When the bond bubble finally bursts, a lot of investors will get hurt

The extent of distortion in the bond markets is quite remarkable.

Two weeks ago, I suggested that the bond market was caught up in a serious bubble and that its potential bursting represented the greatest threat to financial stability. Since then, bond markets here and abroad have indeed been weak. But you ain’t seen nothin’ yet.

paulweighell: "when things have returned to normal" ? You mean when several hundred million Chinese decide to revert to farmland peasants, wearing blue, waving red books and being happy to eat pork once a month instead of competing head on with the West? Ain’t never not going to happen nohow boy… It's a global trade competition and the West got complacent and lost. Fiddling about with monetary stuff will not change lazy overpriced Western labour. The East now has a taste of pork every week and they ain't going backwards just so we can be cock of the walk again…

Peter Snelson: Spot on.

Titus__Pullo: Well luckily we've got an economic Colossus in George Osborne with a cunning plan: we're going to create a British version of Fannie Mae and Freddie Mac and pump up the British property market. So we're basically going to entice those that can't afford to buy property into the market at record low interest rates. Afterall, what could possibly go wrong?

jimmy1952: Roger you say the pound needs to be even lower.  But if trashing the currency was all that is needed for exports then Britain would be the biggest exporter in Europe (the pound has fallen 20% against the Euro since the Euro since the Euro was introduced) and Zimbabwe would be the biggest exporter in the world!!! We need to aim for the top, competing with Germany and Switzerland on Quality and Innovation.  Not aim for the bottom competing with Bangladesh on cheapness of labour.

lanthalus:  Spot on jimmy. It's become a cliche to repeat Einstein's comment that attempting to do the same thing over and over but to expect a different result is a sign of madness - but that's what devaluation has become. How often do we have to see nations with (long term) stable currencies succeed before the penny drops?

steveby: Absolutely Jimmy. But it's as well to remember that Bootle makes his living by prophesying doom. If we relied on the analyses of Capital Economics we'd all be making our way down to t'cut carrying sackfuls of bricks.

ceekay: But if you look at our currency it should be much, much weaker. Why? Debt. We still have one of the worst levels of debt in the world. Both public and private. It's barely serviceable, except for money printing, therefore we are broke. We still spend more than we make. If a country is 'broke' it's currency collapses.  I believe the only reason it's at current levels is because we still control most of the tools that affect it, unlike the doomed Euro. So while, like you, I wish we were a strong exporting nation with a strong currency, the countries you mention have a massive trade surplus and very low debt. And for Blighty, that's a long way off.

sailor_steve:  Sterling, despite the debt problems of both government and individuals, is perceived as a safe haven.  Of course if the UK votes itself out both of the EU & EEA then this status would dissolve overnight and sterling would sink like a stone.

dacorum: sailor_steve If we left the EU and faced retaliation, the EU would be cutting off their nose to slight their face.  Why? Because leaving the EU would be a massive vote of no confidence in "the project" that will shake the EU to its foundations and the EU could not therefore afford to lose what would be their biggest export market outside the EU by blocking our exports to the EU.  If we left the EU, it would be the Euro that will lose confidence, not sterling.  

michaelindeutschland: great comment jimmy - somebody has to attempt to raise their standard of living in order to be able to buy from markets with a lower standard of living, which would over time raise their standard of living. ( the quality of life is a different debate ) every central Bank seems to be haring from the blocks in a race to the bottom - especially Draghi who seems hell bent on reducing wages right across the Eurozone. There are some here in Germany - the Altenative für Deutschland, who are willing to take a real, but quantified risk and revert to our own currency. we believe this will give us greater spending power, incentivise our industry to offer higher quality products ( which have by definition a higher profit margin ) so further enhancing our standard of living, and give us a chance to help pull our near neighbors up with us. as for quality of life - the southern europeans had a much higher quality of life than we - weather, food, strong families ties etc., until the euro decimated this. balance and self correcting compensation mechanisms ( it´s late, and I am a little tired to flesh that statement out - but hopefully some may find a germ of a concept in there )…

albatross: The Weimar Republic was another fine example of financial mismanagement founded on debasement of the currency

suburban_john: Strange that we are coming to accept QE as as both necessary and almost normal. Yet it remains a Great Experiment, born of necessity and continued for fear of the alternatives. But you can't print money on this scale without major consequences; eventually the chickens will come home to roost.

Neil Wilson: Good job that isn't happening then. QE is an asset swap. A liquidity upgrade. All it really does is remove an amount of interest income from the private sector and forces them to fight over what income remains.

