The global sovereign bond bubble and the interconnected derivatives network
Much attention has been focused lately on the fate of Deutsche Bank vis-à-vis Lehman Brothers being ground-zero for the collapse of the 2008 housing bubble. But in the background — silently — for the last 30 years a much more dangerous bubble has been inflating that is on a vastly greater scale than the 2000 dot com bubble and the 2008 housing bubble combined.
In the aftermath of the housing bubble collapse, the world’s central bankers (US Federal Reserve, European Central Bank, and the Bank of Japan) as an emergency measure in a concerted effort lowered interest rates to unprecedented levels and kept on lowering them to all-time historical lows, even to below zero (“NIRP”) in Japan and several eurozone countries including Germany. Bond interest rates and their prices are inversely related (i.e. when interest rates decline bond prices rise) and as a consequence have become extremely overvalued (“a bubble”).
This bubble, however, is the “mother of all bubbles” because it is monolithic with currencies, bonds, and derivatives and is so pervasive and dominant that it has inflated asset prices of the stock market and residential and commercial real estate in its wake. To give you an inkling how enormous this bubble is, the derivatives alone linked to this monolithic financial network exceed one-quadrillion US dollars (>USD 1Q) or 55 times the size of US GDP.
It is only a matter of time before this bubble, as every bubble in the past has attested, will collapse and the longer it takes the worse the effects. But there is a crucial difference besides the size: the network structure of this bubble is composed of the hierarchy and dense interconnectedness of three layers (currencies ⇋ bonds ⇋ derivatives) and this network — given the global banking network architecture — is embedded in every systemically-important banking node, not just a single node failure like Deutsche Bank or Lehman Brothers. In other words, it is a network nested inside a network. A bond selloff has high centrality in every node, not just one, and then radiates outwardly simultaneously from each and every node — it is like every major star in a galaxy exploding at the same time.
Simply, the Achilles heel of the global financial system is a sustained, high-volume, sovereign bond selloff. This architectural vulnerability and its detonation is an unrecognized hazard, has no remedy, is long overdue, and is inevitable.
To say this will not happen is foolish because the scale of the sovereign bond bubble’s overvaluation metrics are currently nearly twice that of the dot com bubble’s stature and is continuing to inflate as NIRP and ZIRP expand raising aggregate bond prices to higher and higher historical highs and taking equity and real estate asset classes along for the ride.
To review the Prevailing Gray Swan on the “Bursting of the global sovereign bond bubble and the interconnected financial derivatives network”, please see the intelligence briefing:
http://medium.com/deepconnections/prevailing-gray-swans-7-september-30-2016-8c1df681fd52#.mu2h33c6q
It will provide insights into financial bubbles not previously addressed and will describe the history, architecture and vulnerabilities of the largest financial bubble in history.
With Appreciation,
James Autio