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Kudos to the Bank of Japan. Its heroic campaign to water down the yen has borne fruit. The Japanese may not have noticed it because it is not indicated in bold red kanji on their bank and brokerage statements, and so they might not give their Bank of Japandemonium full credit for it, but about 20% of their magnificent wealth has gone up in smoke in 2013. And in 2014, more of it will go up in smoke – according to the plan of Abenomics.
What folks do notice is that goods and services keep getting more expensive. Inflation has become reality. The scourge that has so successfully hallowed out the American middle class has arrived in Japan. The consumer price index rose 1.6% in December from a year earlier. While prices of services edged up 0.6%, prices of goods jumped 2.6%.
It’s hitting households. In December, their average income was up 0.3% in nominal terms from a year earlier. But adjusted for inflation – this is where the full benefits of Abenomics kick in – average income dropped 1.7%. Real disposable income dropped 2.1%.
Abenomics is tightening their belts. But hey, they voted for this illustrious program. So they’re not revolting just yet. But they’re thinking twice before they extract with infinite care their pristine and beloved 10,000-yen notes from their wallets. And inflation-adjusted consumption expenditures – excluding housing, purchase of vehicles, money gifts, and remittances – dropped 2.3%.
But purchases of durable goods have been soaring. Everyone is front-loading big ticket items ahead of April 1, when the very broad-based consumption tax will be hiked from 5% to 8%. Pulling major expenditures forward a few months or even a year or so is the equivalent of obtaining a guaranteed 3% tax-free return on investment. That’s huge in a country where interest rates on CDs are so close to zero that you can’t tell the difference and where even crappy 10-year Japanese Government Bonds yield 0.62%. It’s a powerful motivation.
And it has turned into a frenzy. In December, households purchased 32.2% more in durable goods than the same month a year earlier, in November 25.2%, in October 40.4%. These front-loaded purchases have been goosing the economy in late 2013. But shortly before April 1, they will grind to a halt. The Japanese have been through this before.
In 1996, after the consumption tax hike from 3% to 5% was passed and scheduled to take effect on April 1, 1997, consumers and businesses went on a buying binge of big-ticket items to dodge the extra 2% in taxes. The economy boomed. But it ended in an enormous hangover. In the spring 1997, as the tax hike took effect, business and consumer spending ground to a halt, and the economy skittered into a nasty recession that lasted a year and a half!
First indications of a repeat performance are already visible. The Japan Automobile Manufacturers Association (JAMA) forecast last week that sales of automobiles, after an already lousy 2013, would plunge 9.8% this year to 4.85 million units, the lowest since 2011 when the earthquake and tsunami laid waste to car purchases.
In response, automakers will curtail production for domestic sales. Other makers of durable goods – those that still manufacture in Japan – will prepare for the hangover in a similar manner. Housing and construction will get hit. Retailers will get hit too. During the last consumption tax hike, many large retailers tried to keep their chin above water by not passing the 2% tax hike on to their customers but shove it backwards up the pipeline to their suppliers. This time, having learned its lesson, the government is insisting on inflation, and it passed legislation last year that would force retailers to stick their customers with an across-the-board 3% price increase.
In 2014, the hangover will be even worse than in 1997. Businesses and consumers are dodging a hike of three percentage points, not two percentage points. Hence, the motivation to front-load is even stronger, the payoff greater, and the subsequent falloff steeper. This, on top of the already toxic concoction of stagnant wages and rising prices. Oh, and the plight of the retirees, whose savings and income streams are gradually getting eaten up by inflation. The glories of Abenomics.
But there are beneficiaries. Japan Inc. benefits from lower cost of labor. The government, without having to reform its drunken ways, might somehow be able to keep its out-of-control deficits and its mountain of debt from blowing up in the immediate future. Throughout, the Bank of Japan, which is buying up enough government bonds to monetize the entire deficit plus part of the mountain of existing debt, will remain in control of the government bond market, what little is left of it – even if it has to buy the last bond that isn’t totally nailed down. But for the real economy the party is now ending, and by spring, a pounding hangover will set in.
According to Japan’s state religion of Abenomics, devaluing the yen would boost exports and cut imports. The resulting trade surplus would jumpstart the economy and induce Japan Inc. to invest at home. It would save Japan. But the opposite is happening. Read…. Why Japan’s Trade Fiasco Worries Me So Much
The world’s biggest economies will need to refinance $7.43 trillion of sovereign debt in 2014 as bond yields begin to climb from record lows, threatening to raise borrowing costs while nations struggle to bring down elevated budget deficits.
The amount of bills, notes and bonds coming due for the Group of Seven nations plus Brazil, Russia, India and China is little changed from 2013 after dropping from $7.6 trillion in 2012, according to data compiled by Bloomberg. At $3.1 trillion, representing a 6 percent increase, the U.S. faces the largest tab. Russia, Japan and Germany will see refinancing needs drop, while those of Italy, France, Britain, China and India increase.
While budget deficits in developed nations have fallen to 4.1 percent of their economies from a peak of 7.8 percent in 2009, they remain about double the average in the decade before the credit crisis began. The cost for governments to borrow may rise further after average yields last year rose the most since 2006, as the global economy shows signs of improving and the Federal Reserve pares its unprecedented bond buying.
“Refinancing needs remain elevated in many developed nations, particularly the U.S.,” Luca Jellinek, the London-based head of European rates strategy at Credit Agricole SA, said in a Dec. 30 telephone interview. “The key here is demand rather than supply. If demand drops as growth picks up, and we expect it will, that could put pressure on borrowing costs.”
Debt as a proportion of the economies of the 34 members of the Organization for Economic Cooperation and Development will rise to 72.6 percent this year from 70.9 percent last year and 39 percent in 2007, according to the group’s forecasts.
The amount of government debt obligations contained in a benchmark Bank of America Merrill Lynch index has more than doubled to $25.8 trillion since the end of 2007 as countries from the U.S. to Japan financed increased spending to counter the worst economic crisis since the Great Depression.
After interest-rate cuts around the world and the Fed’s bond purchases pushed down average yields on government notes to an all-time low of 1.29 percent in May, borrowing costs have since jumped, according to the Bank of America Merrill Lynch Global Broad Market Sovereign Plus Index.
Yields climbed to 1.84 percent by the end of December, making the 0.41 percentage point increase in 2013 the biggest in seven years, the data show. That represents an extra $4.1 billion in annual interest on every $1 trillion borrowed.
Bond buyers are demanding more compensation as the Fed plans to scale back its own monthly debt purchases in January to $75 billion from $85 billion and the U.S.-led recovery prompts investors to seek assets with higher returns such as equities.
Government debt lost an average 0.36 percent worldwide last year, the first decline since 1999.
Based on 41 economists surveyed by Bloomberg on Dec. 19, the Fed will reduce its buying by $10 billion in each of the next seven meetings before ending its stimulus in December.
The U.S., the world’s largest economy, will expand 2.6 percent this year after 1.7 percent growth in 2013 and accelerate 3 percent in 2015, which would be the fastest in a decade, according to economists surveyed by Bloomberg. With Europe and Japan also forecast to grow, the three economies will all expand for the first time since 2010.
“With the Fed pulling back on bond purchases and growth picking up, bond investors will demand higher yields to justify investment,” Mohit Kumar, a money manager at GLG Partners, a hedge-fund unit of Man Group Plc, said by telephone from London. “We need to price in higher risk premium in an environment where rates and market volatility are likely to increase.”
Even as faster growth helps increase tax revenue, higher refinancing costs may squeeze governments that are still contending with fiscal deficits. Spending will outstrip revenue in the world’s largest economies by 3.3 percent of their gross domestic product this year, versus an average of 1.75 percent in the 10 years through 2007, data compiled by Bloomberg show.
