Inflating the debt bubble to Armageddon levels

Recently, one of my friends asked me, ‘Why does it matter if the US raises rates? It’s only 0.25%!

Looking at the micro number, he’s got a point. But there’s a bigger play at stake.

If you’re looking — or waiting — for a major financial shock, focus your attention on the global debt markets. According to ING Research, the global debt market is worth US$223.3 trillion. That staggering figure is worth three and a half times more than the all the world’s stock markets.

The US$223.3 trillion in total global debt includes government debt of $55.7 trillion. Financial-sector (banks, insurance companies, etc.) debt of $75.3 trillion. And household and corporate debt of $92.3 trillion. The combined total is roughly 300% of world Gross Domestic Product (GDP). A completely unsustainable number.

Yet remarkably, this number excludes the global derivatives market. According to the Bank of International Settlements, in its own right, the global derivatives market is worth a shocking US$700 trillion. Now to be fair, a large amount of these positions aren’t pure speculative punts.

Nevertheless, something’s going to have to give. As legendary investor, Jim Rogers put it: ‘The world is swimming in an artificial ocean of liquidity. And this just can’t last.

And it won’t last.

A US rate rise would increase the debt floating around the world — of which a significant amount is priced in US dollars.

According to a recent Bank of International Settlement (BIS) paper, ‘Banks and bond investors have increased the outstanding US dollar credit to non-bank borrowers outside the United States from US$6 trillion to US$9.6 trillion by end-March 2015.’

Looking further into the future, several rate rises would exponentially grow this number.

Understandably, punters are worried.

But the worries won’t end there…

Look out below

An interest rate rise, or rises, would send the US dollar higher.

With a slowing world economy and depreciating currencies, a higher US dollar makes it more difficult to service these debts. In this regard, investors will flock to the US dollar asset markets. Initially the US bond market. But when chaos starts, the stock market will attract the majority of capital.

When this US dollar squeeze comes, riskier emerging markets (EM) will feel the most pain.

Since the Global Financial Crisis, thanks to money printing and near-zero interest rates, emerging markets have accessed cheap US dollars. BIS argues that EM debts have doubled since the Lehman crisis to US$3 trillion.

Rating’s Agency Fitch, believes that is a gross understatement. This month it said, ‘External debt in these in these countries has increased by $2.8 trillion to $7.5 trillion since the Lehman crisis. The most extreme rise has been in Latin America, where gross external debt has jumped by 118%.’

Nevertheless, the world has set the stage for a truly massive global dollar squeeze. As the Fed reverses course, raising rates significantly higher, it will drain dollar liquidity from global markets. Emerging markets in particular will suffer.

So when the US dollar explodes higher, watch out for the EM debt crisis.

The US dollar, rising in anticipation of higher US rates, has already jumped 10–30% against EM currencies this year. A rising dollar will trigger bulk corporate and sovereign defaults across emerging markets.

When this kicks off, capital will move rapidly from emerging into the US markets. This will send the dollar even higher. In my view, if not earlier, this should happen around mid-2016.

The US rate hike will have gigantic implications on the world

Unfortunately, the emerging market crisis is one of many financial challenges the world faces in the years ahead.

We’ll see the property market bubble pop. As well as the energy junk bond market. It’s likely that some Exchange Traded Fund (ETF) providers could go under. And many ‘too big to fail’ banks across the world too.

Australia’s big four banks aren’t even guaranteed to be safe during the next financial crisis.

This is because, among many factors, the next real crisis will be felt in the government bond markets. The majority of Western and Eastern governments across the world will default on all their debts.

We’re at a peak in the 30-year government bond bubble. The US first interest will mark the peak.

A US interest rate increase of 1–2% (US Fed plans to raise to 4% by 2017) could result in a bond price decline equivalent to multiple years of income. This would inflict major capital losses. And when interest rates rise higher, it will cost governments more to refinance their maturing debts.

Eventually debt levels will be too high to service. No one will want to buy debt (or bonds). And governments will have no choice but to default. When this happens, if you own bonds, you will get none of your money back.

Thankfully, this is still a couple of years away. There’s time to sort your portfolio out, in preparation for the next major financial crisis.

I’ve been explaining exactly how to do this to Resource Speculator readers since November last year.


Jason Stevenson

Analyst, Resource Speculator

Ed Note: This article was first published in Money Morning.

Join Markets and Money on Google+

Jason Stevenson is Markets & Money’s resource analyst. He shares over a decade’s worth of investing and trading experience across resource stocks and commodity futures and options. He originally studied accounting and finance at Curtin University, where he was awarded a first-class honours degree. His professional background stems across high-net-worth, top tier accounting (corporate finance, tax and auditing), and sell-side equities research. Before joining the team at Markets and Money, Jason worked at boutique firms which advised fund managers and high-net-worth clients on where to invest. Whether it’s gold, crude oil, copper or an obscure metal like vanadium, you can rely on an in-depth analysis in Markets and Money. Jason also brings you extensive macro, political and geopolitical analysis from around the world. He leaves no stone unturned when it comes to telling the truth. Jason is also the lead analyst of Gold Stock Trader, a premium service for investors serious about precious metal stocks. Websites and financial e-letters Jason writes for:

Leave a Reply

Your email address will not be published. Required fields are marked *

Markets & Money