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The bursting of the bond bubble has begun.
As I’ve outlined previously the primary concern for Central Banks is the
bond bubble. CNBC and other financial media focus on stocks because the asset
class is more volatile and so makes for better content, but the foundation of
the financial system is bonds. And bonds are THE focus for Central Banks.
In the simplest of terms, the world is awash in too much debt. The bond
bubble was close to $80 trillion in size going into 2008. The Central Banks
had a choice to either let the defaults hit and clear out the garbage debt
from the financial system or attempt to inflate the debts away.
They chose to attempt to inflate the debts away. Put differently, all of
their policies were aimed at containing debt deflation… or the process
through which debt becomes less and less serviceable leading to eventual
insolvency and default.
To whit:
1) Central Banks cut interest rates to zero to make bond
payments smaller.
2) Central Banks launched QE and other programs to put a floor
beneath bond prices (when bond prices rise, bond yields fall and debt
payments become smaller and easier to service).
3) Central Banks provided verbal intervention promising to do
“more” or “whatever it takes” whenever bonds came close to ending their bull
market.
As a result of this, the financial system has become even more leveraged
than it was in 2007 at the beginning of the last debt crisis.
Globally the bond bubble has grown by more than $20 trillion since 2008.
Today it is north of $100 trillion, with an additional $555+ trillion in
derivatives trading based on it.
Yes, $555 TRILLION, more than seven times global GDP, and more
than 10 times the Credit Default Swap market ($50 trillion), which triggered
the 2008 Crisis.
By not allowing the bad debts to clear in 2008, the Central Banks
conditioned everyone from consumers to corporations to believe that business
cycles could be contained and that the bond bubble/ bull market had not
ended.
As a result of this, TRILLIONS of dollars of capital have been
misallocated. The evidence is everywhere you look. Corporates around the
globe have been issuing record amounts of debt, much of it in US Dollars.
Few of these bonds were high quality. Indeed, globally over 50% of all
corporate bonds are now “junk.”
Chinese firms might be the most out of control when it comes to bond
issuance, but they are hardly unique. As the below chart reveals, the pace of
corporate debt issuance in Emerging Markets worldwide has been extraordinary
relative to economic growth.
Today, the Emerging Market corporate bond market is equal to nearly 75% of
total Emerging Market GDP. It was at just 50% in 2007 during the last peak!
H/T Jeroen Blokland
This has also been the case in the US where corporates have posted
four straight years of record bond issuance.
Moreover, most of US corporate bond issuance is going towards stock
buybacks and financial engineering (massaging results to look better than
they are) NOT legitimate expansion.
As a result of this, the financial system today is even more
leveraged with more garbage debt than it was going into 2008.
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