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The 441 TRILLION Dollar Interest Rate Derivatives Time Bomb

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The Derivatives Time BombDo you want to know the primary reason why rapidly rising interest rates could take down the entire global financial system?  Most people might think that it would be because the U.S. government would have to pay much more interest on the national debt.  And yes, if the average rate of interest on U.S. government debt rose to just 6 percent (and it has actually been much higher in the past), the federal government would be paying out about a trillion dollars a year just in interest on the national debt.  But that isn’t it.  Nor does the primary reason have to do with the fact that rapidly rising interest rates would impose massive losses on bond investors.  At this point, it is being projected that if U.S. bond yields rise by an average of 3 percentage points, it will cause investors to lose a trillion dollars.  Yes, that is a 1 with 12 zeroes after it ($1,000,000,000,000).  But that is not the number one danger posed by rapidly rising interest rates either.  Rather, the number one reason why rapidly rising interest rates could cause the entire global financial system to crash is because there are more than 441 TRILLION dollars worth of interest rate derivatives sitting out there.  This number comes directly from the Bank for International Settlements – the central bank of central banks.  In other words, more than $441,000,000,000,000 has been bet on the movement of interest rates.  Normally these bets do not cause a major problem because rates tend to move very slowly and the system stays balanced.  But now rates are starting to skyrocket, and the sophisticated financial models used by derivatives traders do not account for this kind of movement.

So what does all of this mean?

It means that the global financial system is potentially heading for massive amounts of trouble if interest rates continue to soar.

Today, the yield on 10 year U.S. Treasury bonds rocketed up to 2.66% before settling back to 2.55%.  The chart posted below shows how dramatically the yield on 10 year U.S. Treasuries has moved in recent days…

10 Year Treasury Yield

Right now, the yield on 10 year U.S. Treasuries is about 30 percent above its 50 day moving average.  That is the most that it has been above its 50 day moving average in 50 years.

Like I mentioned above, we are moving into uncharted territory and this data doesn’t really fit into the models used by derivatives traders.

The yield on 5 year U.S. Treasuries has been moving even more dramatically…

5 Year Treasury Yield

Last week, the yield on 5 year U.S. Treasuries rose by an astounding 37 percent.  That was the largest increase in 50 years.

Once again, this is uncharted territory.

If rates continue to shoot up, there are going to be some financial institutions out there that are going to start losing absolutely massive amounts of money on interest rate derivative contracts.

So exactly what is an interest rate derivative?

The following is how Investopedia defines interest rate derivatives…

A financial instrument based on an underlying financial security whose value is affected by changes in interest rates. Interest-rate derivatives are hedges used by institutional investors such as banks to combat the changes in market interest rates. Individual investors are more likely to use interest-rate derivatives as a speculative tool – they hope to profit from their guesses about which direction market interest rates will move.

They can be very complicated, but I prefer to think of them in very simple terms.  Just imagine walking into a casino and placing a bet that the yield on 10 year U.S. Treasuries will hit 2.75% in July.  If it does reach that level, you win.  If it doesn’t, you lose.  That is a very simplistic example, but I think that it is a helpful one.  At the heart of it, the 441 TRILLION dollar derivatives market is just a bunch of people making bets about which way interest rates will go.

And normally the betting stays very balanced and our financial system is not threatened.  The people that run this betting use models that are far more sophisticated than anything that Las Vegas uses.  But all models are based on human assumptions, and wild swings in interest rates could break their models and potentially start causing financial losses on a scale that our financial system has never seen before.

We are potentially talking about a financial collapse far worse than anything that we saw back in 2008.

Remember, the U.S. national debt is just now approaching 17 trillion dollars.  So when you are talking about 441 trillion dollars you are talking about an amount of money that is almost unimaginable.

Meanwhile, China appears to be on the verge of another financial crisis as well.  The following is from a recent article by Graham Summers

China is on the verge of a “Lehman” moment as its shadow banking system implodes. China had pumped roughly $1.6 trillion in new credit (that’s 21% of GDP) into its economy in the last two quarters… and China GDP growth is in fact slowing.

