What is a margin call and why does it matter??
Introduction to Margin Call
A margin call occurs when an investor borrows money to purchase an asset, which then decreases in value and forces the investor to sell the asset to repay the loan.
Most investors are familiar with margin calls within their brokerage accounts, where they borrow money to invest in stocks.
In practice, margin calls can result in losses and potentially wipe out an investor's capital.
"Understanding Margin Call with an Apple Stock Example
Investors often use margins to amplify their profits when they are bullish on a particular stock.
An example is buying 100 shares of Apple stock for $10,000 with a borrowed amount of $5,000.
If the investor sells 50 shares at $200 per share, they can use the proceeds to repay the margin loan, leaving 50 shares at no cost.
However, margin calls can have adverse effects, as highlighted by the example of an investor buying Coinbase stock on margin.
"Now, this sounds nice in theory, but we all know that in practice, it could have gone the exact opposite direction. Take, for example, the stock Coinbase."
High Leverage in Debt Markets
Debt markets, such as bonds and treasuries, are often more highly leveraged than equity markets.
Investors can use leverage to purchase debt and create additional debt by borrowing against existing debt.
Charles Schwab allows investors to buy treasury bills with just 10% of the total cost, indicating the extent of leverage in debt markets.
Debt markets being highly leveraged can pose risks, especially when major financial institutions are involved.
"Debt markets around the world are much more highly leveraged than equity markets are, and the real trouble here comes from major financial institutions, especially banks, that deal in dollars all around the world."
The Eurodollar System
The Eurodollar system refers to foreign financial institutions holding U.S. dollars as assets outside the jurisdiction of the Federal Reserve.
When money is spent to purchase something from another country, a dollar is sent to the foreign bank, which can then use it as an asset to make loans.
This facilitates the creation of a significant amount of Hidden dollar debt, estimated to be around $65 trillion globally.
Financial institutions dealing in the Eurodollar system, including banks, could face liquidity issues and be forced to liquidate distressed debt assets.
"The Eurodollar system is any time outside of America, there's a financial institution with a dollar IOU. Now, that dollar is an asset for that bank, and so that bank can make a loan on that dollar."
Breakout of Interest Rates
Interest rates, indicated by treasury yields, are on the verge of breaking out, with the U.S. 30-year treasury yield at its highest since 2011.
The chart pattern and technical analysis suggest that interest rates at the long end of the curve could significantly increase soon.
Higher interest rates result in lower bond prices, and inversely correlated bond prices could lead to a collapse in bond prices.
This setup and potential collapse in bond prices could have significant consequences for investors.
"Interest rates are on the verge of breaking out, with the U.S. 30-year treasury yield at the highest it's been since 2011."
Major Players Selling U.S. Treasuries
China, the second-largest holder of U.S. treasuries, is currently a big seller, with an economic situation that necessitates selling.
Japan, with a massive debt-to-GDP ratio and collapsing currency, also has a significant interest in selling U.S. treasuries.
Both China and Japan have already started selling U.S. treasuries, and the trend is expected to continue.
The selling of U.S. treasuries by these major players adds to the potential collapse of bond prices.
"China, who 10 years ago held 1.3 trillion dollars in U.S. treasuries, now only holds 835 billion dollars, and this sell-off is only just getting started." "Japan currently has 1.1 trillion dollars worth of U.S. treasuries, unfortunately, Japan is in a very similar economic situation."
Outlook on Bond Prices
The setup for bond prices is primed for a collapse as interest rates and yields skyrocket.
The inverse correlation between yields and bond prices suggests that higher interest rates mean lower bond prices.
The potential catalysts for the collapse include the selling of U.S. treasuries by major players and the breakout of interest rates.
Investors should be aware of the risks associated with bond prices and position themselves accordingly.
"The chart setup is primed for bond prices to collapse as interest rates and yields skyrocket."
U.S. Treasuries Selling and Federal Reserve Balance Sheet
U.S. Treasuries holdings have dropped from 1.3 trillion to 1.1 trillion outside the U.S.
Japan and China, the largest holders of U.S. Treasuries, are both selling big amounts, pushing prices down.
The Federal Reserve's balance sheet has been declining, indicating they are letting some bonds get paid back and not rolling over the debt.
The Federal Reserve is not currently a net buyer of U.S. Treasuries.
"We have China, Japan, and the FED all selling, selling, selling U.S. treasuries."
Government Debt and Borrowing
Governments borrowing more debt is equivalent to selling more debt.
U.S. government is projected to borrow $5.2 billion every single day for the next 10 years, according to the Congressional Budget Office.
This would put the total national debt above $50 trillion in the next decade.
"The US government is going to borrow 5.2 billion dollars every single day for the next 10 years."
Impact on Interest Rates and Market Crash
The current sellers dominate the U.S. Treasury market, potentially causing interest rates to break out to a multi-decade high and bond prices to fall.
Margin calls occur when over-leveraged markets experience forced selling, which can happen in the debt markets.
A potential crash in the bond market could trigger a stock market crash.
Traditionally, stock market crashes were accompanied by a rise in bond prices, but in this scenario, both stocks and bonds could crash simultaneously.
"What happens when that stops working? You get a stock market crash right at the same time as you get a bond market crash."
Escalation of Government Intervention and Risk
The history of government intervention shows an escalation of intervention leading to greater crises.
The government's balance sheet is in a bad shape due to the increasing shift of wealth from the public sector to the private sector.
This escalation of risk lies with the central government, making it the worst position of all.
"It does not seem to me more plausible that we have a ... central government itself from absorbing all of the risk of the entire system."
Flight to Safety into Treasuries
The main problem here is not a sell-off of treasuries, but rather a flight to safety into treasuries.
This flight to safety is actually a flight to dollars, as assets including treasuries, corporate bonds, and stocks all get sold off together.
This could lead to a mad scramble for dollars and a spike in the dollar index, especially globally.
Most dollars in the euro dollar system are simply IOUs for dollars.
"Flight to safety is more likely a flight to dollars as assets including treasuries, corporate bonds, and stocks all get sold off together."
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