Markets were left reeling today as US long bonds continued their downward spiral.
“We’ve seen $13 trillion wiped off bond markets around the world,” says a shocked Stanley Hoffman, Senior Bond Trader at MorganStanleyGoldmanSachs.
Analysts are already laying the blame on the 2009 ‘gold-rush’ of long bonds which governments around the world issued in order to cover the calamitous debt crunch of 2008. “The US government alone issued more than two trillion of these bonds in 2009 to bailout the banks and the motor industry,” says economist Judy Hoffstadter.
Throughout the last decade, government issuing of long bonds allowed them to support cherished industries and nationalize significant chunks of their economies.
“The US government now owns about half of their economy. Europe is even worse. France now owns about 73% of listed companies, the UK 57%, and Germany some 62%,” says Heinrik Klein at Deutsche Bank.
What looked like an easy way to raise money and support industry has proven to be a shocking failure.
“The oversize businesses that governments bought, created inefficient jobs and offered poor fiscal returns. But it was those returns that were ultimately supposed to cover the bond payments,” says Hoffstadter.
In January, GMChryslerFord, an auto making behemoth, revealed that vehicle sales for the previous 12 months had been 53% below target. A company that employs 80% of auto workers in the US sells only 22% of the vehicles that Americans buy.
Bond traders reacted immediately, selling treasury bonds. As audits in other parts of the world revealed similar waste, carnage followed.
On Friday, Treasury Secretary, Timothy Geithner, begged Congress to authorize the sale of US$ 5 trillion in shares that the government owns in order to bail out the bonds. He was rejected. On Wall Street, the markets continue their fall.
ANALYSIS >> SYNTHESIS: How this scenario came to be
In 2008, after a boom which lasted 15 years, the banking industry fumbled and the world economy was devastated. This had been the most predicted market collapse ever.
In 1996, Robert J Shiller, then at the US Federal Reserve predicted that the US stock exchange had risen to irrational levels. He voiced his concerns to then Fed Chairman, Alan Greenspan who used the phrase “irrational exuberance” in a famous speech.
It didn’t stop the stock markets crashing in 2001. In 2005, Shiller called the markets again, this time in housing. Working with Karl Case, he produced a new form of House Price Index. The Case-Shiller Home Price Index which “measures the residential housing market, tracking changes in the value of the residential real estate market in 20 metropolitan regions across the United States. These indices use the repeat sales pricing technique to measure housing markets. This methodology collects data on single-family home re-sales, capturing re-sold sale prices to form sale pairs.”
In 2005, Shiller’s index was showing that after remaining static since 1945, house prices began to shoot up exponentially in 2002. He published a book, “Irrational Exuberance”. Lots of people read it, but governments and regulators failed to pay attention.
The collapse, in 2008, has generated plenty of analysis. However, it must be put in perspective. In 2009, after two years of economic crisis, the Financial Times listed actual direct losses as a result of home-loan defaults as being US$ 1.06 trillion.
At the time, total outstanding US home loans totaled US$ 47 trillion. In other words, the credit crisis was triggered by losses of only 2% of bank debtors’ books, well within the 7 – 8% of cash reserves that banks were reporting. The problem wasn’t the losses; the problem was a sudden and catastrophic loss of business confidence.
In 2008, banks financed more than 25% of their daily trade from interbank lending. That market dried up in October 2008 and, by mid-2009, banks were only able to access 9.5% of their daily needs from interbank lending. The trillions of dollars pumped into the world’s financial markets in 2009 and 2010 were a state-led effort to get interbank lending started again.
As governments showed a willingness to bail out banks, other industries leapt onto the free-money-train. Soon, economies were starting to look woefully nationalized.
All of these bills needed financing.
2009-2010: G20 Carves Up The World
In April 2009, against a backdrop of rioters and 14,000 special policemen, the G20 meet in London to discuss the credit crisis and a way out. The main differences are between the US and UK, who believe that governments must take on vast new debt to finance massive public spending, and Germany, who believe that governments should not. In between is China, which is exceptionally uncomfortable about being forced to commit their almost US$ 2 trillion in reserves to finance this credit binge.
