When the next major crisis unfolds, investors might have to learn a new acronym – JGBs.
The global credit crisis has impacted all our lives in many ways – some small, some not so small. One of the small things we’ve had to deal with is an invasion of acronyms.
Who knew that strings of letters could be so deadly? Just as a sampling from the smoking wreckage, we’ve had to hear all we can stand about CDS (credit default swaps)... MBS (mortgage-backed securities)... Option ARMs (adjustable-rate mortgages)... NINJA loans (no income, no job, no assets)... and that’s just the tip of the iceberg. Were we to dive into the likes of TARP, TALF, PPIP, and other alphabet soup programs, we could be here all day.
The way things have been handled – i.e. badly, with an eye for slapping duct tape on a broken system and rewarding the players that broke it – it’s just a matter of time before the next crisis rolls along. (Or rather, in many ways, a continuation of the same crisis, as the true problems haven’t been dealt with at all.)
Mr. Market does have a penchant for surprises, though. The sucker punch tends to come flying out of nowhere (rather than the expected place). Consider the main culprits of the 2007-2008 debacle – the major banks. It’s easy to forget now, but for years everyone thought the next meltdown would be caused by hedge funds.
That is partly why the next crisis could be tied to a horror-show acronym investors haven’t learned yet: JGBs.
“Japanese Disease”
What are JGBs, you ask? Japanese Government Bonds.
For the better part of two decades, the Land of the Rising Sun has been piling up enormous amounts of debt. Perpetually low interest rates on this debt have allowed Japan to become, by debt-to-GDP measure, the most insanely indebted country in the world.
As fund manager Hugh Hendry observed this summer:
Over the last 20 years, the Japanese have fought crisis after crisis by expanding the public sector debt. They’ve issued trillions, literally trillions of yen, and debt is now approaching two hundred percent of GDP. What’s happened to government bond yields? They’ve gone down.
Those in the deflationary camp point to Japan as a reason to be bullish on U.S. Treasuries.
If America apes Japan, the deflationists argue, then the U.S. economy will sink slowly into the muck as the government issues ever larger amounts of debt. The deflationary belief is that households, banks and businesses will buy up all the bonds (for lack of better options) as the nation sinks into malaise. This would, in turn, keep long-term interest rates low in the style to which Japan has become accustomed.
To understand this argument, it is important to think in relative terms. Those who fear inflation point to the trillions of dollars being pumped into the system. But the deflationists tend to ask, what if the hole we are attempting to fill is actually much bigger than we realize?
That is to say, what if the Fed’s $5 trillion worth of credit creation efforts (to hazard a guess) are actually pitted against an economic contraction gap of $10 trillion or $15 trillion, with the effects of government debt “crowding out” private sector loans further making the problem worse? And what about the hoarding tendencies of U.S. banks, as shown by excess reserves hitting a record of $1.06 trillion?
The deflation camp would argue that, even though the Fed should stimulate more than it is actually doing, it is constrained by political opposition... and as a result, America is in position to limp along painfully for years (à la Japan), with more and more people parking their cash in USTs for lack of an appealing alternative.
If the deflationists are right, in other words, the inflation hawks will be left scratching their heads... having underestimated the size of a too-big-to-fill velocity hole created by a slow-motion deflationary bust.
Your humble editor does not personally endorse this argument, mind you. He is just spelling it out. The argument has power, in part, because what was just described is by and large the Japanese experience. (That is why many refer to the above scenario as “Japanese Disease.”)
A Very Special Case
It is important to remember too, though, that Japan is a very special case. The main difference between Japan and the United States is that virtually all of Japan’s debt – upwards of 95% of it – has been purchased domestically, by Japanese savers and Japanese institutions.
So if you’ve ever wondered who in their right mind would buy JGBs (Japanese Government Bonds) at near zero interest rates for all those years, now you’ve got your answer. The purchases have been a combination of politics and inertia, bolstered by a well-entrenched deflationary mind set among long-suffering Japanese savers.
And this brings us back around to the “ticking time bomb” question. For 20 years, Japan has piled ever greater amounts of debt on its corporate and private citizens. But what happens when the locals run out of cash? When the bottomless appetite for low-interest rate bonds disappears, what will Japan do?
It is a fascinating question because of the abrupt manner in which things could play out...