This is what a credit bubble bursting looks like: the pumping becomes more and more frantic with less and less returns.

And Chinese stocks just experienced their largest decline since 2009.  The second largest economy on earth is starting to have significant financial problems at the same time that our markets are starting to crumble.

Not good.

And don’t forget about Europe.  European stocks have had a very, very rough month so far

The narrow EuroStoxx 50 index is now at its lowest in over seven months (-5.4% year-to-date and -12.5% from its highs in May) and the broader EuroStoxx 600 is also flailing lower. The European bank stocks pushed down to their lowest in almost 10 months and are now in bear market territory – down 22.5% from their highs. Spain and Italy are now testing their lowest level in 9 months.

So are the central banks of the world going to swoop in and rescue the financial markets from the brink of disaster?

At this point it does not appear likely.

As I have written about previously, the Bank for International Settlements is the central bank for central banks, and it has a tremendous amount of influence over central bank policy all over the planet.

The other day, the general manager of the Bank for International Settlements, Jaime Caruana, gave a speech entitled “Making the most of borrowed time“.  In that speech, he made it clear that the era of extraordinary central bank intervention was coming to an end.  The following is one short excerpt from that speech…

“Ours is a call for acting responsibly now to strengthen growth and avoid even costlier adjustment down the road. And it is a call for recognizing that returning to stability and prosperity is a shared responsibility. Monetary policy has done its part. Recovery now calls for a different policy mix – with more emphasis on strengthening economic flexibility and dynamism and stabilizing public finances.”

Monetary policy has done its part?

That sounds pretty firm.

And if you read the entire speech, you will see that Caruana makes it clear that he believes that it is time for the financial markets to stand on their own.

But will they be able to?

As I wrote about yesterday, the U.S. financial system is a massive Ponzi scheme that is on the verge of imploding.  Unprecedented intervention by the Federal Reserve has helped to prop it up for the last couple of years, and there is a lot of fear in the financial world about what is going to happen once that unprecedented intervention is gone.

So what happens next?

Well, nobody knows for sure, but one thing seems certain.  The last half of 2013 is shaping up to be very, very interesting.

  • MichaelfromTheEconomicCollapse

    Is this what is going to cause the derivatives bubble to burst?

    By the way, if you want to follow me on Twitter, you can find me here…


    • Kim

      Yes. The bank is the horse feed supplier and he is out of feed. Yet there are 100s if not 1000s of contracts out there. Bank didn’t predict a storm was coming.

      • Keenan

        and the people who did put the screws to them. Is that less immoral? (think George Soros)

  • JB

    Why are interest rates rising if you are expecting deflation before hyperinflation?

    • andrewp111

      Short term movements don’t necessarily have anything to do with long term trends. A temporary market imbalance can cause a surge in interest rates, just as a short squeeze can briefly send any stock to the moon and back.

  • Kim

    Another way to put it: say a horse breeder wants to buy a very large amount of horse feed six months from now, and today’s market price is $1.25 a lb. the horsebreeder decides to sign a contract with the supplier that promises he will purchase a large amount of horse feed from him in six months for $1.50 a lb, regardless of its market price. The supplier is hoping horse feed will be around $1.40 in six months time, in that case, supplier comes out ahead. Models project it’ll be somewhere between $1.40 to $1.60 a lb in six months time. Six months is up and horse feed shot up, for whatever reason, to $5.00 a lb. the supplier is contractually obligated to sell a large amount to the breeder at contractually agreed up price of $1.50. The supplier, unless he has a stockpile of horse feed, is effectively out of business. That is a derivative.

    • Richard

      Excuse me, in the ‘real world’ the supplier will already have covered himself by buying the feed immediately upon concluding the deal with the horse breeder. No supplier would EVER allow himself to be exposed in the way you describe. Sorry. Just doesn’t happen. That’s why we have futures markets. This is not a good example of a derivative as referenced by Michael, although it is technically a ‘derivative’.

