severe  outcome than foreseen by most.