The debate is inconclusive and acrimony is fueled by increasing evidence of protectionist economic policies being introduced by all of the G20 members. Publicly, all politicians claim that protectionism is bad, but at home they are pandering to the worst of their political lobbyists.
The IMF releases findings showing that world trade has shrunk by 9% in less than 12 months. China, once again, declares that they would prefer it if the world went off the dollar standard in preference for a basket of currencies.
At the end of 2009, despite continuous stimulus packages, US unemployment hits 10%, three million people are unemployed in the UK and Europe has 17% unemployed. The US has issued almost US$ 4 trillion of new bonds to finance their bail-outs. The UK is just behind with US$ 1 trillion, and the EU with US$ 2.5 trillion. Between 2009 and 2010, governments around the world issue US$ 14 trillion in new bonds.
With no agreement, the US and UK go in the direction of big-spending founded on treasury-bond issues, while Europe maintains a cautious approach. China is left isolated and stuck having to harbor their reserves in US dollars.
2010-2011: Great Depression 2.0
In January 2010, a bond issue for US$ 100 billion by the UK government receives no bids. For the second time, the UK has to go to the IMF for a loan. The political fall-out brings down the Labour government. In subdued elections in March, David Cameron wins a narrow victory. For the second time, a Conservative government takes over a Britain in financial meltdown.
The pain isn’t isolated to the UK. Neither the big-spending approach by the US, nor the conservative-support approach by Germany, is having much impact. President Barack Obama is still popular but attitudes are changing fast. Detractors are quick to show parallels with his predecessor, George W Bush, and are calling the economy “his 9/11 moment.”
China and India, despite being a still small part of the global economy, are drawing closer in an effort to gain an advantage from their large internal markets. India has less reliance on exports than does China, and both start technology and infrastructure swaps in order to stimulate a shared market.
Tata Motors opens a large factory outside Shanghai producing a Chinese version of their immensely popular Nano budget car, now priced at US$ 1,500. Huawei and Haier enter India, producing low-priced mobile phones and budget household electronics. Both countries find ready consumers in South East Asia, Latin America and Africa.
Both Europe and the US continue to see their economies shrink. The US by 0.3% in 2011, and the EU by 1.2%. Japan is finding that its position in South East Asia is allowing its economy to hold station, with growth of 0.1%.
By the end of 2011, though, India is growing at 6.2%, and China is back at 8.3% growth. For the first time in almost a century, the EU and US see net emigration as people head to emerging markets in search of jobs and opportunities.
2012-2018: The Big Boom Is On
On 12 February 2012, Chinese Finance Minister, Xie Xuren, and India’s Finance Minister, Arvind Virmani, address a packed press conference in Bangkok, Thailand.
For months, the US dollar has been weakening and increasingly unstable, while a wide range of other currencies, including the euro, British pound, ruble, yuan and Indian rupee have all been rising. Speculation has been rife, but the announcement is still shocking.
“The Indian Minister and I would like to announce that, from midnight tonight, we no longer recognize the US dollar as the world’s reserve currency. We have chosen a basket of currencies on which to base our reserves and have adjusted our economic policy accordingly,” says Xuren.
There is pandemonium. The dollar halves its value against other major currencies within days.
Confusion abounds. On the one hand, this is good for debtors, since their dollar borrowings have just been reduced. But creditors are left ruined.
China and India had been secretly adjusting their sovereign investments for two years. Caught short are Japan, Russia and Saudi Arabia, as well as a host of private funds in Europe and North America.
Barack Obama is seeking re-election in the US, but is suffering from some of the lowest ratings since George W Bush was in power. The Republicans are still in disarray, but opinion polls show them winning a comfortable victory. Democrats lost the Senate in 2010, but still control the House. Obama, realizing that he is becoming a political liability, stands down in favor of Hillary Clinton.
By the narrowest of margins, Clinton wins the elections and becomes the first female US President.
At the end of 2012, though, markets are already rebounding. For the first time, the US consumer and US government are unable to simply print money and issue bonds to get out of trouble. The lower dollar value has revitalized US manufacturing.