In the U.S., the world’s largest debtor nation with $11.8 trillion of marketable debt obligations, the amount due this year will increase by about $187 billion, data compiled by Bloomberg show. France, faced with an economy that has barely grown in two years, will see the amount of debt securities due this year rise by 15 percent to $410 billion.
China will lead emerging-market economies with the amount of maturing bonds increasing by 12 percent to $143 billion.
Japan will have $2.38 trillion of bonds and bills to refinance this year, 9 percent less than in 2013, while the amount of German debt maturing this year will decrease by about 5.3 percent to $268 billion.
Including interest payments, the amount of debt that needs to be refinanced by the G-7 countries plus the BRIC nations this year increases by about $712 billion to $8.1 trillion, according to data compiled by Bloomberg.
“There has been a shift of a significant amount of debt” into the public sector during the crisis, saidNicholas Gartside, London-based international chief investment officer for fixed-income at J.P. Morgan Asset Management, which oversees $1.5 trillion. “Despite some improvement on the debt front, there is still a lot of deleveraging to go. The process is still ongoing and will continue for many years.”
Forecasters are overestimating the likelihood government debt costs will increase because the global economic recovery remains fragile and disinflation is starting to emerge, according toSteven Major, head of global fixed-income research at HSBC Holdings Plc, Europe’s largest bank.
The world economy will to expand 2.83 percent this year, according to forecasts compiled by Bloomberg, slower than the average 3.43 percent during the five-year span between the end of the dot-com bust in 2002 and the start of the credit crisis.
Slowing inflation also preserves the purchasing power of fixed-rate interest payments, which may support demand for bonds. Consumer prices in the U.S. will rise less than 2 percent in 2014 for a second straight year, which has only happened one other time in the last half century, data compiled by Bloomberg and the Bureau of Labor Statistics show.
In the 18 nations that share the euro, the inflation rate will be 1.2 percent, the lowest in five years.
“Growth may have picked up but it’s still pretty weak compared to previous cycles,” Major said in a telephone interview on Dec. 31. “Inflation is falling in many developed countries. Central banks should be worried about disinflation rather than inflation. It’s hard for me to imagine that bond yields will rise much against this backdrop.”
Some nations are starting to rein in spending, which may help contain borrowing costs. Government bond sales in the euro area, excluding issuance used to refinance maturing debt, will decline to 215 billion euros ($293 billion), the least since 2009, Morgan Stanley predicted.
Germany said in December that it plans to curb bond and bill sales this year by 17 percent to 205 billion euros as tax revenue rises and Chancellor Angela Merkel seeks to end net new borrowing by 2015. In the U.S., the budget deficit will drop to to 3.4 percent of the economy this year, versus 10 percent five years ago, economist forecasts compiled by Bloomberg show.
Demand at U.S. government debt auctions remained stronger than before the financial crisis as investors bid for 2.87 times the amount sold last year, the fourth-highest ratio on record and surpassed only in the the prior three years.
Buying of Japanese debt was underpinned by the Bank of Japan’s commitment to buy 7 trillion yen ($71 billion) a month of bonds, a pace that would equal more than 50 percent of the 155 trillion yen in notes that Japan plans to sell this year.
“Investors should not and will not be concerned about the supply picture,” said Major, who predicts that yields on the benchmark U.S. 10-year note will decrease to 2.1 percent by year-end from 2.99 percent last week.
His estimate conflicts with the majority of forecasters in a Bloomberg survey who say U.S. borrowing costs will increase. They anticipate yields on the 10-year notes, which rose 1.27 percentage points last year to 3.03 percent, the highest since 2011, will climb to 3.38 percent on average. No one in the survey projected yields falling below 2.5 percent. The yield was at 2.98 percent as of 9:56 a.m. London time.
Borrowing costs in all the G-7 nations are all poised to increase in 2014, based on the estimates. Yields on German bunds will increase to 2.28 percent by year-end, while those for similar-maturity U.K. gilts will end the year at 3.36 percent. That would be the highest for both nations since 2011.
Among the BRIC nations, only bond yields in India and China are poised to drop, the data show.
With global growth picking up, investors such as Standard Life Investments predict government bonds will underperform this year and are holding a greater proportion of equities than their benchmarks used to measure performance.
“We are not enthusiastic about government bonds,” Frances Hudson, a strategist at Standard Life in Edinburgh, which oversees $294 billion, said in an telephone interview on Jan. 2. “It’s reasonable to expect bond yields to rise from record lows as recovery gains momentum.”
Following is a table of projected bond and bill redemptions and interest payments in dollars for 2014 for the Group of Seven countries, Brazil, China, India and Russia using data compiled by Bloomberg as of Dec. 30:
To contact the reporter on this story: Anchalee Worrachate in London email@example.com
By Roger Bootle
We can all breathe a sigh of relief that the world is not going to come to an end as a result of a default by the US government. Well, for now, anyway. But this does not mean that debt problems have gone away. Indeed, across the Pacific a serious debt problem is still building in Japan.
Whereas the US debt crisis has been triggered by a disagreement between Democrats and Republicans over the role of the state in the economy and society, and specifically over “Obamacare”, Japan’s debt problem is a slow burner.
As a share of GDP, government debt has been growing since the early 1990s. This is the result of the long-running weakness of economic growth, repeated fiscal stimulus packages and a long period in which the overall price level has stagnated or fallen. Japan has managed to muddle through, but it now looks as though it is close to a tipping point.
The scale of the problem is staggering. Japan’s net government debt is about 140pc of GDP. This is way ahead of the US, which is on 87pc, and not that far below Greece. What’s more, it is easy to see the ratio increasing further. The IMF expects net debt to rise to 148pc of GDP over the next five years. In fact, if the economy performs badly, inflation remains low or borrowing costs rise, debt could easily follow an explosive path, with the ratio quickly rising towards 300pc of GDP.
So what to do? If Japan followed anything like this path, then some form of default would eventually become inevitable. Accordingly, why not cut the whole process short and get the thing over and done with by defaulting now?
Quite apart from all the usual objections to default, Japan suffers from another major obstacle, namely that its debt is overwhelmingly held by Japanese financial institutions, including banks. A default would land the financial sector with massive losses and could cause a catastrophic financial crisis.
The orthodox way to tackle debt is to impose austerity via cuts to government spending or increases in taxes. In fact, Japan will increase its consumption tax in April and quite considerable deficit reduction is promised for the next few years.
But this runs into two problems that are familiar from a European perspective. First, such austerity is not popular and the politicians in Japan may yet baulk at the scale of the tightening to be imposed.
Second, austerity tends to reduce GDP – even though George Osborne may believe that it hasn’t done so in the UK. If it does reduce GDP, then the debt to GDP ratio would probably rise.
Faster economic growth would help but is in practice difficult to achieve. The government is pursuing some supposedly radical structural reforms but it is unlikely that, even if these are pushed through, they will have much of an impact soon enough. And in trying to grow its way out of the debt problem, unlike America, Japan faces a huge demographic hurdle. It simply isn’t making enough Japanese. The size of the workforce is already falling and will continue to do so for decades.
The way out for Japan is to try to engineer a higher rate of inflation, perhaps much higher than the current 2pc target. For any given rate of increase of real GDP this would give a higher rate of growth of nominal GDP, that is to say, expressed in money terms. With debt fixed in money terms this would, other things being equal, bring down the debt to GDP ratio.
Admittedly, other things may not be equal. The danger is that markets would force up the rate of interest on Japanese debt and thereby increase the amounts that the government had to pay out in debt interest. That could easily offset the effect of higher inflation.