      • chilller

        The same futures markets that help drive prices up for everyone…THAT futures market?

        • Kim

          There are many types of derivatives. A futures contract is just one example. All derivatives have one thing in common tho: a bet on future earnings or rates or currencies. A bet is a bet.

          • MichaelfromTheEconomicCollapse

            It is true – there are many, many different types of derivatives.


      • MT

        Dude. It was an analogy. It wasn’t a story about horses.

      • JK

        That example is the real world. It’s called leverage, i.e. over-leverage. Are you saying the banks are not and have not been over-leveraged?

        Deregulation of leverage limits, capital requirements and other deregulatory measures are the main causes of this global economies financial woes.

        • archer

          It’s called Capitalism, when trillions can be made without producing anything, we kicked out the “free enterprisers” and kept the capitalists.

      • Kim

        Of course in the real world any supplier would have covered himself or not entered into a risky agreement. But the banks aren’t operating in the real world. They are betting on future investments based on stable interest (market) rates. The banks are irresponsible. That was the point of my crude illustration.

        • archer

          that was a good example, it’s naïve to think that a supplier would by enough to cover all futures, that’s what makes it a gamble on both sides.

      • jim_robert

        I’m just trying to learn here, so bear with me…. What if the supplier was not ABLE to buy the horse feed upon concluding the sale? (e.g., to change tropes, think corn or soybeans. In fact, for the example – and yes, I know this is a stretch, but bear with me – lets say the horse food IS corn. But it is March, and the corn isn’t planted yet, nor are there even long term weather forecasts out yet). What if – to change metaphors again – the supplier DID buy his feed at conclusion of contract, but then leased it out, expecting to be able to buy it back cheaper when he needed it? (think gold leasing here). Comments anyone? What am I missing?

        • Kim

          Yes, contracts can get complicated. There can be many parties to a contract and you can buy and sell contracts, transfer them, et cetera, but at the end of the day, when it comes to derivatives, someone is going to win and someone is going to lose. When it comes to things you can predict, all goes smoothly, but if something unpredictable happens, like a wild fire, drought, currency devaluations, rapidly rising interest rates, well, there are going to be a lot of losers.

      • Sonny

        I disagree…..look at what happened to AIG. Were they hedged? Look what happened to the people who were hedged with MF Global.

        • michaelwarhurst

          No. AIG insured or warped the worthless derivatives so that they
          could be rated by crooked agencies as AAA and fetch prices far greater than
          their actual worth and which meant that governments and pension funds could buy
          them and they became ‘weapons of mass financial destruction’. The senior
          management at the Wall Street banks purveying this trash, AIG senior
          management, rating agencies, et al pocketed hundred of millions in bonus money
          some of which was used to corrupt the governments and thwart democracy.

          The real crime here is that this type of fraud has been greatly
          encouraged, as not a single individual who planned, executed or profited
          personally from it has yet been charged and convicted and jailed – so there is
          almost zero incentive now to avoid and refrain from schemes whose only
          objective is to unimaginably hugely reward a small group of too big to fail too
          big to jail criminals and punish ordinary Americans. The biggest criminals in
          the History of America in plain view executed the most profitable scam ever at
          the expense of ordinary Americans and they have not been punished and are still
          raking in hundreds of millions of scamola loot and ‘reward’ for their work!?

          In reality the big scam was in convincing ordinary Americans
          that these corporations and individuals were ‘too big to fail and too big to
          jail’ which has created the opportunity not only for justice not to be done but
          for this same group of criminals to not only benefit from but also repeat their
          crimes – apparently with immunity and a lifetime get out of jail free card.
          Mean while ordinary folk are jailed for highway driving offences. Liberty and
          justice for all is being abandoned, killed and buried.

      • Karen Ancheta Martinez

        not necessarily. That same merchant may believe that the prices may go down in the coming months so he holds out hoping for that outcome. When the tidal wave of price increase hits him it is too late to buy. This is not the market for responsible people buying tangible items, it is a casino pure and simple so don’t expect many responsible people like yourself to be involved.