Imagine you run a business that has two main customers. You have been selling regularly to these customers, month in and month out, for the better part of two decades. Your entire business, and your leveraged balance sheet, hinges on the continued good will of these reliable two. Then, one day, the purchase orders start declining. Before long, you hear the unthinkable: “Sorry, no more buying – we’re done.” What happens to your business?
It implodes, that’s what.
Godzilla in Waiting
The market has been lulled into complacency by the impressive staying power of a long-term trend. After all, Japan’s debt sales have been going on for twenty years. Their interest rates have stayed low all that time. Why would things ever change?
Because in terms of big macro-economic megacycles, two decades is an eye blink. It is only human psychology that lulls us into thinking the recent past can extend on out to forever. In terms of the question “Why would things change,” one could ask the same of U.S. consumer saving and spending habits, which have finally reversed after a quarter-century run. Some holes just take a long time to fill.
David Einhorn, the founder of Greenlight Capital, believes that Japan could enter a “currency death spiral” if the JGB situation spins out of control. Putting his money where his mouth is, Einhorn has positioned his $5 billion fund to take advantage of a JGB crisis scenario by betting on higher Japanese interest rates. (When bonds fall in price, interest rates rise.)
Einhorn further noted in a recent speech that “When the market refuses to refinance at cheap rates, problems emerge,” and said a potential catalyst for a JGB meltdown could be Japanese savers starting to spend more in retirement (thus buying fewer bonds).
Another major note of concern is the delicate psychology of the market. It is a wondrous thing that Japan can putter along with a debt load approaching 200% of GDP, a truly staggering sum. But the market is complacent only because no cracks in the dam have appeared. At the first sign of real trouble, psychology could shift from complacency to panic in a very short period of time, causing the floodgates to open and the JGB dam to burst.
Japan is the second largest economy in the world, and one of the largest (if not THE largest) regular buyers of U.S. Treasury bonds. “Japan bought a net $105 billion of U.S. government debt through August,” Bloomberg reports, “exceeding China as the biggest foreign buyer and boosting its holdings to $731 billion, or more than 10 percent of the total market.”
So, needless to say, a JGB meltdown would be a very, very big deal. Were the yen to enter a “death spiral,” to use Einhorn’s phrase, the global economy would be knocked off its axis.
Whispers in the Wind
Let it be said that the timing for a JGB meltdown remains unclear. No one is going to ring a bell. Whether it be next month, next year, or another two years down the road, it’s hard to say.
The disconcerting thing, though, is that events have progressed to the point where the meltdown could happen at any time. That’s why it makes sense to keep an eye on current events as Japan’s economy struggles.
“Japanese government bond yields closed at their highest level in three months,” the Financial Times reported last week, “as poor demand at a 10-year bond auction underscored concerns over rising issuance in the world’s largest bond market.” The Mainichi Shimbun (a Japanese newspaper) further reported last week that JGB popularity is falling among individual investors.
If we see a JGB crisis, it will come with great turmoil, which means both great risk and great potential reward. For those without the means to make sophisticated interest rate bets (as Einhorn has done), the most direct means of profit would be catching the massive “death spiral” move in the yen as the crisis unfolds. This is precisely the type of global macro mega-opportunity in which Currency Profits Trader and Macro Trader specialize.
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Dagelijks zie ik de situatie van Japan in de voetnoot van economische artikelen voorbij komen omdat de huidige kredietcrisis vooral zijn speerpunten heeft in de VS-Europa.
Schijn bedriegt..... er zijn meer tekenen dat de volgende crisis zich uit de kiem zal ontwikkelen vanuit het verre oosten (met Japan in het bijzonder - Exportland pur sang bij uitstek). Qua frequentie zag ik deze artikelen al vanaf begin dit jaar.... en het begint nu echt leuke proporties aan te nemen. Meer dan reden genoeg voor een separaat topic.
Japanese government bonds - not a topic that normally fires up commentators and investors - are moving increasingly into the spotlight following - shock, horror - warnings about a possible credit rating downgrade to Japan’s sovereign debt.
Amid concerns about Japan’s rising levels of public spending and debt issuance, the JGB saga took a fresh twist on Tuesday as Fitch Ratings warned Tokyo to keep to its borrowing target or risk a credit rating downgrade. Adding to the debate, Hirohisa Fujii, the finance minister, acknowledged the problem and tried to reassure nervous investors by agreeing that public spending should be cut.
“Losing the confidence of the market would be damaging to our national interests”, he added.