In fact, it could lead to the debt ratio ending up higher. Yet in the Japanese case, this is unlikely.
The Bank of Japan would continue to hold short-term interest rates at close to zero for several years. That would ensure that the rates on short-term debt remained subdued. Moreover, it would continue to buy huge quantities of Japanese government debt. It might also consider obliging financial institutions to hold extra amounts of government debt.
How would Japan achieve higher inflation? Quantitative easing (QE), or printing money, as it is colloquially known, will eventually give you higher inflation – provided that you do it on sufficient scale. This is what the Japanese central bank now seems prepared to do.
A fall of the yen would be a crucial part of the mechanism by which inflation moved higher.
This is what has happened recently. Japanese inflation has risen to 0.9pc, but almost wholly as a result of the fall of the yen from the high 70s to the dollar to about 100. There has been hardly any domestically generated inflation. But if the yen continued to weaken, that would surely follow.
Throughout the past 30 years, Japan has been a testing ground both for problems and their possible solutions that have appeared later in the West. It experienced a bubble economy in the late 1980s and then experienced the pain of a long drawn-out balance sheet recession, brought on by the collapse of asset prices and the drying up of credit.
It also went through a slow dragging deflation of consumer prices before anyone in the West thought that this was an issue. And for some time now it has faced the problems caused by an ageing and falling population.
Could it also show the way on the inflation solution to the debt problem which continues to bedevil so many countries in the West? For the UK, a deliberate embrace of higher inflation remains only a risk rather than a probability. For we are in a very different position from Japan. Our debt ratio is nowhere near as high and our potential to grow our way out of the problem is much greater, not least due to our more favourable demographic prospects. The same is true for the US.
But there are several members of the eurozone for whom this is not true. Greece and Italy spring to mind. Unless their debt is “forgiven”, some form of default appears inevitable.
While they remain in the euro, of course, they cannot default through inflation because they do not control their own monetary policy.
But if they were to leave the euro, the Japanese experience might be highly influential.
Roger Bootle is managing director of Capital Economics firstname.lastname@example.org
While the distraction of Japanese currency collapse, the resultant nominal offsetting surge in the value of the Japanese stock market, the doubling of the Japanese monetary base and the BOJ’s monetization of 70% of Japan’s gross issuance have all been a welcome diversion in a society still struggling with the catastrophic aftermath of the Fukushima explosion on one hand, imploding demographics on the other, and an unsustainable debt overhang on the third mutant hand, the reality is that Japan, despite the best intentions of Keynesian alchemists everywhere, is doomed.
One can see as much in the following two charts from a seminal 2012 research piece by Takeo Hoshi and Tatakoshi Ito titled “Defying Gravity: How Long Will Japanese Government Bond Prices Remain High?” and which begins with the following pessimistic sentence: “Recent studies have shown that the Japanese debt situation is not sustainable.” Its conclusion is just as pessimistic, and while we urge readers to read the full paper at their liesure, here are just two charts which largely cover the severity of the situation.
Presenting the countdown to Japan’s D-Day.
The technical details of what is shown below are present in the appendix but the bottom line is this: assuming three different interest rates on Japan’s debt, and a max debt ceiling which happens to be the private saving ceiling, as well as assuming a 1.05% increase in private sector labor productivity (average of the past two decades), Japan runs out of time some time between 2019 and 2024, beyond which it can no longer self-fund itself, and the Japan central bank will have no choice but to monetize debt indefinitely.
and Exhibit B.
Figure 12 shows the increase in the interest rate that would make the interest payment exceed the 35% of the total revenue for each year under each of the specific interest scenarios noted in the chart above (for more details see below). The 35% number is arbitrary, but it is consistent with the range of the numbers that the authors observed during the recent cases of sovereign defaults. In short: once interest rates start rising, Japan has between 4 and 6 years before it hits a default threshold.
The paradox, of course, is that should Japan’s economy indeed accelerate, and inflation rise, rates will rise alongside as we saw in mid 2013, when the JGB market would be halted almost daily on volatility circuit breakers as financial institutions rushed to dump their bond holdings.
In other words, the reason why Japan is desperate to inject epic amounts of debt in order to inflate away the debt – without any real plan B – is because, all else equal, it has about 8 years before it’s all over.
Here is how the authors summarize the dead-end situation.
Without any substantial changes in fiscal consolidation efforts, the debt is expected to hit the ceiling of the private sector financial assets soon. There is also downside risk, which brings the ultimate crisis earlier. Economic recovery may raise the interest rates and make it harder for the government to roll over the debt. Finally, the expectations can change without warning. Failure in passing the bill to raise the consumption tax, for example, may change the public perception on realization of tax increases. When the crisis happens, the Japanese financial institutions that holds large amount of government bonds sustain losses and the economy will suffer from fiscal austerity and financial instability. There may be negative spillovers for trading partners. If Japan wants to avoid such crisis, the government has to make a credible commitment and quick implementation of fiscal consolidation.
A crisis will happen if the government ignores the current fiscal situation or fails to act. Then, the crisis forces the government to choose from two options. First, the Japanese government may default on JGBs. Second, the Bank of Japan may monetize debts. The first option would not have much benefit because bond holders are almost all domestic. Monetization is the second option. Although that may result in high inflation, monetization may be the least disruptive scenario.
Finally, this is how the BOJ’s epic monetization was seen by the paper’s authors back in March 2012.
Bank of Japan could help rolling over the government debt by purchasing JGBs directly from the government. The Bank of Japan, or any other central bank with legal independence, has been clear that they do not endorse such a monetization policy because it undermines the fiscal discipline. However, at the time of crisis, the central bank may find it as the option that is least destructive to the financial system. If such money financing is used to respond to the liquidity crisis, this will create high inflation.
The prospect for high inflation will depreciate yen. This will partially stimulate the economy via export boom, provided that Japan does not suffer a major banking crisis at the same time.
An unexpected inflation will result in redistribution of wealth from the lenders to the borrowers. This is also redistribution from the old generations to the young generations, since the older generation has much higher financial assets whose value might decline, or would not rise at the same pace with inflation rate. This may not have such detrimental impacts on the economy, since many who participate in production and innovation (corporations and entrepreneurs) are borrowers rather than lenders.
For now monetization is indeed less disruptive. The question is for how much longer, since both Japan and the US are already monetizing 70% of their respective gross debt issuance. And once the last bastion of Keynesian and Monetarist stability fails, well then…
Once the crisis starts, the policy has to shift to crisis management. As we saw above, the crisis is likely to impair the financial system and slow down consumption and investment. Thus, the government faces a difficult tradeoff. If it tries to achieve a fiscal balance by reducing the expenditures and raising the taxes, the economy will sink further into a recession. If it intervenes by expansionary fiscal policy and financial support for the financial system, that would make the fiscal crisis more serious. This is a well-known dilemma for the government that is hit by debt crisis…. If not helped by the government, the banking system will be destroyed, and the economy will further fall into a crisis. Rational depositors will flee from deposits in Japanese banks to cash, foreign assets or gold.
* * *
The private saving ceiling is the absolute maximum of the domestic demand for the government debt, but the demand for JGBs will start falling well before the saving ceiling is ever reached. One potential trigger for such a change is that the financial institutions find alternative and more lucrative ways to invest the funds. In general, when the economic environment changes to increase the returns from alternatives to the JGBs, the interest rate on JGBs may start to increase. If this suddenly happens, this can trigger a crisis. Increases in the rate of returns may be caused by favorable changes in the economic growth prospect. The end of deflation and the zero interest rate policy would also lead to higher interest rates.
