In a world full of bubbles that will all burst, it is of
course impossible to forecast which will be the first ones to cause havoc for
the world economy. One of the biggest bubbles that would clearly bring down
the financial system is the bond market. Here we have a $100 trillion market
which has grown exponentially in the last 25 years and which has virtually
gone vertical since the 2006-9 crisis.
Desperate governments are raising money as if there was
no tomorrow in the hope that they can keep the world afloat for another few
years. But as I have stressed so many times, you can create neither economic
stability nor wealth by printing money or increasing the debt burden.
Governments cannot afford interest rates above zero
Under normal conditions governments would be totally
insolvent with the high levels of debt they are raising. But Japan solved
that problem over 20 years ago by setting rates at zero. That trend has
accelerated in the last couple of years and there are now around $8 trillion
of government bonds with negative yield around the world. But governments of
course never have a problem paying the interest since they will just issue
more debt to pay it.
As governments around the world compete in lowering
interest rates, the Fed in the US continues to threaten with rate increases.
But we are in a global financial system which is totally interdependent.
Therefore the biggest economy in the world cannot raise rates without major
consequences for the financial system and for the dollar. Also, for the US
itself, raising rates at this stage goes totally against the trend of the
real economy. Company profits are declining, and so is industrial production
together with many important indicators such as freight, transport and
container traffic. And real unemployment is not 5% but 23%. More importantly,
US federal debt, now at $19 trillion is forecast to increase to at least $28
trillion, by the Central Budget Office in the next ten years. But debt could
easily grow to $35 trillion or more by 2025 if US growth is subpar which is
likely to be the case. With these pressures it is unlikely that the US
government hikes rates in June in spite of the noise they are making
currently.
Interest rates of 15-20% will lead to mass defaults
The dilemma for the world is that with $230 trillion in
debt, higher interest rates are guaranteed to lead to defaults and helicopter
money. This in turn will accelerate the currency race to the bottom, leading
to hyperinflation and much higher interest rates.
Currently the world doesn’t see the risk of
hyperinflation. But this is an obvious consequence of the debt folly created
by governments. They are unlikely to let the world economy go into a global
deflationary implosion before first throwing unlimited amounts of worthless
printed money at the problem.
100 year bonds will mature worthless
It is totally incomprehensible that anyone can lend money
to governments at zero or negative yields when it is totally clear that no
government will repay this debt in today’s money. It is even more difficult
to understand how anyone can lend money to insolvent governments for 50 or
100 years. Countries like Belgium, France, Spain and Italy have all issued 50
year bonds. We can be quite certain that the last two countries will
definitely not be able to repay these loans and probably not the other two either.
But that doesn’t really matter since the ECB (if it is still around) will
just issue funny money to buy these bonds as it becomes the only buyer of
bankrupt Eurozone debt. Then we have Mexico, Belgium and Ireland which have
all issued 100 year bonds! Ireland, for example, was virtually bankrupt a few
years ago and only back in 2011 they paid 14% on their 10 year bond. Now they
have just raised 100 year money at 2.3%! It is absolutely guaranteed that the
value of the Euro as well as the value of this bond will have gone to zero
long before the 100 years are up. How then can any sane investment manager
buy this bond? He is obviously not worried since he won’t be around at
maturity but the likelihood is that the bond will be worthless during his
active professional life.
Long rates will turn up in late 2016
The chart below shows the 10 year US treasury bond but
shows yield rather than the price of the bond. The very steep rise of the
bond (fall in the yield), from 16% in 1980 to 2% today takes the rate back to
the record low at the end of WWII. This is a 36 year cycle that is likely to
top sometime in 2016. The rise in the yield could be very swift due to
massive money printing and a collapsing dollar. I would expect the yield to
reach at least 16% in the next 5-7 years and possibly a lot higher.
In the next 12-18 months there will be two forces pulling
yields in different directions. Governments and central banks will continue
to keep short rates at zero or negative. But this is a battle that they will
lose since holders of long term bonds will realise that not only won’t the 50
or 100 year bonds be repaid but nor will the shorter maturities. Big holders
of US debt like Japan, China and Russia will compete in getting rid of their
rapidly deteriorating paper. There is clearly a first mover advantage here
before panic sets in.
The consequences of much higher rates will of course not
just affect lenders and borrowers. The $1.5 quadrillion derivatives market is
totally linked to interest rates and once rates increase, most derivatives
will become totally worthless. And this is a problem of a magnitude that even
helicopter money cannot solve.
The end game will lead to the biggest implosion in
history
This brings us back to risk. As I have stated many times,
economic, financial and geopolitical risk is greater than ever in the world
today. Let us hope that the worst case scenario doesn’t materialise, because
if it does, life on Earth will be very different for a very long time. We
must remember that since we have had the biggest bubble in history over the
last 100 years, the end game is likely to lead to the biggest implosion in
history of the world economy and financial system.
Whatever the outcome of the crisis that the world will
find itself in over coming years, it is absolutely essential to insure wealth
against these risks. The best financial insurance available and by far the
cheapest is physical gold and silver stored outside the banking system. This
is the only insurance available where the premium, invested in metals,
doesn’t have to be paid annually at higher rates but instead appreciates as
risk increases.
Egon von Greyerz
Founder and Managing Partner
Matterhorn Asset Management AG
matterhorn.gold
goldswitzerland.com