  • 2Gary2

    Michael–I am sorry if I asked you this already. Are you planning a second book? You kinda left things hanging at the end of the first one.

    • callmecordelia1

      Yes he did!! 🙂 I want to know the rest of Diesel’s story!

      • MichaelfromTheEconomicCollapse

        I am glad to hear some people ask about a second book. I would like to write one.

        What does everyone think?

        Should I?


        • callmecordelia1

          Yes, and tell us what happened to Diesel! 🙂 I really enjoyed the book, Michael. I smiled through the whole part about Mondo.

        • albinorhino

          your book was horrible. please do not subject yourself to more embarrasment

  • Tosheba

    Wall Street = America’s casino. U.S. Government = enabler.

    • chilller

      Gambling = Wall Street’s addiction
      US gubermint = the pusher man

    • WarriorClass III

      Exactly. None of this idiocy would be possible without very corrupt governments, and the U.S. gov is at the top of the list. Hopefully the people will realize that we have not had a representative government for a very long time (1860) and their vote means exactly squat. Too bad it won’t be until AFTER the SHTF. Hopefully we will replace the Lincoln legacy with a Jeffersonian one this time.

  • Lennie Pike

    Caruana obviously knows that the financial system will not “stand on it’s own”. His statement reveals him as a liar as all advocates of fiat money systems are. He knows very well what comes after the present system explodes.

    • MichaelfromTheEconomicCollapse

      And could the BIS intend for the financial system to go down?


  • JohnO

    I bought a pile of Gold and Silver over last few years, as a hedge against the comming implosion.. But now even my Gold and Silver – measured in dollars – have lost a fair bit of their value.

    So where do we invest? Shares? Bonds? Bullion? Or just sit on Fiat cash in a bank account or keep it under the bed? Everything looks hopeless 🙁

    • Ayn Rand

      The homestead my friend. The homestead. Food, water, defenses, physical gear, gas, oil, etc. etc. But most of all, yourself. Skills are a great asset.

    • kleptom1

      The people selling Gold are the ones that bought it at $300/ oz. Those buying now are the stupid idiots who beleive the doom and gloom spouted by authors trying to sell their end of world books. Sell your Gold and take your loss> When the prices go back to $300/ oz then its the time to buy. When the next cycle comes by, sell at $1600/oz to the other idiots who fell for the fear induced story. BAM! your rich.

      • Ayn Rand

        Seriously, look at inflation.
        Not the government models, but the REAL models that were used decades ago. Real inflation is estimated around 10%

    • Gene Baugh BBA

      I recommend stockpiling some cash but not all in a bank account. In an emergency the banks may close for an extended “Holiday.”

    • kathy k

      No matter what hang on to the silver & gold No matter what

  • Howard Glen Martinez

    I’m stockpiling sardines, crackers and bottled water. My breath may stink, but my tummy will be full.

    • Mark Powell

      You need mustard for the sardines.

  • seth datta

    Mate, most people in London are stone broke. They are talking about laying pensions and free healthcare to the wayside soon. If the derivatives bubble does burst, it’ll be a bloody nightmare.

    • andrewp111

      The City of London is the center of massive financial speculation because they allow infinite rehypothecation. If the CITY ever goes under, so does the entire financial world.

  • Cincinnati Dave

    This whole thing is like watching a train wreck happen in slow motion and there is really NOTHING that anyone can do to stop it!

  • faded

    Micheal I just wanted you to know i gave a reference to your site in my youtube video. God bless Should i do anything else i havent used any of your material i jsut told people to check out your sites for facts.

    • MichaelfromTheEconomicCollapse


      What you did sounds great. I am always honored when others consider my material to be valuable enough to share other places. The more people that see this stuff the better. 🙂


      • Faded

        Well hopefully one day i’ll be able to do a interview with you on the things to come.

