"The World's Debt is Not a Concern"
In the financial world, there's growing concern about the potential risks in the bond market, with some experts predicting a bubble that could lead to increased volatility. This apprehension, often referred to as the valuation risk, forms the first layer of worry.
The second layer of risk, the credit risk, is expected to continue growing, particularly in Japan and Europe. The long-term challenge for Japan's economy is the potential increase in default risk due to each household having to refinance a larger amount of government debt. This risk is exacerbated by Japan's declining population, which has dropped from about 128 million people to currently 125 million, and forecasts predict that just 100 million people will live in Japan in 2050.
Graphic two shows Japan's population development, while graphic one illustrates Japan's debt as a percentage of GDP. Both graphics reveal that Japan, one of the world's most debt-laden nations, has increased its government debt even further, despite its heavy indebtedness.
In Europe, calculations suggest that in the past decade, intraday liquidity in trading books for High Yield corporate bonds has been reduced by up to 90%. This reduction could lead to a situation where a large sell-off in these bonds might not be absorbed by trading books anymore but would be sold off directly in the market.
Italy's mid-term threat is a continuing decline in its credit rating, with the current BBB rating being uncomfortably close to "junk-bond" status. This threat is further compounded by the European Central Bank's (ECB) recent decision to cut interest rates and announce more bond purchasing on the 12th of September. While this move is intended to stimulate the economy, some argue that monetary stimulus doesn't bring any good anymore.
Elsewhere, China's debt pile, particularly from state-controlled enterprises, remains a long-term challenge, despite a decrease in pressure over the past 18 months. The global financial crisis ten years ago could be nothing compared to the coming credit crisis, which might occur 10 to 20 years into the future.
In the long term, investors may flee from credit risks and move into assets like equities, gold, and cryptocurrencies. However, the risk of a bond market bubble exploding is being discussed, and the potential consequences could be significant. It's a situation worth keeping a close eye on.
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