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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