Could the global bond market cause another financial crisis in 2013?
With Christmas and New Year cheer and optimism still bubbling away
for most of us we now need to turn our attention to the major risk
factors that are likely to impact upon the world economy and financial
markets during 2013.
While the world economy is estimated to have grown by over 3 percent
in 2012 overall and has enjoyed such a remarkable escape from the
paralysis affecting some of its constituents like Europe, a major issue
is whether this stable growth trajectory will continue for the
foreseeable future.
At the end of the day the global stock market has been a secular bear
market for over a decade and we are now at the juncture of ascertaining
whether the bear will have its final growl in 2013 or we will enter a
new market phase.
The economic fundamentals are very strong for world economic growth,
thanks to a relatively soft landing for China.
However, a number of world risk factors prevail that could upset the
world's economic and financial stability. The major risk factor emanates
from the global bond market where yields have been driven down to
historic lows on both sides of the Atlantic due to Quantitative Easing
[QE] or the printing of money.
This has had a knock on effect in emerging markets, through the
interest rate parity mechanism and emerging economy sovereign debt
yields are also historically very low, despite their high level of
political risk and this may be why emerging economies outperformed the
world's average GDP growth by around 2% because of lower financing
costs.
Global risk emanates from the northern hemisphere, in particular the
EU and US but these can wreak havoc elsewhere. Europe is still a major
issue in terms of world economic fortunes and 2013 will be a make or
break year for them in terms of the single currency that necessitates
closer banking and political union. Already, the UK is hinting of the
need for a tiered system of membership to exist, which although critics
describe as a "two speed EU", would allow banking, monetary and
political union to move forward at a faster rate.
For would-be contenders on the European continent this could boost
the viability of the Eurozone, whilst keeping the rationale of a strong
Europe intact and expand the free trade area without leaving anybody
out. This consensus has been gathering momentum in recent months and
would certainly fortify the global institutional framework and
contribute to a more stable world economic growth.
If Europe is unable to sort out its banking and monetary union in
2013 and if some member states were to leave the Euro then this will
have severe repercussions on the world's markets. However, markets are
pricing in that this is unlikely to happen, unlike during 2011 at the
height of the crisis.
In my view, the risks to the world's economic system emanate from a
lagged effect of the dangerous combination of the massive stimulus to
the global economy that has occurred since the onset of the crisis with
a series of massive QEs that were required to keep the banking sector
afloat to avoid a second Great Depression.
Although required at the time, government spending can crowd out
private sector investment in the medium term and Quantity Theory of
Money [if you believe in it] suggests that increases in the money supply
through QE will not increase GDP growth in periods of economic
recession, depression or financial repression that we now live in.
It can be argued that this was exhibited in Japan's economy during
the early 2001 and beyond when the Bank of Japan was a major initiator
of the QE monetary approach. Asset values fell rather than increased as
predicted by QE. This is however highly debatable.
What QE and stimulus have done is to increase imbalances in the
global economy which have not been helped by a commodity boom, which has
distorted currencies like the Australian and Canadian dollar relative to
the US dollar and increased the yield differential artificially between
major developed countries, which is a major driver of disequilibrium in
the world economy.
When will these imbalances be corrected? This process could begin in
2013. Whether you look at 'fast food' indicators like the Big Mac
currency valuation produced by the Economist magazine or a more detailed
analysis of the spike in many countries Terms of Trade [that research
shows is mean reverting] or long-run relative purchasing power parity,
it often takes a crisis to start the process of adjustment back to a
general equilibrium.
Where will the crisis emanate from? I believe that there will be a
major movement of capital in the global bond market into equities and
the real economy when finally GDP returns to its normal trajectory.
Combined with a gradual easing to QE and Stimulus, this will cause a
major jolt to the global bond market which could see price falls of
around 25% with at least a 2% increase in yield that are the true rates
that reflect current global risks.
But the worse is the 0.75 quadrillion-dollar murky, unregulated
derivatives market that will also be impacted by a sudden shock to the
global bond market and who knows what might happen.
The collapse of a major investment bank could be a trigger that sets
off a global financial tsunami.
The best scenario is that the United States will continue to lurch
between the hospital wards of economic recuperation throughout 2013 and
we are expecting to see quite dramatic volatility in the world economy.
VIX, the future uncertainty indicator is currently climbing and is
certainly a key indicator to look at to gauge investors' global risk
expectations throughout 2013, and one that is prone to unexpected spikes
with slow exponential decay.
Another key indicator is the Baltic Dry Index [BDI] which measures
freight rates for bulk cargo across 40 major shipping lanes in the world
and which proxies for world trade.
Despite some encouraging manufacturing statistics coming out from old
dragon economy China, the BDI has remained bouncing along the bottom of
the harbour since the onset of the global financial crisis.
Finally, global political dynamics has its hot spots too which may
have far reaching implications for the world economy in terms of
relations with major world trading partners such as China, Asia and the
Middle East.
These include tension throughout the Middle East between themselves
and with the West and the perceived shift in the balance of economic
power between China and Japan uncovering latent tensions.
China has already stopped extraction of rare earth materials at the
end of 2012 which will affect the semi-conductor industry in both US and
Japan. A trade war could be in the cards. Who knows?
In summary, global risk factors emanating from Europe, the United
States coupled with a softening of China's economy and political tension
in the Middle East and the Far East, the world will need to continue to
navigate even more carefully through the treacherous economic oceans
that lurk beyond the horizon like the artificially manipulated global
bond market with its attachments to the quadrillion dollar derivatives
market.
It has been a long bear market and major events will unfold in 2013
in the US, Europe, the Middle East and the Far East that may affect
whether this bear will continue its aggressive growling. It's a
financial jungle out there.
The world needs to continue to prepare for the unexpected. We may
only be half way through this present crisis and the next one may
already be an economic monster of our own making lurking in the global
bond market.
- Third World Network Features
|