In Figure 6 , the authors calculate Japan’s debt’GDP over the next three decades using the following assumptions on the interest rate:
- R1: Interest rate is equal to the largest of the growth rate (?t) or the level at 2010 (1.3%).
- R2: Interest rate rises by 2 basis points for every one percentage point that the debt to GDP ratio at the beginning of the period exceeds the 2010 level (153%).
- R3: Interest rate rises by 3.5 basis points for every one percentage point that the debt to GDP ratio at the beginning of the period exceeds the 2010 level (153%) .
R1 is motivated by the fact that the average yield on 10 year JGBs over the last several years has been about the same as the GDP growth rate during the same time interval, but constrains the interest rate to be much lower than the current rate even when the GDP growth declines further. R2 and R3 assume that the interest rate rises as the government accumulates more debt. Many empirical studies have demonstrated such relation. R2 (2.0 basis points increase) uses the finding of Tokuoka (2010) for Japan. R3 (3.5 basis points increase) assumes the coefficient estimate used by Gagnon (2010). It is the median estimate from studies of various advanced economies
A more reasonable scenario is to assume the growth rate of GDP per-working-age person (or an increase in labor productivity) to be similar to that of the 1990s and 2000s. We consider two alternative growth rates per-working-age population. The low growth scenario is that the increase in labor productivity at 1.05% (average of 1994-2010) and the high growth scenario is at 2.09% (average of 2001-2007, the “Koizumi years”).12 Table 6 shows the growth decomposition on the assumption of the 1.05% growth rate of GDP per-working-age person…. The upper bound for the debt accumulation is reached by 2024 at the latest.
When it comes to reckless money creation, it turns out that China is the king. Over the past five years, Chinese bank assets have grown from about 9 trillion dollars tomore than 24 trillion dollars. This has been fueled by the greatest private debt binge that the world has ever seen. According to a recent World Bank report, the level of private domestic debt in China has grown from about 9 trillion dollars in 2008 to more than 23 trillion dollars today. In other words, in just five years the amount of money that has been loaned out by banks in China is roughly equivalent to the amount of debt that the U.S. government has accumulated since the end of the Reagan administration. And Chinese bank assets now absolutely dwarf the assets of the U.S. Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England combined. You can see an amazing chart which shows this right here. A lot of this “hot money” has been flowing out of China and into U.S. companies, U.S. stocks and U.S. real estate. Unfortunately for China (and for the rest of us), there are lots of signs that the gigantic debt bubble in China is about to burst, and when that does happen the entire world is going to feel the pain.
It was Zero Hedge that initially broke this story. Over the past several years, most of the focus has been on the reckless money printing that the Federal Reserve has been doing, but the truth is that China has been far more reckless…
You read that right: in the past five years the total assets on US bank books have risen by a paltry $2.1 trillion while over the same period, Chinese bank assets have exploded by an unprecedented $15.4 trillion hitting a gargantuan CNY147 trillion or an epic $24 trillion – some two and a half times the GDP of China!
Putting the rate of change in perspective, while the Fed was actively pumping $85 billion per month into US banks for a total of $1 trillion each year, in just the trailing 12 months ended September 30, Chinese bank assets grew by a mind-blowing $3.6 trillion!
I was curious to see what all of this debt creation was doing to the money supply in China. So I looked it up, and I discovered that M2 in China has grown by about 1000% since 1999…
So what has China been doing with all of that money?
Well, they have been on a buying spree unlike anything the world has ever seen before. For example, according to Reuters China has essentially bought the entire oil industry of Ecuador…
China’s aggressive quest for foreign oil has reached a new milestone, according to records reviewed by Reuters: near monopoly control of crude exports from an OPEC nation, Ecuador.
Last November, Marco Calvopiña, the general manager of Ecuador’s state oil company PetroEcuador, was dispatched to China to help secure $2 billion in financing for his government. Negotiations, which included committing to sell millions of barrels of Ecuador’s oil to Chinese state-run firms through 2020, dragged on for days.
And the Chinese have been doing lots of shopping in the United States as well. The following is an excerpt from a recent CNBC article entitled “Chinese buying up California housing“…
At a brand new housing development in Irvine, Calif., some of America’s largest home builders are back at work after a crippling housing crash. Lennar, Pulte, K Hovnanian, Ryland to name a few. It’s a rebirth for U.S. construction, but the customers are largely Chinese.
“They see the market here still has room for appreciation,” said Irvine-area real estate agent Kinney Yong, of RE/MAX Premier Realty. “What’s driving them over here is that they have this cash, and they want to park it somewhere or invest somewhere.”
Apparently a lot of these buyers have so much cash that they are willing to outbid anyone if they like the house…
The homes range from the mid-$700,000s to well over $1 million. Cash is king, and there is a seemingly limitless amount.
“The price doesn’t matter, 800,000, 1 million, 1.5. If they like it they will purchase it,” said Helen Zhang of Tarbell Realtors.
So when you hear that housing prices are “going up”, you might want to double check the numbers. Much of this is being caused by foreign buyers that are gobbling up properties in certain “hot” markets.
We see this happening on the east coast as well. In fact, a Chinese firm recently purchased one of the most important landmarks in New York City…
Chinese conglomerate Fosun International Ltd. (0656.HK) will buy office building One Chase Manhattan Plaza for $725 million, adding to a growing list of property purchases by Chinese buyers in New York city.
The Hong Kong-listed firm said it will buy the property from JP Morgan Chase Bank, according to a release on the Hong Kong Stock Exchange website.
Chinese firms, in particular local developers, have looked overseas to diversify their property holdings as the economy at home slows. Chinese individuals also have been investing in property abroad amid tight policy measures in the mainland residential market.
Earlier this month, Chinese state-owned developer Greenland Holdings Group agreed to buy a 70% stake in an apartment project next to the Barclays Center in Brooklyn, N.Y., in what is the largest commercial-real-estate development in the U.S. to get direct backing from a Chinese firm.
And in a previous article, I discussed how the Chinese have just bought up the largest pork producer in the entire country…
Just think about what the Smithfield Foods acquisition alone will mean. Smithfield Foods is the largest pork producer and processor in the world. It has facilities in 26 U.S. states and it employs tens of thousands of Americans. It directly owns 460 farms and has contracts with approximately 2,100 others. But now a Chinese company has bought it for $4.7 billion, and that means that the Chinese will now be the most important employer in dozens of rural communities all over America.
For many more examples of how the Chinese are gobbling up companies, real estate and natural resources all over the United States, please see my previous article entitled “Meet Your New Boss: Buying Large Employers Will Enable China To Dominate 1000s Of U.S. Communities“.
But more than anything else, the Chinese seem particularly interested in acquiring real money.
And by that, I mean gold and silver.
In recent years, the Chinese have been buying up thousands of tons of gold at very depressed prices. Meanwhile, the western world has been unloading gold at a staggering pace. By the time this is all over, the western world is going to end up bitterly regretting this massive transfer of real wealth.
Unfortunately for the Chinese, it appears that the unsustainable credit bubble that they have created is starting to burst. According toBloomberg, the amount of bad loans that the five largest banks in China wrote off during the first half of this year was three times larger than last year…
China’s biggest banks are already affected, tripling the amount of bad loans they wrote off in the first half of this year and cleaning up their books ahead of what may be a fresh wave of defaults. Industrial & Commercial Bank of China Ltd. and its four largest competitors expunged 22.1 billion yuan of debt that couldn’t be collected through June, up from 7.65 billion yuan a year earlier, regulatory filings show.
And Goldman Sachs is projecting that China may be facing 3 trillion dollars in credit losses as this bubble implodes…
Interest owed by borrowers rose to an estimated 12.5 percent of China’s economy from 7 percent in 2008, Fitch Ratings estimated in September. By the end of 2017, it may climb to as much as 22 percent and “ultimately overwhelm borrowers.”
