This week has started off miserably. China had problems within their banking system last night as bank transfers, ATMs, online banking and wires did not work. Europe announced that their $500 billion bailout fund for banks is no longer the case; they now say that 60 billion Euros will be the limit…retroactively. To put this in perspective, Spain had already been promised 100 billion Euros for their banking system; I guess the money is not coming? Our stock market has started the day down 230 points and the 10 yr. Treasury yield is now 2.64%, this is another .12 basis points higher on the day and now nearly 70% higher than it was back in April.
As I wrote over the weekend, this is “one gigantic global margin call.” Please understand how many of these interest rate derivatives work. When the rates go against you, “margin” must be posted. By “margin” I mean collateral.
To put in perspective what is happening, Zerohedge calculated that the Fed lost $35 billion this morning alone and $250 billion over the last 2 months. The Fed only has (had) $65 billion of equity capital yet in just several hours they lost half of it…again…this is because they hold $3.5 trillion in assets. This is the equivalent of a trader putting up $2 and buying $100 worth of assets, they have 50-1 leverage. They may not even be the most egregious out there. There are derivative contracts that are over 100-1 leverage that must post collateral each day. At least the Fed doesn’t have to post any collateral against losses because they can be “trusted.”
Can you see what is happening? The “button has been pushed” either on purpose, inadvertently or because “they had to.”
And yes, if the average rate of interest on U.S. government debt rose to just 6 percent (and it has actually been much higher in the past), the federal government would be paying out about a trillion dollars a year just in interest on the national debt.
But that isn’t it. Nor does the primary reason have to do with the fact that rapidly rising interest rates would impose massive losses on bond investors.
At this point, it is being projected that if U.S. bond yields rise by an average of 3 percentage points, it will cause investors to lose a trillion dollars.
Yes, that is a 1 with 12 zeroes after it ($1,000,000,000,000).
But that is not the number one danger posed by rapidly rising interest rates either.
Rather, the number one reason why rapidly rising interest rates could cause the entire global financial system to crash is because there are more than 441 TRILLION dollars worth of interest rate derivatives sitting out there.
This number comes directly from the Bank for International Settlements- the central bank of central banks.
In other words, more than $441,000,000,000,000 has been bet on the movement of interest rates.
Normally these bets do not cause a major problem because rates tend to move very slowly and the system stays balanced.
But now rates are starting to skyrocket, and the sophisticated financial models used by derivatives traders do not account for this kind of movement.
So what does all of this mean?
It means that the global financial system is potentially heading for massive amounts of trouble if interest rates continue to soar.
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