Governments around the world find a new market for non-dollar-denominated bonds and treasury bonds are popular with investors finally happy to find something worth buying.
The boom is on.
Financial regulations agreed during the last five years have made listing on public exchanges an expensive and unpleasant experience for companies. New Private Equity firms issue billions of dollars of private bonds and thousands of companies around the world de-list. Many are bought by governments, eager to promote job creation and to be seen to be intervening in their economies.
In 2006, the total world bond market was worth US$ 45 trillion, with US$ 970 billion in bonds traded daily. By the end of 2014, the market is US$ 82 trillion, with US$ 2.3 trillion traded daily.
In 2018, the bond market is worth US$ 130 trillion.
“I fear that we have rediscovered ‘Irrational Exuberance’,” says Robert Shiller, now 72.
“The structural readjustment that was necessary back in 2009 never happened. It is still necessary, only now the consequences are going to be even worse.”
In 2009, only 1 billion people were considered ‘middle-income’ or middle-class. In 2018, it is 4 billion, with most people’s savings and pensions invested in private and public bonds.
World growth has averaged 4.2% for the last three years, and – as in 2008 – no-one is considering the consequences, if a major economy were to default on its debt.
In December 2018, the US government issues a Methuselah Bond worth US$ 1 trillion. It is oversubscribed four times. The top of the market has been reached.
19 August 2019: The Reason We Hate Mondays
Treasury bonds have not been well-spent. State-owned companies are inefficient and there has been little innovation to show for all the staff working in vast factories. Output is slowing, as is market demand.
The gap between ‘real’ growth and bond yields is profound. “What I fear is that governments themselves have become Ponzi schemes,” says Heinrik Klein at Deutsche Bank. “Bond issues are used to pay off previous releases. And the sizes of the bond releases are rising merely to cater for the expectation of future growth. It is deeply terrifying.”
“I’m convinced it is going to have to blow soon. GMChryslerFord employs three million people, yet only sells two million cars a year. Their losses are covered by the state, which owns them. Something has to give at some point,” says John Galt of Walker Prime, a hedge fund in Melbourne, Australia. “Yes, of course we’re shorting them. All of them.”
In early March, sentiment turns negative. Governments in Europe struggle to respond. France now owns 73% of the businesses in the country and finds it impossible to demand efficiency from their workers. Riots turn ugly as workers demand higher pay to meet rising inflation.
With inflation in the US at 15.3%, and an eye-popping 17.8% in the EU, governments have been forced to sell Treasury Index Protection Securities – securities where the security principle is inflation-adjusted – after several failed bond auctions.
As tax rates rise to cover the rate of inflation and the inefficiencies of the markets, fewer and fewer people are paying more and more. The top tax rate in the UK heads back to 80%, last seen under the Labour government in the 1970s. A riot breaks out in California after several factories voluntarily liquidate in a coordinated move after company tax rates are raised to 55%.
The French government floats the idea of a 100% tax along with a full cradle-to-grave social welfare system. No-one calls this Communism, but private investors flee and the Euronext Bourse in Paris is forced to suspend trading as stocks plunge 99% in hours.
A conference of the 32 large economies is called in Shanghai. The G32 collapses in acrimony as governments refuse to agree on ways to privatize their industries.
In September, one million US autoworkers down tools. Productivity actually goes up. Vandalism follows and several plants are burned down. The assets underpinning US bonds are in danger of being destroyed.
On 15 August, the US defaults on a US$ 1 billion TIPS bond issued in 1999. Inflation-adjustment has driven the redemption value of the bond to almost US$35 billion. The 2018 Methuselah Bond was spent almost immediately on other bond redemptions, as well as on further bailouts to the auto and airline industries, leaving the state virtually bankrupt. On Friday, 16 August, Timothy Geithner, chairman of the US Treasury begs the Senate to sell its stake in the auto industry to raise cash to repay other bonds. The senate rejects him and instead passes one of the most rapid special resolutions in history; they command the US Treasury to print US$ 4 trillion in new, unsecured, banknotes in order to pay off future debts.
Investors have been waiting for this.
On Monday morning they start selling. Within hours, US$ 13 trillion has been obliterated and the world economy starts to tumble.