Meanwhile, China’s total credit will be pushed to almost 250 percent of gross domestic product by then, almost double the 130 percent of 2008, according to Fitch.
The nation might face credit losses of as much as $3 trillion as defaults ensue from the expansion of the past four years, particularly by non-bank lenders such as trusts, exceeding that seen prior to other credit crises, Goldman Sachs Group Inc. estimated in August.
The Chinese are trying to get this debt spiral under control by tightening the money supply. That may sound wise, but the truth is that it is going to create a substantial credit crunch and the entire globe will end up sharing in the pain…
Yields on Chinese government debt have soared to their highest levels in nearly nine years amid Beijing’s relentless drive to tighten the monetary spigots in the world’s second-largest economy.
The higher yields on government debt have pushed up borrowing costs broadly, creating obstacles for companies and government agencies looking to tap bond markets. Several Chinese development banks, which have mandates to encourage growth through targeted investments, have had to either scale back borrowing plans or postpone bond sales.
This could ultimately be a much bigger story than whether or not the Fed decides to “taper” or not.
It has been the Chinese that have been the greatest source of fresh liquidity since the last financial crisis, and now it appears that source of liquidity is tightening up.
So as the flow of “hot money” out of China starts to slow down, what is that going to mean for the rest of the planet?
And when you consider this in conjunction with the fact that China has just announced that it is going to stop stockpiling U.S. dollars, it becomes clear that we have reached a major turning point in the financial world.
2014 is shaping up to be a very interesting year, and nobody is quite sure what is going to happen next.
While one can make an argument that the central banks have now destroyed all traditional “cycles”, including the economic “virtuous cycle“, the business cycle and even the leverage cycle, the question remains how much longer can the Fed et al defy mean reversion and all laws of nature associated with it. That said, assuming the fake market environment we find ourselves in persists for at least another year, this is what the leverage cycle would look like assuming $10 trillion in global central bank assets were a pro forma new normal.
Keep a close eye on China: it is on the cusp between the end of the leverage cycle (where as we reported over the past two days, it has been pumping bank assets at the ridiculous pace of $3.5 trillion per year) and on the verge of having its debt bubble bursting. What happens then is unclear.
Some thoughts on the above graphic from SocGen:
For the first time post-crisis, we expect advanced economies in 2014 to see a marked increase in their contribution to global growth. Emerging economies have over the past few years offered a welcome support to global growth, but this relied in part on a build-up of credit that now needs to be paid down. The hope is for advanced economies to take over the baton from the emerging economies as the main driver of global growth. The US is now poised for sustainable recovery and in Japan hopes remain that Abenomics will work. The euro area, however, continues to lag. As such the growth relay from emerging to advanced is likely to prove a bumpy process. Commodity markets will sit at the heart of this dynamic – our strategists look for range-bound markets in 2014.
This new rotation of the global leverage cycle is an integral part of our monetary policy outlook, which we discuss in greater detail in the following sections. Several features are worth noting:
Time for emerging economies to deleverage: Post crisis, emerging economies adopted accommodative economic policies to offset the collapse in demand for their output. Providing a further boost, accommodative monetary policies in advanced economies drove significant financial flows into the region. Combined, these fuelled credit expansion. With the turn in the US interest rate cycle back in the spring, external financing conditions tightened. Moreover, in a number of emerging economies, policymakers have become increasingly concerned by a build-up in leverage; this is not just a story of level, but also one of speed. As seen from our leverage cycle, we believe the emerging economies have now moved to a phase of deleveraging. Our emerging market theme, however, is not just one of a cyclical downturn. As we have highlighted on several occasions, we believe potential growth is structurally slowing and no more so than in China.
China must tame excess capacity: With NFC debt at over 150% of GDP and significant excess capacity, China is ripe for deleveraging. Already in 2013, a notable feature of our forecast has been that the Chinese authorities would resist market pressure to ease monetary policy and further fuel the credit bubble. Nonetheless, shadow bank credit has continued to expand and, with that, problems of excess capacity. China’s challenge now is to deleverage and reform. The two in many ways go hand in hand and we discuss these issues in Boxes 5 and 14. It is worth nothing here that reform in China is tantamount to removing the 100% implicit state guarantee. And looking ahead, even state-backed companies could be allowed to fail. Herein resides also a potential trigger for the risk scenario of a hard landing, should such a company failure be poorly managed and spin out of control.
Japan’s corporate sector to cut savings to invest:Investment and savings are two sides of the same coin and to secure sustainable recovery in Japan, corporations need to reduce savings and invest. The BoJ’s monetary policy is already working through the currency channel and our expectation is to see a pick-up in corporate investment next. This is not just a function of monetary policy, but also the two remaining arrows of Abenomics, namely fiscal stimulus and structural reform. We see significant opportunities medium-term from reform as discussed in Box 13. Short-term, the BoJ is poised to deliver further stimulus and we look for additional asset purchases to be announced early in the new fiscal year (commencing April 1).
US credit cycle is turning: Credit channels have been repaired, household balance sheets deleveraged and excess housing stock unwound. Combined, these lay the foundations for sustainable recovery. In 2013, fiscal tightening exerted a headwind to growth, but this is now easing allowing GDP growth to accelerate to 2.9% in 2014. For the Fed, setting the right monetary policy during this transition will be challenging. A glance at our leverage cycle suggests that the challenge as recovery gains traction over time is to avoid a build-up of excess leverage. This is not an immediate concern to our minds. Although we forecast household credit expansion, our forecast for household income growth is higher, entailing some further reduction of the household debt-to-income ratio.
UK housing credit has been boosted by government measures: Supported by policy initiatives, UK housing is staging a recovery. This is highly dependent on mortgage loan conditions and the BoE will be keen to keep rates low. We expect the Bank to lower the unemployment rate threshold on its forward guidance from 7.0% to 6.5% (and reduce the NAIRU from 6.5% to 6.0%). The hope medium-term, is that this housing-driven recovery will eventually become broader based with stronger confidence, consumption, exports, corporate investment and lower unemployment. Much will depend, however, on euro area recovery as of 2015. Longer-term, a possible UK referendum on EU membership remains a point of uncertainty.
Euro area still facing headwinds: Individual euro area economies are in very different stages on the leverage cycle. Germany is the most advanced, followed by France, Italy and Spain. For several euro area economies, financial fragmentation and fiscal austerity remain serious headwinds. 2014 will see the arrival of a Single Supervisory Mechanism. As we discuss in Box 10, progress on a Single Supervisory Mechanism continues to disappoint and our base line remains for only a gradual repair of credit channels. Moreover, structural reforms are also not progressing at the desired pace, albeit with significant variation from country to country. The danger for the euro area is to become trapped in a lost decade of very low growth and low inflation. The ECB still has options. The real game changer opportunities, however, reside with governments to deliver quantum leaps on reform – at both the euro area and national levels. For now, progress remains disappointingly slow.
Summing up our view, 2014 will thus be the first year post crisis when advanced economies make an increased contribution to global GDP growth.
* * *
Chart Of The Day: How China’s Stunning $15 Trillion In New Liquidity Blew Bernanke’s QE Out Of The Water | Zero Hedge
Much has been said about the Fed’s attempt to stimulate inflation (instead of just the stock market) by injecting a record $2.5 trillion in reserves into the US banking system since the collapse of Lehman (the same goes for the ECB, BOE, BOJ, etc). Even more has been said about why this money has not been able to make its way into the broader economy, and instead of forcing inflation – at least as calculated by the BLS’ CPI calculation – to rise above 2% has, by monetizing a record amount of US debt issuance, merely succeeded in pushing capital markets to unseen risk levels as every single dollar of reserves has instead ended up as assets (and excess deposits as a matched liability) on bank balance sheets.
