Japan is drifting helplessly towards a dramatic fiscal crisis. For 20 years the world's second-largest economy has been able to borrow cheaply from a captive bond market, feeding its addiction to Keynesian deficit spending - and allowing it to push public debt beyond the point of no return. The rocketing cost of insuring against the bankruptcy of the Japanese state is telling us that the model has smashed into the buffers. Credit default swaps (CDS) on five-year Japanese debt have risen from 35 to 63 basis points since early September. Regime-change in Tokyo and the arrival of Yukio Hatoyama's neophyte Democrats - raising $550bn (£333bn) to help fund their blitz on welfare and the "new social policy" - have concentrated the minds of investors at long last. "Markets are worried that Japan is going to hit a brick wall: the sums are gargantuan," said Albert Edwards, a Japan-veteran at Société Générale. Yukio Hatoyama (pictured left), the new Japanese prime minister, has several large challenges to tackle ... Simon Johnson, former chief economist of the International Monetary Fund (IMF), told the US Congress last week that the debt path was out of control and raised "a real risk that Japan could end up in a major default". The IMF expects Japan's gross public debt to reach 218% of gross domestic product (GDP) this year, 227% next year, and 246% by 2014. This has been manageable so far only because Japanese savers have been willing - or coerced - into lending for almost nothing. The yield on 10-year government bonds has been around 1.30% this year, though they jumped to 1.42% last week. - Telegraph Dominant Social Theme: Don't look to the man behind the curtain? Free-Market Analysis: The UK Telegraph more than any other mainstream newspaper we read (at least on the âNet) seems to make the occasional stab at analyzing what's really going on in the world. It's covered the desperate difficulties of Eastern Europe, the deepening troubles in Ireland (resulting in the unfortunate pro-EU vote), the unrolling depression in Spain and now, the terrible problems that Japan is facing. These are not stories that you find in the New York Times for the most part, or other mainstream American and Western media. The idea that most of the mainstream media seems to run on these days, (including the Telegraph most days) in fact, is that one must not "talk down" the economy (what's left of it anyway). But is this not really a specious argument? Yes, a Keynesian, socialist argument, to be sure, in that it assumes that the problem with the economy is that consumers aren't consuming and that one must tread carefully until sentiment reverses itself. In fact, as most anyone who understands economics knows (free-market economics being real economics), the problems that the world regularly experiences have a great deal to do with central bank overprinting of money and subsequent booms and terrible busts. We don't mind pointing out the difficulties the world is in because the mainstream press is generally so reluctant to do so (and, of course, if the mainstream press did its job there would be less room for the Bell). In any event, most of the commentary these days seems to be about the West's nascent recovery, so it is salutary to remember that there are still a few problems lurking in the background. And, no ... we don't think we'll much aggravate the world's desperate situation by making a few modest points in this regard. Consumers, the ones that are left, will still spend their ever-depreciating cash. Thus it is, we've taken up the cudgel once more and reminded our mostly perspicacious viewers of what they likely already know: that there is a commercial real estate crunch waiting in the wings, that derivatives issues (hundreds of trillions of dollars) remain unresolved, that the current inflation of assets across the board is preparing the marketplace for a "carry trade" crash of major proportions. And on and on. The world is not a safe place despite the best efforts of central bankers. In fact, the world is in a quandary exactly because of them. Here's some more from the Telegraph's article on Japan: Japan Post Bank is balking at further additions to its $1.7 trillion holdings of state debt. The pillars of the government debt market are crumbling. Little wonder that the Ministry of Finance has begun advertising bonds in Tokyo taxis, featuring Koyuki from The Last Samurai. If Japan's bond rates rise to global levels of 3% to 4%, interest costs will shatter state finances. No one knows exactly when a country tips into a debt compound trap. But Japan must be close, even allowing for the fact that liabilities of the state Loan Programme (FILP) have fallen by 40% of GDP since 2000. "The debt situation is irrecoverable," said Carl Weinberg from High Frequency Economics. "I don't see any orderly way out of this. They will not be able to fund their deficit. There will be a fiscal shutdown, a pension haircut, and bank failures that will rock the world. It is criminally negligent that rating agencies are not blowing the whistle on this." Mr. Hatoyama inherited a country that was already hurtling into sovereign "Chapter 11". The Great Recession has eaten up 27% in tax revenues. Industrial output is down 19%, even after the summer rebound; exports are down 31%; the economy is 10% smaller today in "nominal" terms than a year ago - and nominal is what matters for debt. Tokyo's price index fell 2.4% in October, the deepest deflation in modern Japanese history. Real interest rates have risen 300 basis points in a year. It reads like a page from Irving Fisher's 1933 paper, Debt Deflation Causes of Great Depressions. The Bank of Japan seems oddly insouciant. It will end its (feeble) quantitative easing in December by suspending purchases of corporate debt, much to the fury of the Finance Ministry. "This is incredibly dangerous," said Russell Jones from RBC Capital Markets. "The rate of deflation is shocking. The debt dynamics are horrible and there is the risk of a downward spiral." ... Japan's terrible errors are by now well known. It failed to jettison its mercantilist export model in time. It resisted the feminist revolution, leading to a baby strike by young women. It acquiesced in a mad investment bubble (like China now) in the 1980s, stealing growth from the future. It wasted its immense fiscal firepower, scattering money for 20 years on half-baked spending projects to