The 10 year yields for selected countries is depicted below.
The western world bond market is the biggest disaster waiting to happen. The debt structure of some of these countries is mind boggling. Some countries roll over almost half their debt each year. This is analogous to the adjustable mortgage rates that homeowners took out in the early 2000’s. When interest rates went up a few hundred basis points they could no longer afford their mortgage payments.
Far more dangerous is the OTC derivative market. Interest rate contracts have a notional value of 500 trillion dollars. To put this number in perspective, the world GDP is 80 trillion dollars. What will happen when interest rates begin to rise and governments default? How much money is put aside to cover these OTC derivatives? I suspect the answer is close to zero.
Micheal Lewis wrote a book called, “The Big Short: Inside the Doomsday Machine“. They made a movie from the book. Micheal Lewis is an excellent writer. He correctly details how the OTC derivative market played an important role in the 2008 meltdown.
Basically, banks hold an enormous amount of OTC derivatives. 99% of them are fraudulent. That is, if they were ever called upon to perform their duty the banks would go bust. For years, the lie was the following:
“Housing prices don’t go down.”
When housing prices did go down and homeowners defaulted, the OTC derivative imploded.
The new lie is this:
“Governments don’t default.”
They will default though, in one form or another. Average Joe still thinks US government bonds are the safest investment.
The probability of the OTC derivative being this large over the next 30 years is unlikely. How it ends is anyone guess. The range is from World War III to cascading defaults.