Well, yes…
As Reuters reports, Japanese sovereign credit default swaps spreads have nearly doubled in the past week as investors fretted that the government faces a funding crunch over its ballooning public debt, which the IMF estimates will spiral to 227 per cent of GDP next year, by far the worst among G7 countries.
Yields on benchmark 10-year JGBs closed at 1.47 per cent on Tuesday, near their highest level for five months, after rising steadily in recent weeks. Even though, the FT notes, Japanese yields remain relatively low on a global basis — and below the levels of a decade ago, when yields rose from 0.77 per cent to 2.47 per cent in the space of five months - the market move in Japan could herald a wider shift in market sentiment towards sovereign debt at a time of massive government issuance around the world.
The rise in JGB yields is also creating an unwelcome headache for the new government in Tokyo, as Japan’s debt is so high that its servicing costs will rise sharply if JGBs move, by even a small amount, the report adds. Total Japanese government debt is close to 200 per cent of GDP.
According to Short View’s Jennifer Hughes, concerns that the Japanese government will have to borrow more than it has budgeted for next year are “hardly unique to Japan”. Indeed, she notes in a Tuesday column:
Governments around the world are sensitive just now because of their extra borrowing and the risks are rising that they too could face sharp jumps in the cost of those loans. Ideally, markets would adjust steadily and calmly to the fiscal situation as news emerged. But the likelihood is a far lumpier ride. Current low bond yields reflect many factors but one of those is some investor complacency about the economic outlook. This leaves markets wide open to the risk that any reaction to bad fiscal news is very sudden.But the “complacency” factor is one area where Japan differs markedly from some other countries. In fact, the ups and downs of economic policy under the new Hatoyama administration has investors clearly spooked.
Bond markets “have a history of savage sentiment changes which can send yields spiking higher”, says Hughes, reminding us of a famous example of such “bond vigilantism” which resonates today: the pain inflicted on the Clinton administration in 1994, as bond markets became nervous of rising inflation from the government’s economic stimulus efforts. Ten-year yields jumped 2.5 percentage points in 10 months, prompting James Carville, the Clinton strategist, to famously claim he would like to be reincarnated as the bond market: “Then you can intimidate everyone,” he said.
Concludes Hughes:
Japan is right to be concerned about the bond market’s unease. Other governments should take note too; episodes far worse are increasingly likely to erupt elsewhere — and they can be very expensive.
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alphaville.ft, ziet het ook.
quote:Je gaat toch niet in Japan sparen?Op donderdag 12 november 2009 09:57 schreef Lyrebird het volgende:
Tip gevraagd: wat doe ik met mijn Japanse spaarcentjes?
quote:Nou ja, sparen. Ik verdien hier in Japan geld, en dat staat nu op zo'n ouderwets spaarbankboekje. Voor de rente hoef je dat hier niet te doen, het is meer gemakzuchtOp donderdag 12 november 2009 10:20 schreef m0m0 het volgende:
[..]
Je gaat toch niet in Japan sparen?
Aan de andere kant: het sparen in Japan is vrij inelastisch. Dus als er meer geld nodig is, dan zal de rente fors omhoog moeten om meer geld naar JMB's te laten gaan.
quote:Buying Power......Op donderdag 12 november 2009 11:08 schreef Lyrebird het volgende:
[..]
Nou ja, sparen. Ik verdien hier in Japan geld, en dat staat nu op zo'n ouderwets spaarbankboekje. Voor de rente hoef je dat hier niet te doen, het is meer gemakzucht
http://www.google.com/finance?q=JPYEUR
Slipping away.
quote:Roep dat niet te hard, Japan is een redelijk gesloten gemeenschap en het vergrijzingsprobleem gaat daar hard kicken (Zelfs harder dan bij ons).Op donderdag 12 november 2009 11:19 schreef en_door_slecht het volgende:
Hm, ik denk niet dat het allemaal zo snel in elkaar zal donderen. Japanners zijn rare spaarders en hebben veel geld (uit eigen zak) nodig om hun pensioen te betalen. Die lopen niet zomaar weg. Wel komt natuurlijk het probleem dat er steeds minder spaarders zijn (werkenden) en er steeds meer mensen zijn die hun spaarpot op gaan eten (65+).
Aan de andere kant: het sparen in Japan is vrij inelastisch. Dus als er meer geld nodig is, dan zal de rente fors omhoog moeten om meer geld naar JMB's te laten gaan.
