The Phaserl


Why Rising Interest Rates Could Be “Potentially Lethal”

by Doug Casey, Casey Research:

Interest rates are soaring…

The yield on the U.S. 10-year Treasury note has jumped from 1.37% to 2.3% in just four months.

The yield on the Italian 10-year government bond has more than doubled since August.

Libor, one of the world’s most important benchmark rates, has jumped from 0.61% at the start of the year to 0.91%. It’s now at its highest level since 2009.

Most people wouldn’t think much of this. Some folks might even start dozing if you rattled off these facts. But Dispatch readers know these kinds of moves have a huge impact on the global financial system.

That’s because interest rates are the price of money. When they move a lot, they affect stocks…bonds…property…even the cash in our wallets.

• Big moves in interest rates also have a huge impact on derivatives…

Derivatives are securities that derive their value from another security, like a stock or bond.

If the term sounds familiar, it’s because they played a major role in the last financial crisis.

During the last housing boom, banks created derivatives tied to mortgages. These complex instruments were supposed to protect banks from big losses if housing prices fell.

Instead, they blew up when housing prices crashed.

• Derivatives helped turn the U.S. housing meltdown into a full-blown global financial crisis…

To prevent a repeat of the 2008–2009 financial crisis, the government started heavily regulating banks.

They put in new rules to curb excessive risk-taking. They required banks to hold more capital. But they didn’t stop banks from using derivatives.

E.B. Tucker, editor of The Casey Report, says the five biggest U.S. banks—JPMorgan Chase, Citigroup, Goldman Sachs, Bank of America, and Wells Fargo—have $179 trillion worth of derivatives sitting on their books.

That’s a gigantic number. To help you wrap your head around this figure, we put together the following chart.

It compares the value of derivatives held by these banks with their combined market value. You can see their derivative exposure far exceeds their combined worth.

• Now, executives at one of these banks would probably tell you to not worry about this…

They might even say derivatives make the financial system safer.

That’s because derivatives were created as a form of financial insurance. They’re supposed to keep a bank from losing money when the price of assets moves against them.

But E.B. says most banks don’t use derivatives for protection anymore. They use them to make money. They’re a huge source of profit for these institutions.

• Derivatives aren’t just a problem for the U.S. banking system…

They’re a threat to the entire global banking system. You can see why in the chart below.

As you can see, the total value of outstanding derivatives is nearly seven times higher than the annual output of the global economy.

You don’t have to work on Wall Street to realize the global economy would be in serious trouble if the derivatives market started to unravel.

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3 comments to Why Rising Interest Rates Could Be “Potentially Lethal”

  • rich

    Buffett: “As long as our debt is in dollars, it cannot cause us any problems. (We can always print more dollars.)” Oh Warren, please no…

    Warren Buffett’s Meeting with University of Maryland MBA/MS Students – November 18, 2016

    Question 3: Are you concerned by the size of the national debt?

    WB: The gross debt of the U.S. is 100% of GDP, but the net debt (subtracting trust funds) is less, at 70%+ of GDP. Our net debt was as high as 120% of GDP in World War II and as low as 35% -38% in the Reagan years. As long as our debt is in dollars, it cannot cause us any problems. (We can always print more dollars.) Taxes have accounted for 16% – 20% of GDP over time. Medical costs today represent 17% of GDP, up from 5% in 1970. The next highest country spends only 11% of GDP on health care. Corporate taxes equal 2% of GDP down from 4% in the past.

    Warren says stop worrying….fire up the printing presses…..

  • Craig Escaped Detroit

    Warren says stop worrying….fire up the printing presses…..

    I’d say, “Line up the ‘printing press people’, and declare: “Ready, Aim, FIRE!”.

    Load them into the incinerator and fire it up.

  • Carlos

    The stock market is roaring to all time highs as we are in the midst of a mighty BULL MARKET. Makes sense to Warren to fire up the printing presses cuz he makes more money.If the Fed raises interest rates even a quarter % that would send even more investments out of bonds and into stocks in an environment of falling wages and falling consumption. Only way to maintain profits is by raising prices, which of course will kill the consumption even more, leading to higher prices; and it spirals out of control. Since there is no real free markets, just manipulation of those markets it means that the fed will have to increase prices of some assets to off-set the rise in money printing so that the asset holders don’t lose value. This is the pattern since 2008. Stocks and real estate have been the real winners since then but it appears that those asset classes are about tapped out at these interest rates or higher. The fed will have to go deep into negative rates to keep that pattern alive. Rising interest rates, even modest ones, will result in much higher commodity prices, and much higher stock prices to maintain the value of all the increasing money being printed. No mater which way they go the manipulation will fall on the shoulders of the consumer in the way of higher prices. Rising interest rates will result in much higher prices for the consumer and will likely end this fantasy economy quickly as people begin to starve and go homeless even more than now. No worries for guys with a few billion in assets to throw around at what ever is going up. As always the rich guys are not going to suffer. On the other hand falling interest rates can keep the delusion going for a lot longer and with moderately less pain for the average man.

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