keep the economy afloat. QE was too little, too late, and this is the lesson for the West. We must cut borrowing drastically over the next decade, and offset this with ultra-easy monetary policy. Does Downing Street understand this? Does the White House? Does the European Central Bank? Clearly not. We were pleased to see in the above excerpt, the reference to China's current asset bubble, as we've long harped upon it. When the China bubble finally bursts (tomorrow? in a decade?) the world will truly find itself in a desperate way. We've done our best to point this out numerous times, and to see it acknowledged by the mainstream press is a step forward in our opinion (kind of like an alcoholic breaking through by acknowledging his addiction). As for the conclusion to the article above, we differ of course. We do not think that what put Japan into the metaphorical clink was a baby strike or even the jettisoning of its mercantilist model. In fact, when the heck DID Japan jettison its mercantilist model? The Japan we know and love is like a clam: the pearl of the marketplace is firmly nestled in the midriff of the statist mollusk. Japan is mercantilist. The West is mercantilist. The difference between Japan currently and the rest of the West is probably one of time and perhaps of culture. The population seems very hard working and not prone to disorderly bursts of insurrection. The Japanese tolerate a great deal, in other words, and their culture discourages discord. In a fiat money economy, a lack of opposition to the central banking power structure makes the inevitable decay that much more likely and deeper ... sooner rather than later. The Telegraph calls for Japan to cut back its social spending and open the floodgates of cheap money. This is indeed probably all that can be done when fiat money has worked its black magic and wreaked its havoc. But the West generally is well down the road toward this solution (the wildly cheap-money part, anyway) and the result will only be more tears. It is impossible to grow a stable world by applying this treatment because the booms only get wilder and the busts only get deeper. Conclusion: There is a real solution, of course, one that would not be hard to implement. A private market-based gold and silver standard would provide a platform for real and sustainable growth. Asia (Japan and China) will learn this along with the rest of the world when the current global fiat money regime achieves the finality of the collapse it so richly, inevitably, deserves http://thedailybell.com/578/America-Grows-Closer-to-the-Third-World.html
Japan has been spiraling for arnd 20 years now. Every year, it's one of the more popular trades among the Western hedge fund types (e.g. Julian Robertson) out there to short JGBs. Every year, like clockwork, these Western hedge fund types get spanked by japanese domestics and leave with their tail between their legs. Maybe now is finally the time to pay the piper for Japan. However, you need to be aware that people have been saying the same thing for a long time now, but so far, no juice.
While anecdotal evidence should only be a tertiary indicator, I find it extremely *interesting* that JGBs are being advertised in Japanese taxis. However I am not sufficiently confident to follow David Einhorn et al in this trade - I am much more comfortable with my long gold (versus US Dollar) and short S&P 500 pair. In the event that there is a severe dislocation in Japan, it's likely this would be positive for my pair.
I am not trying to disparage Einhorn, but he probably doesn't have more than 2 or 3 basis points of their capital at risk. Its easy to go public w/a position like this and look like a genius when it works out, but there is no way he has very much at risk on it. Remember, Einhorn was publicly short Lehman all the way to 0 - his fund still lost a lot of money in 08 because it was such a small position for him. Einhorn can put on a few of these 'Black Swan' trades (he also owns long-dated way out of the money puts on US Treasuries) and, if they don't work, its no big deal. If they do work, it adds a few % points to their performance. Ultimately, Einhorn will make the bulk of his money w/his stock picks. It would be tough for a non-institutional (smaller account) trader to put an option trade on like this w/o risking a much higher % of their capital. Portfoliio mgmt is at least as important as prognostication at this level.
There is no proof that Keynes was ever right. Politicians love his ideas, of course. It allows a lot of money to flow through their grubby hands to their grubby friends... so in their eyes Keynes is King but basically... no real proof for it at all....
http://ftalphaville.ft.com/blog/2009/11/06/81901/japan-bond-yields-rise/ -- it's pretty much what Martinghoul was saying...
very true, and it does not look that THIS is the time to put on the trade at least I dont see any indication that the timing is any better than in the past. If at all I would rather assume that the new government will start looking to consolidate. Hatoyama already pointed out several times that he is very keen on not exceeding 45,000bn yen. All bets are off in case we fall off the cliff and tax revenues tumble for another round.
Lots of discussion of this issue here: http://www.nuclearphynance.com/Show Post.aspx?PostIDKey=135553 I priced up some high strike structures in yen and they are crazily expensive. It's almost like a bi-modal distribution or a massively fat tail on the high rates side. Maybe it's just domestics expecting stupid price-insensitive Westerners, I don't know.
interesting discussion, thanks for the link. IMHO, a debate about insolvency is completely unwarranted. Lets not forget this is a nation of people who do anything but admit defeat. Should the situation get further out of hand then I expect to see the last farmer in the most remote country side to slaughter his piggy bag in order to buy some debt papers. But this is all fundamental talk. I bet should the ball ever get rolling then there will enter sufficient sharks to really get JGBs moving just its gonna be too late then to jump on any options train. Therefore I believe putting on a trade on the back of options is and remains a bad approach to this.
Once Japan unravels there will be plenty of time to enter the trades speculating against the bonds/curreices. I'll patiently wait for a downtrend to establish itself.