Updated: Sep 25, 2019
A Runaway Recession Could Hit Harder and Faster Than Anyone Expects.
By Jack Bine BSBA.f; MBA ABD
Financial markets are in a flurry after news broke that for the second time in under a week bond markets showed an inverted yield curve. This indicator says that bondholders and investors believe that their money is at a higher risk of loss in the short term than in the long. As long term bonds are for five times as long (10 years/30 years) there is usually considerable uncertainty in looking that forward into the future. Thus riskier future speculation must be incentivized with more sizable guaranteed interest rates. The scenario we currently find ourselves is the opposite. Currently, two-year short term bonds have become perceived as riskier than long term bonds as investors lose confidence in the short term economic conditions. Instead, tieing up their money for lower yields, than risk losing it in the short term due to financial instability.
While an inverted yield curve does not cause a recession, it is a definite predictor of one. They have not only proceeded the 2008 financial crisis, as has been widely reported. However; they also proceeded the dot com bubble bursting in 2001, the recession in 1990 largely caused by the oil scarcity after the 1991 "Desert Storm" operation, and the junk bonds collapse of 1981. Unfortunately, often even the talk of an inverted yield curve can cause investors' confidence to fall lower and make the problem significantly worse, which then forces the price of short term bonds even higher creating a feedback loop.
We currently find ourselves in the precarious economic situation outlined above. Post TARP policies have encouraged risky investment by the largest financial institutions, due mainly to the fact that they know that they are the central stores of wealth in the economy and as such are indeed "too big to fail.". The total amount in the derivatives market (Market Value 12.7 Trillion) is now the highest in history, even higher than the pre-2008 collapse. While many may consider the stock market itself as some form of gambling, the derivatives market is a purely speculative market that allows for tremendous gains, but equally significant losses. Instead of investing in a company, with assets, customers, contracts, and the like; derivatives are simply contracts between individual entities and usually take the form of futures and options. As this market is purely speculative, it is highly dependent on investor confidence. Again, this market is currently undermined and getting worse daily. This space we find ourselves in now is like a gasoline-soaked rag, ready to lite on fire with little more outside actions.
A spark, any shock, could kick off a runaway sell event on Wall Street. Investors pull their money from an uncertain market to protect what they have left.1929, and 2008 shows these same patterns of behavior. The largest financial institutions could be subject to complete collapse, which could lead to another event in one decade where the American people are tapped to bail out the financial institutions. It is easy to imagine the current government unable to put together a parachute-like TARP, which would then lend toward the 1929 Great Depression scenario vs. the 2008 Great Recession.
We have no shortage of events that could kick off this apocalyptic scenario. Iran is seizing oil tankers and stocking up nuclear material in the middle east, an ongoing trade war between the world's two largest economies (one mainly based as a free market, and one mostly state-planned) including future tariff increases, and of course October 31; Brexit. Shocks like these events are inevitable, but with the global economy more linked than ever, the effects will ripple out across the entire world.
The global economy is like many people chained together in the ocean. Then some will be swimming stronger than others, and if someone starts to drown, the stronger swimmers can combine efforts to pull them along. However, if too many start to drown at once, they will pull the others to the bottom. Trade binds us all to each other. Therefore, it may very well be that an event that takes place outside the United States borders that causes this dangerous and unstable situation to collapse. If this happens, it will drag us all, to the bottom.