Much less has been said that of the roughly $2 trillion increase in US bank assets, $2.5 trillion of this has come from the Fed’s reserve injections as absent the Fed, US banks have delevered by just under half a trillion dollars in the past 5 years. Because after all, all QE really is, is an attempt to inject money into a deleveraging system and to offset the resulting deflationary effects. Naturally, the Fed would be delighted if instead of banks being addicted to its zero-cost liquidity, they would instead obtain the capital in the old-fashioned way: through private loans. However, since there is essentially no risk when chasing yield and return and allocating reserves to various markets (see JPM CIO and our prior explanation on this topic), whereas there is substantial risk of loss in issuing loans to consumers in an economy that is in a depressionary state when one peels away the propaganda and the curtain of the stock market, banks will always pick the former option when deciding how to allocated the Fed’s reserves, even if merely as initial margin on marginable securities.
However, what virtually nothing has been said about, is how China stacks up to the US banking system when one looks at the growth of total Chinese bank assets (on Bloomberg: CNAABTV Index) since the collapse of Lehman.
The answer, shown on the chart below, is nothing short of stunning.
Here is just the change in the past five years:
You read that right: in the past five years the total assets on US bank books have risen by a paltry $2.1 trillion while over the same period, Chinese bank assets have exploded by an unprecedented $15.4 trillion hitting a gargantuan CNY147 trillion or an epic $24 trillion – some two and a half times the GDP of China!
Putting the rate of change in perspective, while the Fed was actively pumping $85 billion per month into US banks for a total of $1 trillion each year, in just the trailing 12 months ended September 30, Chinese bank assets grew by a mind-blowing $3.6 trillion!
Here is how Diapason’s Sean Corrigan observed this epic imbalance in liquidity creation:
Total Chinese banking assets currently stand at some CNY147 trillion, around 2 ½ times GDP. As such, they have doubled in the past four years of increasingly misplaced investment and frantic real estate speculation, adding the equivalent of 140% of average GDP – or, in dollars, $12.5 trillion – to the books. For comparison, over the same period, US banks have added just less than $700 billion, 4.4% of average GDP, 18 times less than their Chinese counterparts – and this in a period when the predominant trend has been for the latter to do whatever it takes to keep commitments off their balance sheets and lurking in the ‘shadows’!
Indeed, the increase in Chinese bank assets during that breakneck quadrennium is equal to no less than seven-eighths of the total outstanding assets of all FDIC-insured institutions! It also compares to 30% of Eurozone bank assets.
Truly epic flow numbers, and just as unsustainable in the longer-run.
But what does this mean for the bigger picture? Well, a few things.
For a start, prepare for many more headlines like these: “Chinese buying up California housing“, “Hot Money’s Hurried Exit from China“, “Following the herd of foreign money into US real estate markets” and many more like these. Because while the world focuses and frets about the Fed’s great reflation experiment (which is only set to become bigger not smaller, now that the Fed has thrown all caution about collateral shortage to the wind and will openly pursue NGDP targeting next), China has been quietly injecting nearly three times in liquidity into its own economy (and markets, and foreign economies and markets) as the Fed and the Bank of Japan combined!
To be sure, due to China’s still firm control over the exchange of renminbi into USD, the capital flight out of China has not been as dramatic as it would be in a freely CNY-convertible world, although in recent months many stories have emerged showing that enterprising locals from the mainland have found effective ways to circumvent the PBOC’s capital controls. And all it would take is for less than 10% of China’s new credit creation to “escape” aboard from the Chinese banking system, the bulk of which is quasi nationalized and thus any distinction between prive and public loan creation is immaterial, for the liquidity effect to be as large as one entire year of QE. Needless to say, the more effectively China becomes at depositing all this newly created liquidity, the faster prices of US real estate, the US stock market, and US goods and services in general will rise (something the Fed would be delighted with).
However, while the Fed certainly welcomes this breakneck credit creation in China, the reality is that the bulk of these “assets” are of increasingly lower quality and generate ever lass cash flows, something we covered recently in “Big Trouble In Massive China: “The Nation Might Face Credit Losses Of As Much As $3 Trillion.” It is also the reason why China attempted one, promptly aborted, tapering in the summer of 2013, and why the entire third plenum was geared toward economic reform particularly focusing on the country’s unsustainable credit (and liquidity) creation machine.
The implications of the above are staggering. If the US stock, and especially bond, market nearly blew a gasket in the summer over tapering fears when just a $10-20 billion reduction in the amount of flow was being thrown about, and the Chinese interbank system almost froze when overnight repo rates exploded to 25% on even more vague speculation of a CNY1 trillion in PBOC tightening, then the world is now fully addicted to about $5 trillion in annual liquidity creation between just the US, Japan and China alone!
Throw in the ECB and BOE as many speculate will happen eventually, and it gets downright surreal.
But more importantly, as with all communicating vessels, global liquidity is now in a constant state of laminar flow – out of central banks: either unadulterated as in the US, Japan, Europe and the UK, or implicit, when Chinese government-backstopped banks create nearly $4 trillion in loans every year. If one issuer of liquidity “tapers”, others have to step in. Indeed, as we suggested a few weeks ago, any possibility of a Fed taper would likely involve incremental QE by the Bank of Japan, and vice versa.
However, the biggest workhorse behind the scenes, is neither: it is China. And if something happens to the great Chinese credit-creation dynamo, then we see no way that the rest of the world’s central banks will be able to step in with low-powered money creation, to offset the loss of China’s liquidity momentum.
Finally, when you lose out on that purchase of a home to a Chinese buyer who bid 50% over asking sight unseen, with no intentions to ever move in, you will finally know why this is happening.
The Failure Of Abenomics In One Chart… When Even The Japanese Press Admits “Easing Is Not Working” | Zero Hedge
Since late 2012 Zero Hedge has been very critical of Japan’s Abenomics experiment, and its first and only real arrow: a massive increase in the monetary base thanks to the BOJ’s shock and awe QE announced in April, resulting in the collapse of the Yen (although in a not zero sum world this means ever louder complaints from US exporters such as Ford competing with Japanese companies), a soaring Nikkei (if only through May), and what was expected to be an economic renaissance as a result of a return to stable 2% inflation.
We repeatedly warned that the only inflation anyone would see in Japan is in imported energy costs and food prices, which in turn would crush real disposable income especially once nominal wage deflation accelerated, which it has for the past 16 months straight. So far this has happened precisely as warned.
Another thing we warned about is that the result of the bank reserves tsunami – just like in the US – lending in Japan would grind to a halt, as everyone and their grandmother sought to invest the resulting excess deposits in risk markets as exemplified best by JPMorgan’s CIO division.
Today, with the traditional one year delay (we assume they had to give it the benefit of the doubt), the mainstream media once again catches up to what Zero Hedge readers knew over a year ago, and blasts the outright failure that is Abenomics, but not only in the US (with the domestic honor falling to the WSJ), but also domestically, in a truly damning op-ed in the Japan Times.
We will let readers peruse the WSJ’s “Japan’s Banks Find It Hard to Lend Easy Money: Dearth of Borrowers Illustrates Difficulty in Japan’s Program to Increase Money Supply” on their own. It summarizes one aspect of what we have been warning about – namely the blocked monetary pipeline, something the US has been fighting with for the past five years, and will continue fighting as long as QE continues simply because the “solution” to the problem, i.e., even more QE, just makes the problem worse.
We will however, show the one chart summary which captures all the major failures of the BOJ quite succinctly.