TheBoggart:  What is does is take money from those who are economically weakest - pensioners and those living on a fixed income - so that people who've taken out large mortgages on property they couldn't really afford have a more comfortable ride.

stephenmarchant: Roger, your prognosis for the bond market is rather long winded to put it politely! Those of us who understand basic mathematics realise that sterling will be hammerred and stagflation will go through the roof. Your reference to the BoE holding interest rates low carefully avoids stating the obvious fact that this would be done by an escalation in QE to mop up the Govt deficit and maintain low Gilt yields. The one thing you are absolutely correct on is that there will be a bond crash - an unprecedented one - and we will witness the 1970s but on steroids. The Govt of the day will have to make emergency cuts to public spending and introduce capital controls to prevent all of that 'hot money' driving sterling into the ground. I would like to paint an optimistic scenario of a new North Sea Oil bonanza to fill the debt black hole but it ain't going to happen this time. My best advice is to buy tangible assets and convert to gold and silver any funny money you have for long term savings. No one will be totally immune from the fallout but let us hope strong political leadership will come to the rescue.

ceekay: Good advice Stephen, except the advice on Gold.  Firstly, Gold is still historically high vs cash therefore it's not a great time to buy. Secondly, and more importantly, if capital controls are introduced I can see a confiscation of Gold, especially under a Labour government, a la FDR. If the crash is as serious as you suggest, am I agree with you it will be, then that is a serious risk so having commodities as more than a small percentage of your wealth is very, very risky.

Titus__Pullo: I tend to agree. I like gold as a hedge against currency debasement but am very wary of the risk of government confiscation when the bond market implodes. As the recent Cypriot confiscations suggest governments will target the wealth of small numbers of high net worth individuals in troubled times. It may be worth holding a single-digit percentage of gold in a wealth portfolio but anything more than that is a risk I personally wouldn't take. But I suppose it's also easy to argue with QE/rock bottom interest rates and the government fiddling the inflation figures that industrial-strength wealth confiscation is well underway at the moment anyway.

McQueue: My thoughts exactly - Roger seems to conflate low interest policy with low bond yields, whereas bonds tend to enjoy an inverse relationship with interest rates… the maths is simple - debase your currency through ZIRP, then pay me a higher return for underpinning your debts denominated in said currency… so QE is introduced to temporarily suppress bond yields by hoovering up the market, debasing the currency again long term (particularly when they announce that hey, why bother unwinding it after all) - this measure clearly has a very limited window of effect before faith is lost and the QE distortion reduces in efficacy - it's the equivalent of trying to fly by pulling on your laces for god's sake.  A second rule of thumb is that bond yields should be greater than the combined value of growth plus inflation for the period - similar outcomes, the other side of the same coin essentially. Inflationary policies should trigger increased bond yields, as a trailing effect. So anyway, now I've stated the obvious and clearly don't get why Roger conflates interest rates and bond yields, any clever sausage out there enlighten me to the new maths he is extolling? I must be missing something here, surely? maybe not…

mistertoad: Good but merely historical points. Your rules of thumb by definition do not hold at all times. A glance at history will show that they can depart for many, many years. Surely the last 5 years, which practically all the City pundits predicted wrongly, is evidence of a new unprecedented era. What if it goes on another 5, 8 years? I think Bootle would be right. Also, what you are not factoring in is the likelihood that US, Eurozone, UK and Japan will ALL engage simultaneously in similar policies.   As they have already done! It is already an unprecedented situation.

McQueue: Yes, I was reading a recent article that was expounding US Treasuries were still very popular despite all the counter-intuitive activities (QE) because there were no good options and it was a default hedge for fund managers. What happens if it carries on for a further period - I think we'll see the embedding of people who have hoovered up assets using cheap money, as they will have had chance to pay down their principles in this window whilst the prudent have suffered, and that there will be an increasingly hard to bridge divide between asset owners and asset renters, essentially the growth of neo-feudalism in society's fabric, but that's a different topic. On an economic front, it seems likely a bond rout will be triggered by (market realised) national debt ceilings being surpassed in countries such as Italy, and this will trigger contagion as the emperor is proven to have no clothes beyond doubt - or maybe something will happen sooner, perhaps triggered in the EZ responding to the German election… or maybe everyone will sit tight and be conservative, as they all have agreed there is just too much to lose (seems unlikely, eventually). Maybe, as you point out, the lockstep policy by so many economies may create a prolonged suspension of market-based rates. It is, ultimately, flying on fumes with no airport in sight.

Peter Snelson: Bottom line money is becoming worthless and 90% of the populations dont get it. Their ever increasing food bills are a confusion to them. Bonds are theft.  When the public understand the scam it will get nasty. Probably the worst in history.