Tijdens de Japanse crisis/deflatie sinds 1989 hebben we in de US/EU juist een enorme economische expansie gehad dus die krachten liepen verschillende kanten op. Maar nu zit bijna de hele wereld in een deflatoir scenario terwijl tegelijktijd alle regeringen hun begrotingstekorten fors vergroten. Wie gaat al die tekorten financieren? Ik kan me niet voorstellen dat bondmarkets wereldwijd dit zonder hikken gaan absorberen.
Welke markt het eerst gaat hikken is moeilijk te voorspellen, maar zodra één van de ontwikkelde bondmarkets in de problemen gaat komen verwacht ik een kettingreactie omdat men zich realiseert dat iedereen in hetzelfde schuitje zit. Het is wachten op de eerste barsten...
Dit plaatje zegt eigenlijk alles :
Helaas (of misschien gelukkig) zijn mensen geen konijnen.
quote:Terwijl als ik in de VS een huis van dit geld wil kopen, de buying power juist aan het toenemen is. Go Obama!Op donderdag 12 november 2009 11:19 schreef Drugshond het volgende:
[..]
Buying Power......
http://www.google.com/finance?q=JPYEUR
Slipping away.
quote:Op donderdag 12 november 2009 05:46 schreef Drugshond het volgende:
More fun with JGBs, more headaches for Japan
Japanese government bonds - not a topic that normally fires up commentators and investors - are moving increasingly into the spotlight following - shock, horror - warnings about a possible credit rating downgrade to Japan’s sovereign debt.
Amid concerns about Japan’s rising levels of public spending and debt issuance, the JGB saga took a fresh twist on Tuesday as Fitch Ratings warned Tokyo to keep to its borrowing target or risk a credit rating downgrade. Adding to the debate, Hirohisa Fujii, the finance minister, acknowledged the problem and tried to reassure nervous investors by agreeing that public spending should be cut.
“Losing the confidence of the market would be damaging to our national interests”, he added.
Well, yes…
As Reuters reports, Japanese sovereign credit default swaps spreads have nearly doubled in the past week as investors fretted that the government faces a funding crunch over its ballooning public debt, which the IMF estimates will spiral to 227 per cent of GDP next year, by far the worst among G7 countries.
Yields on benchmark 10-year JGBs closed at 1.47 per cent on Tuesday, near their highest level for five months, after rising steadily in recent weeks. Even though, the FT notes, Japanese yields remain relatively low on a global basis — and below the levels of a decade ago, when yields rose from 0.77 per cent to 2.47 per cent in the space of five months - the market move in Japan could herald a wider shift in market sentiment towards sovereign debt at a time of massive government issuance around the world.
The rise in JGB yields is also creating an unwelcome headache for the new government in Tokyo, as Japan’s debt is so high that its servicing costs will rise sharply if JGBs move, by even a small amount, the report adds. Total Japanese government debt is close to 200 per cent of GDP.
According to Short View’s Jennifer Hughes, concerns that the Japanese government will have to borrow more than it has budgeted for next year are “hardly unique to Japan”. Indeed, she notes in a Tuesday column:
Governments around the world are sensitive just now because of their extra borrowing and the risks are rising that they too could face sharp jumps in the cost of those loans. Ideally, markets would adjust steadily and calmly to the fiscal situation as news emerged. But the likelihood is a far lumpier ride. Current low bond yields reflect many factors but one of those is some investor complacency about the economic outlook. This leaves markets wide open to the risk that any reaction to bad fiscal news is very sudden.But the “complacency” factor is one area where Japan differs markedly from some other countries. In fact, the ups and downs of economic policy under the new Hatoyama administration has investors clearly spooked.
Bond markets “have a history of savage sentiment changes which can send yields spiking higher”, says Hughes, reminding us of a famous example of such “bond vigilantism” which resonates today: the pain inflicted on the Clinton administration in 1994, as bond markets became nervous of rising inflation from the government’s economic stimulus efforts. Ten-year yields jumped 2.5 percentage points in 10 months, prompting James Carville, the Clinton strategist, to famously claim he would like to be reincarnated as the bond market: “Then you can intimidate everyone,” he said.
Concludes Hughes:
Japan is right to be concerned about the bond market’s unease. Other governments should take note too; episodes far worse are increasingly likely to erupt elsewhere — and they can be very expensive.
=================================================
alphaville.ft, ziet het ook.