More importantly, we will repost the Japan Times Op-Ed from last night, titled “BOJ’s money mountain growing but debt may explode” because it not only copies all we have said over the past year, but is a dramatic reversal from the Japanese population eagerly drinking Abe’s Koolaid long after its expiration date. Because once the media starts asking questions, the broader population can’t be far behind.
From Japan Times, November 17, 2013 highlights ours
BOJ’s money mountain growing but debt may explode
by Reiji Yoshida
Haruhiko Kuroda hit the ground running when he was appointed by Prime Minister Shinzo Abe in March to take charge of the Bank of Japan.
Out of the blue, the central bank’s new governor unveiled a super-aggressive easing policy the next month to double the nation’s monetary base in just two years. He said the BOJ would buy more than ¥7 trillion in long-term Japanese government bonds per month to flood the financial system with money to end more than a decade of deflation.
The BOJ’s nine-member Policy Board unanimously supported Kuroda’s goal of stoking 2 percent inflation in two years — a surprise about-face from its stance under his predecessor, Masaaki Shirakawa, who was concerned about the potential side effects of embracing such radical quantitative easing.
More than six months have passed. How has the BOJ’s strategy changed Japan’s financial markets and the real economy?
Critics say Kuroda’s monetary easing scheme isn’t working, although most of the public apparently believes otherwise.
There are growing signs of inflation, but not the sort heralding the start of Abe’s much-advertised recovery and rising wages. Instead, imported fuel and other products have become more expensive because of the weak yen ushered in by Kuroda and Abe, and this bodes ill for the public’s living standards.
Meanwhile, Kuroda’s aggressive plan is allowing the debt-ridden government to issue fresh bonds continuously, further increasing the likelihood of a fiscal crisis, they said.
“People have been deceived by ‘Abenomics,’ ” Yukio Noguchi, a prominent economist and adviser to Waseda University’s Institute of Financial Studies, told The Japan Times in a recent interview.
“Monetary easing is not working, and it’s going nowhere,” Noguchi said.
Since April, the BOJ has been gobbling up JGBs from banks and the open market. Its purchases amount to roughly 70 percent of the value of all new JGBs issued.
But the banks are just stowing that money in their accounts at the BOJ because they can’t find any companies interested in borrowing it.
“There is no demand for funds on the part of businesses. That’s why the monetary easing is not working,” Noguchi said.
Japan’s monetary base — the sum of cash in circulation plus banks’ current account balances at the BOJ — surged from 23.1 percent in April to 45.8 percent in October, thanks to the BOJ’s aggressive operations.
But its money stock — the total amount of monetary assets available in an economy including credit created by bank loans, but excluding deposits held by financial institutions and the central government — only rose to 3.3 percent from 2.3 percent in the period.
This means banks are just depositing the massive funds provided by the BOJ in their own accounts at the central bank. The unloaned cash is thus having little affect on the real economy.
Meanwhile, the long-term interest rate, which theoretically factors in an expected rate of inflation, has fallen and is dwindling at an ultralow level of around 0.6 percent.
This signals that the market does not yet seriously believe that inflation in Japan will reach Kuroda’s 2 percent goal, said Kazuhito Ikeo, an economics professor at Keio University.
“When the policy interest rate has effectively fallen to zero, monetary policy won’t work much any more,” Ikeo said in a recent interview.
Ikeo believes the economy is stuck in a rut because its potential for economic growth has declined and monetary measures alone can’t solve the problem, he said.
“I think it has become clearer that there is a limit to what monetary policy can do,” Ikeo said.
Much of the public believes the drastic easing measures adopted by Abe and Kuroda helped weaken the yen and benefitted exporters. The yen-dollar rate has fallen from around 78 to about 100 over the past 14 months. This helped send the Nikkei stock index soaring from December, one of the main reasons Abenomics has public support.
But the yen started depreciating last fall, long before Kuroda’s widely proposed takeover at the BOJ officially took place in April, Noguchi said.
Abe was just “lucky” to see the yen fall, Noguchi claimed, crediting the easing of the eurozone debt crisis last fall rather than clear signs that Abe’s Liberal Democratic Party was getting ready to boot the unpopular Democratic Party of Japan from power.
In September, Japan’s consumer price index rose 0.7 percent from the same month last year to log its fourth consecutive rise, hinting at inflation. The uptick, however, was misleading. It was largely caused by the costly rise in energy imports, exacerbated by a weaker yen.
This, of course, is not a sign of economic recovery, both Noguchi and Ikeo said.
Workers’ real wages fell 2 percent in August compared with the same month the previous year, logging two drops in a row. Inflation without wage hikes will only erode people’s living standards.
“It is wages that matter. If prices go up without a rise in wages, the real income of the people just goes down,” Noguchi said.
Abe apparently is well aware of this risk and has repeatedly urged top business leaders in Keidanren, the nation’s largest business lobby, to push for wage hikes to generate “a virtuous cycle” of raises and economic expansion.
Noguchi calls Abe’s approach “sheer nonsense” because Japan is not a planned economy and the government thus cannot force businesses to raise wages against their will.
Probably the biggest risk with Abenomics, however, is a potential crash in JGB prices that would cause long-term interest rates to spike and gut the debt-laden government.
Ikeo pointed out that the BOJ’s massive bond purchases are in fact helping the debt-ridden government finance itself, even if the central bank claims this is not its intention. If the BOJ keeps up this charade, confidence in JGBs might crash, Ikeo said.
“Soon or later, concerns over fiscal sustainability will emerge. You can’t rule out the possibility of a surge in the (long-term) interest rate at a critical point,” he said.
The resulting surge in debt-serving costs would devastate the government, which has already racked up a public debt totaling almost 200 percent of gross domestic product — the highest of all developed countries. Nearly half of Japan’s ¥92.6 trillion general account for fiscal 2013 is barely being financed by fresh JGB issues.
According to Noguchi’s simulation, if the average JGB yield jumps to 4 percent in fiscal 2014, debt-serving costs will leap to a staggering ¥50 trillion in fiscal 2025 alone, which is more than half the size of the fiscal 2013 budget.
“This is nothing but fiscal bankruptcy,” Noguchi warned.
For some two decades, fears and rumors have swirled about just such a scenario. Economists who warned of the impending crisis were labeled alarmists while speculators who bet on it always lost.
That situation may soon change.
Japan’s trade balance has turned into a deficit and the current account surplus has shrunk. Japan posted a surplus of ¥3.05 trillion in the current account for the April-September half, the second-lowest level since 1985, when comparable data became available.
Ikeo warned that if the current account balance sinks into red and people are convinced the yen will no longer strengthen, investors may start buying foreign bonds and ditch their JGBs.
Another possible danger is, ironically, a full-fledged economic rebound, which would also push up long-term interest rates, Ikeo said.
The government needs to walk “a dangerous narrow path” of seeking a recovery while trying to prevent interest rates from surging at the same time, he said.
Testosterone Pit – Home – What Will It Take To Blow Up The Entire Japanese Banking System? (Not Much, According To The Bank of Japan)
Hideo Hayakawa, former Bank of Japan chief economist and executive director, set the scene on Wednesday when he discussed the BOJ’s ¥7-trillion-a-month effort to water down the yen by printing money and gobbling up Japanese Government Bonds. It wants to achieve what is increasingly called “2% price stability,” a term that must be a sick insider joke played on the Japanese people. He warned that if these JGB purchases are “perceived as monetization“ of Japan’s out-of-whack deficits, it would drive up long-term JGB yields “to 2% to 3%.” Up from 0.60% for the 10-year JGB. “But once interest rates start rising, they would overshoot,” he said. So maybe 4%?
