Often times I like to write about an event or someone else’s article because of the importance to the overall picture. Today I will do something a little different. Below is an e-mail I received last Thursday from a friend. I have the utmost respect for his thought process and his knowledge. The writer is "plugged in" if you will, he has very high and powerful contacts in both China and London while he operates out of North America. The following is chilling to say the least because it comes from someone who "knows", it is not a speculation on his part because he is seeing it real time! I will add my comments afterward.
"I have been pounding the drum for some time about shrinking liquidity and what the impact will be. Well, I can tell you that we are almost there and a real crisis is developing far faster than what I envisioned that is impacting the 75 Trillion Shadow Banking sector which is on the verge of implosion. Focus on Europe as the real crunch will spread like a wildfire from there seizing up all credit markets.
We will ignore China and the BRIC for the time being as to impact and focus on the European Ponzi that the bankers have brought to the table.
The specific area we should keep an eye on is the U.S./bund 10yr yield spread, currently quoted at 155bp. This spread will start taking its lead from the euro, so when that starts to lose favor keep sharp eye out for the next shoe to drop.
Asian shares were very volatile today, Shanghai in particular, trading with a 10% variation (daily low to high) today as PBOC were active again. In Europe we did see small gains intraday in DAX and CAC but neither could hold on and actually closed well into negative territory both down over 1%. UK FTSE never got into the green all day and closed -1.5%. Even seasoned Traders are scared now about intra day swings and being caught in a downdraft at closing. Banks are tightening the leash on trading lines to reduce exposure which is sure to castrate liquidity of bonds.
Credit markets are almost closed, I am being told! I REPEAT again the CREDIT markets are almost closed! Trades are happening by appointment and to even move 1MM EM bonds (at an opening price) is almost impossible. It is not uncommon to hear an indication only to trade and a 2% trade away from from opening, assuming you are able to trade, and desire to trade is no guarantee of a sale. NO ONE is standing up to market prices and to liquidate even a small portfolio can take weeks. It is important that you cannot any longer trade the basis as value is dropping and there no point to partially selling specific bonds unless you can clear a given position! Because once there is a traded price ALL holders of same or similar will have to remark the book. That is unless you are a bank where the Balance Sheet is not a Mark-to-Market approach on a daily basis for the book being held. Think holding government debt at par for the likes of Italy or Spain knowing they can never clear the debt, and knowing that no one will buy at market. So what is the true value of a large portfolio? Do you hang on getting interest while it is still being paid or do you attempt to go to cash? And if you do who is going to step into your shoes ? Especially since the banks are all trying to save cash and want no exposure of any kind. We maybe approaching the point where central banks are losing credibility and their ability to contain the fallout, when governments are so badly in debt they are powerless and rudderless in a sea of chaos.
We are coming very close to complete chaos that will make 2008 look like a walk in the park! We will be fortunate if we make fall without a real financial disaster!
Following up from yesterday let’s ponder the upcoming Crisis that we are facing that specifically involves bonds, which are the bedrock of the financial system and what the fallout maybe.
Every asset class in the world trades based on the pricing of bonds. So the fact that bonds are in a bubble (perhaps the biggest bubble in financial history), means that EVERY asset class is in a bubble. Everything from real estate to stocks to the buying of cars. Ever wonder why car loans in America exceed the value of the cars in question.
Depending on who you speak with globally there are $75-$100 trillion in bonds in existence today.
A little over a third of this is in the US. About half comes from developed nations outside of the US. And finally, emerging markets make up the remaining 14%.
So whatever the real trillion it is, the size of the bond bubble alone should be enough to give pause. Even to the most aggressive or optimistic folks.
However, when you consider that these bonds are pledged as collateral for other securities (usually over-the-counter derivatives) the full impact of the bond bubble explodes higher to something like $500TRILLION. This affects both banks and the shadow banking industry. No wonder the Bank of England is perplexed as to the shrinking liquidity, it is a problem to which they have no solution.
To put this into perspective, the Credit Default Swap (CDS) market that nearly took down the financial system in 2008 was only a tenth of this ($50-$60 trillion).
And this was at a time when there was QE and other means to throw at the problem which are now spent. So what will be used this round?
This is why the shrinking liquidity in bond sales is even to give real pause and wonder what will come to be as confidence in government wanes, and the shrinking liquidity affects all markets at the same time in different degrees but with a universal discount of value and liquidity, egged on by collapsing derivative trades."
So there you have it. This is something I have been saying for quite some time, we are living in the greatest credit bubble of all time…and it is bursting. It is bursting because liquidity is drying up. The point made regarding the inability to offload bonds speaks to just how small the "exit door" really is in the most crowded trade in all of history! I hope you did not miss what was said about "marking to market". The sale of a measly $1 million worth of bonds at any discount affects the pricing of BILLIONS which then acts as a further liquidity restriction on bank balance sheets.
To this point we have not seen much weakness in U.S. markets BUT we are witnessing the "volume" dry up drastically. This lack of volume also speaks to the size of the exit door. Without volume, how does one sell if they want to? Better yet, without sufficient volume, how does one sell if they HAVE TO or are FORCED TO? In Asia, China’s stock market has collapsed over 20% in just three weeks. They are living a real life margin call! What is most humorous to me is China has now instituted rules where stock market margin calls can be met by posting real estate as collateral! Meeting margin with an already margined asset is the recipe for disaster!
Please understand this, "policy" and central banks are doing whatever they can to keep investors away from the exit door because they know there isn’t one. Central banks all over the world are "buyers" of nearly all things paper, do we really have "markets"? Anywhere? Let me finish with this, it is written in the Bible "and on the third day He rose again". Here on Earth I believe we will soon find out after credit breaks, "and on the third day …nothing opened". I truly believe this is possible. I do not believe the Earth can spin more than twice after a true break in the credit markets before a COMPLETE SHUTDOWN will occur. Nothing "paper" will be spared!
Regards, Bill Holter
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