  • kleptom1

    They have been spouting this doom and gloom sheet for years, it is great for selling books but never happens. Ten years from now it will still be here, we we will still be paying bills, collecting checks and moving on with our lives. You cant have a centraly managed economy and believe that things will get grossly out of control. They centraly manage it, which means its not in the best interest to have the wheels fly off. They will keep it going until the end of time becuase it makes them money.

    • Bad_Mr_Frosty

      I think they can massage and manipulate it for another year or so. It can’t continue much longer. 2008 proved that the system can and will slip out of their control.

    • DiscouragedOne

      Or, that could be wishful thinking on your part, not that I would not love it if you are right, but I am sure not going to bet on it.

    • jokyjo

      The former Soviet Union also centrally managed their economy and look how well that worked out for them. We need to return to a real free market, Not a corporately controlled market.
      You are probably correct in that they can keep this going for awhile longer. I seriously doubt for very much longer.
      Once interest rates start rising we are screwed. How are we going to pay for our BIG government and all the handouts we give when our interest on our debt will be more than what we spend in national defense.
      How much debt will we allow our bloated gov’t to stack up? 20 Trillion, 30 Trillion, 50 Trillion? How much is enough?

    • andrewp111

      Low probability events by definition don’t happen very often. The problem is that mega-trillion dollar bets were made on the notion that the probability of certain events is identically zero. If those events actually happen, it is game over for the losers, and possibly for the nation that he losers are headquartered in.

  • markthetruth

    My issue is with Cell phones they are now addictive, annoying and disrespectful

    • jokyjo

      Agree with you 1000%. Most people do not even have a real need for a cell phone. I hate that I can be bothered 24/7. I liked it much better before everyone had a cell phone.

  • energizedmortal

    The sooner things collapse the sooner we can reconstruct.

    • jokyjo

      TPTB will probably drag this out for years and makes us all miserable along the way. Kind of like, “death by a thousand cuts”.

    • Sam

      Agreed. I just want it to happen now so we can get on with building a fairer society

  • Douglas M. Green

    Few points:
    1) $441 trillion cannot be lost, that is the notional value upon which bets are made, i.e. difference in fixed and floating times $441 trillion. Michael’s point is still valid because even that is enormous.
    2) If the interest rate on the 10 year treasury goes to 6%, it will be a while before debt service = $17 trillion times 6% because much of the debt is locked in at lower rates and debt service goes up only when it is rolled over. Michael’s point is still valid though, because debt service would skyrocket anyway.
    3) Even if an entity uses derivatives to hedge, such large losses imply SEVERE counterparty risk. You aren’t hedged if the other party can’t pay you! And if you aren’t hedged, you could go under and start a domino effect.

    • libs_are_the_nazis

      very good analysis

  • Aaron

    when you are talking about 441 trillion dollars you are talking about an
    amount of money that is almost unimaginable.”

    I agree the economy is a disaster but I dont totally buy this derivative thing. (perhaps due to lack of understanding?) I dont think this is real money. This is just made up on the books of corrupt banks.

    Where did this 441 trillion dollars come from? They didnt take it from people, the fed didnt print it up, some banks just drew it up on their own accord to gamble with in their own private casinos.

    So if it came from nothing and becomes nothing again, and had no tangible interaction with a real economy, what is the difference?

    Perhaps someone can explain this to us? In the examples below people are describing futures contracts in animal feed, that has a tangible interaction with the economy between real participants with actual goods. Here, a bunch of banks betting on which way interest rates go? not so much.

    • andrewp111

      Here is the problem. These big banks made derivative bets based on the notion that certain moves in rates are simply impossible. If one of those moves actually happens, one or two of the big 5 banks could be exposed to paying trillions that it does not have. And if it owes those trillions to a non-US institution, it is in real trouble because the regulators can’t force the derivatives to net out to zero or force forebearance. If any of the US big 5 fail, the entire interbank payment system simply shuts down until the Government can work out some way of bringing it back up. Checks will no longer clear and plastic cards won’t work. If 2 or more of the big 5 fail, it will be all that much longer before the system can be brought back on-line. If all 5 fail, it is Game Over.