He’d set the scene for the Bank of Japan’s 81-page semiannual Financial System Report, released the same day. Buried in Chapter V, “Risks borne by financial intermediaries,” is a gorgeous whitewash doozie: if interest rates rise by 1 percentage point, it would cause ¥8 trillion ($82 billion) in losses across the banking system.
This interest rate risk associated with all assets and liabilities, such as bondholdings, loans, and deposits has been dropping since April 1, the beginning of fiscal 2013, the BOJ explained soothingly – the largest decline in 13 years. Banks would be able to digest that 1 percentage point rise.
A big part of that interest rate risk is tied to the banks’ vast holdings of JGBs. The BOJ has begged banks to dump this super-low yielding stuff that could blow up their balance sheets. The three megabanks – Mitsubishi UFJ Financial Group, Mizuho Financial Group, and Sumitomo Mitsui Financial Group – have done that. From the beginning of the fiscal year through August, their JGB holdings plummeted by 24% to ¥96 trillion. And much of what they still hold is paper with short to medium maturities that poses less risk.
The regional banks have not been able to do that, and their JGB holdings remained flat at ¥32 trillion. However, the amount of loans with longer maturities, such as those to local governments, has gone up, which raised the interest rate risk “slightly,” the report said.
Then there are the 270 community-based, cooperative shinkin banks. And they’re stuck in a quagmire. They’re stuffed to the gills with JGBs because, unlike megabanks and, to a lesser extent, regional banks, they have no other options to place their ballooning deposits. On their balance sheets, interest rate risk continued its long and relentless upward trend [my take on the shinkin bank debacle…. “We Don’t Feel Any Impact Of Abenomics Here”]
A 1 percentage point rise would cost megabanks ¥2.9 trillion, regional banks ¥3.2 trillion, andshinkin banks ¥1.9 trillion. A total of ¥8 trillion ($82 billion). If the yield curve steepened, with long-term rates rising 1 percentage point and short-term rates remaining low, the losses would be smaller. In all, it would be survivable. The banking system is safe.
Whitewash doozie because it assumes a 1 percentage-point rise. The yield of the 10-year JGB would rise from todays 0.6% to 1.6%. With annual inflation hitting 2% soon, bondholders would still get sacked. Hence Mr. Hayakawa’s warning: if inflation hits 2%, long-term interest would likely head to 2% or 3%, and once they start rising, they’d “overshoot.” So, with a little overshoot, 10-year JGB yields might rise by 3 percentage points, to 3.6%. Still a very moderate interest rate, by historical standards. What would that do to the banking system?
The report tells us what it would do: megabanks would be severely damaged; the rest of the banking system would be wiped out. If there is a parallel stock market crash, the megabanks would be wiped out as well.
The megabanks combined have ¥28 trillion in Tier 1 capital. Against it are credit risk, market risk from stock holdings, interest rate risk, and operational risk. The risk scenario the BOJ envisioned with a 1 percentage point rise in interest rates would create losses of nearly ¥17 trillion for the megabanks, a big part from its bond and loan portfolio, but an even bigger part from its stockholdings. That would leave about ¥11 trillion in Tier 1 capital.
But if the scenario plays out as Mr. Hayakawa sees it, with a 3 percentage point rise in interest rates, losses at megabanks, according to the report, would jump by ¥4.6 trillion, leaving only ¥6.4 trillion in Tier 1 capital.
Then there is the stock market risk. Traditionally, banks held large chunks of shares of companies they did business with. It cemented the relationship and propped up equities, which in turn made loans appear stronger. It worked wonderfully until the bubble it helped create blew up in 1989. Banks turned into zombie banks. Since then, 20 of these zombie banks have been consolidated into the three megabanks. And they have reduced ever so gradually their stock holdings to get out from under that risk that took them down the last time.
But in the money-printing induced mania, they’ve been adding stocks, and their exposure to the stock market remains enormous. The market downturn envisioned by the BOJ would produce around ¥7 trillion in losses. If that downturn becomes a crash, of which Japan has seen its share, losses could easily wipe out the remaining Tier 1 capital. Bailout time.
Regional banks will get wiped out by a 3 percentage point rise in interest rates. They don’t need a stock market crash. Even the BOJ is worried. According to its risk scenario with a 1 percentage point rise in interest rates, losses will eat up ¥11 trillion of the banks’ ¥15 trillion in Tier 1 capital. Leaves ¥4 trillion. If interest rates rise by 3 percentage points, another ¥4.6 trillion in losses would hit the banks, more than annihilating all of their Tier 1 capital. They’d be goners.
And the beleaguered shinkin banks? They have ¥6.5 trillion in Tier 1 capital. They don’t own a lot of stocks but are loaded with JGBs and local government bonds with long maturities. In the scenario where interest rates rise 1 percentage point, half of their Tier 1 capital would be wiped out. A 3 percentage point rise in rates would produce an additional ¥2.7 trillion in losses, wiping out almost all of the remaining Tier 1 capital.
But the 3 percentage point rise is only theoretical. If that happened, the government wouldn’t be able to make interest payments on its ¥1 quadrillion in debt. The whole house of cards would come tumbling down.
No, interest rates will not be allowed to jump this high. Even if inflation is 6%, the BOJ will see to it that yields remain low. It would impose brutal financial repression. It could use numerous tools, including a yield peg. If it had to, it could print enough money to buy the entire national debt of Japan, even if that might finally be “perceived as monetization” – with all the consequences that this would entail.
Japan is still the second richest nation in the world, according to Credit Suisse. About ¥1 quadrillion of that wealth is tied up in JGBs. But debt that yields almost nothing and can never be paid back, will eventually succumb to fate: either slowly through inflation and devaluation or rapidly through default. Abenomics has chosen the slow route.
But if the house of cards were allowed to come down rapidly, from the ashes would rise a young generation that suddenly could look into the future and actually see something other than the oppressive dark wall of the government debt hurricane coming their way.
Trade is another critical pillar of Abenomics. Devaluing the yen would boost exports and cut imports. The resulting trade surplus would goose the economy. But the opposite is happening. And it isn’t happening in small increments, with ups and downs over decades, but rapidly and relentlessly. It’s not energy imports. They actually dropped! It’s a fundamental shift. Read….Why I’m So Worried About Japan’s Ballooning Trade Deficit
- Kuroda Put Prompts Japan Banks to Shift to Longer Bonds (bloomberg.com)
- Japan banks cut JGB holdings 24 pct in March-August – BOJ (uk.reuters.com)
- PREVIEW-Global woes sap BOJ confidence in economic outlook (xe.com)
- Revenge of the Japanese Zombie Banks (elementulhuliganic.wordpress.com)
CommentsView/Create comment on this paragraphBERKELEY – The dollar is the world’s go-to currency. But for how much longer? Will the dollar’s status as the only true global currency be irreparably damaged by the battle in the US Congress over raising the federal government’s debt ceiling? Is the dollar’s “exorbitant privilege” as the world’s main reserve currency truly at risk?
CommentsView/Create comment on this paragraphTo be sure, the purveyors of dollar doom and gloom have cried wolf before. When the subprime-mortgage crisis hit, it was widely predicted that the dollar would suffer. In fact, the greenback strengthened as investors seeking a safe haven rushed into US Treasury bonds. A year later, when Lehman Brothers failed, the dollar benefited from the safe-haven effect yet again.
CommentsView/Create comment on this paragraphData from the International Monetary Fund confirm that these shocks caused little (if any) decline in the dominance of the dollar in central banks’ holdings of foreign-currency reserves. Likewise, data gathered by the Bank for International Settlements show that the dollar dominates global foreign-exchange transactions as much as it did in 2007.