  • jim

    If you are against derivatives then why is there an add for Binary Options Trading just above this comment section. Seems hypocritical.

  • jokyjo

    As long as Wells Fargo, JP Morgan, HSBC, Goldman Sachs, et al. are making lots of money right now then we should all be happy. /sarc

  • Brad Good

    You are trying to make something out of nothing. The rates are much lower than 1980 and are not going through the roof. Do not panic, look at the Fed websites yourself.

  • Perplexed

    So the central banks’ central bank says easy money policy is over?

    You’ve got to be kidding me. Not one country has done the right thing (except maybe a Baltic State or two) so today’s financial problems are a multiple of 2008’s.

    What O great Central Bank of Central Banks do you prescribe for the world’s over-bloated Governments????? Living within their means? Doubtful.

    Hyper-inflation? Possible.

    New world currency?

  • I wish it were about horse feed and horses ran DC and our government, even with the small brains these majestic animals have. When derivatives collapse so does the economy as predicted! Ratios are way out of proportion and time is not a luxury we have.

  • tim

    is not the us dollar a derivative of gold ? paper notes originally arrived there value from gold or silver

  • Christian Pickett

    Actually the central bank GM does not say its time to see them stand on their own. He says govt has to make the best of this “borrowed time” that loose monetary policy /QE has bought them. He says govt’s need to pay more attention to increasing the productivity of their debt and cut future costs (perhaps pensions) . Although we know govt’s have not in 6 years, no real reason to expect them to, but thats gettig besides the point, which is i take this as the international bank issuing stern advice ” we will not continue w QE infinitely to prop up ur mirage of recovery” you have some time to make ur economys “recovery” less dependent on QE and u need to have that as a priority now. So basically since QE is working to keep economys looking somewhat normal, there is not international pressure on fed reserve or other central banks to taper NOW but they will in next couple years and govt’s need to prepare economies for post QE “life”.

    • Christian Pickett

      To clarify

      The blog author’s error imo is reading “monetary policy has done its part” then not inferring based on context “and now its time for gov’t to make the most of this borrowed time to NOW start to really do their’s” while this is still in place. So there is time for gov’t but will they do their part while monetary policy has done there’s to give them this borrowed time. In fact that IS clearly what was being said by central bank of central banks “GM”.

      How much more time they have to act, well that could be several months to several years.

  • albinorhino

    there are counterparties to each side of the derivatives market. 441 trillion isn’t just going to dissapear. someone will make money and someone will lose money.

    • andrewp111

      The problem is that the counterparty that owes the money simply fails. The party that is owed the money never collects. This is not a problem if all the derivatives among big banks net to zero. But what if a foreign bank is the winner and a big US bank is the loser? A big US bank fails, that is what. And if one of the big 5 fails, the interbank payment system freezes up and shuts down.

  • NotsoNap

    It seems since 1900, this country has been a train with no brakes screaming down a mountain. Everyone on board was born after the train had already reach terminal velocity of wind resistance slowing the trains acceleration. People are waking up and realizing the end of the line is coming and our Lying Freemasonic leaders have been Piped Pipering us along in the dark for 90 years. So you can look at it 2 ways.
    1. You can be Thankful 2 generations of people in the USA had a really nice time on the train with Blinders on.
    2. You can whine and Piss and Moan about how Banksters have taken advantage of you for the last 90 years.
    Late in Life I found out all my older relative had been FreeMasons but NONE of them cared to mention anything of there Freemasonic History to their Own Child. Why all the Secrecy? Are they Ashamed of their Freemasonic History? Kind of like all the Nazi’s Scurrying into the dark when their Plan Failed.

  • Will Hart

    We are in the Japan syndrome. No reason for interest rates to rise because of low inflation. As long as the FED holds interest rates down the gov has a chance of meeting interest payments on the $18 trillion debt. The economy is comatose but this may be our long term future…stag-debt…

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