Saturday, August 10, 2013

The Baddest Bad Bank Of Them All

Over at The Telegraph, Ambrose Evans-Pritchard either did not get the email, or ignored the postscript: "And for Amaterasu's sake, do not let on to what it is that we are doing!" (Link)

Once in an exchange with a noted Japan expert I described Japan Government Bonds as toxic assets. Evans-Pritchard clarifies what I mean.

What is peculiar is the mention of bond vigilantes. More curious still is the mention comes from BNP Paribas chief economist Kono Ryutaro.

What bond vigilantes? Over 90% of JGBs held by domestic investors and most of that, when not by  the Bank of Japan, is by Japan's largest financial institutions. Anyone demanding yield -- a.k.a, lower of bond prices - would open up craters in the capital bases of every major participant in the financial system. So everyone has had an incentive to play nice, especially since the financial system has continued to gorge itself on real income (thanks to deflation) producing JGBs long after the national debt-to-GDP-ratio made any sense.

Exit was kept in check by both the lack of reasonable investment alternatives (see the graphs of Japan's equities markets and real estate prices since 1989) and mutually assured financial destruction if any big player tried to opt out of the game.

So no vigilantes. Instead, a genteel Mexican standoff -- no participant having the ability to get out fast enough to make up for the losses on its hoard of JGBs.

What Bank of Japan Governor Kuroda Haruhiko is offering -- and what made the interest rate volatility in May so inexplicable -- is an orderly and gradual exit from the standoff for non-government market participants. The Bank of Japan promises to expand its balance sheet without limit, under the aegis of doing everything it can to create inflation. Japan's financial giants, not working in sync but not being disharmonious either, sell their JGBs to the BOJ, reducing the riskiness of their portfolios.

Of course, if the BOJ is successful in triggering inflation, then the pressure will be on the financial system players to get out of JGBs all the faster -- faster perhaps than the BOJ can buy the securities on offer.

At that point reported increases in government tax revenues had better be spectacular. If they are not, the JGBs in the portfolios of Japan's financial system will indeed be toxic, transformed into poison by the loss of credibility of the ultimate cover story of the Japanese government's being able to pay JGBs off.

So good luck with that asset switchover, everyone.

As for idle cash appearing on the balance sheets of Japanese megabanks and insurance giants, some of it is going to flow into the equities markets and possibly real estate, reinforcing the emerging bubbles there. However, the financial giants, which employ at least a few individuals who remember the 1980s, are going to direct a lot of the BOJ-printed money overseas. Which means global asset reflation and a tumbling yen. Higher import prices, primarily of energy and raw materials, from the lower yen, yes -- but also more competitive export prices and enormous profits for exporters, at least in their debased accounting currency. Which in turn would mean higher government tax receipts.

Where does the virtuous, BOJ-inspired cycle break down? In competing devaluations of the won and the yuan? Too stupid am I to say.

1 comment:

Troy said...

yes, it is a very complicated picture, with too many moving parts for anyone to actually understand.

But I remember looking on Japan's prospect when the yen was at 80 and thinking, ya know, Japan's has a LOT of leeway to inflate!

When I arrived in Japan I cashed my first batch of travelers checks at 127 to the dollar.

Japan Inc would love to see that FX again. Consumers, not so much!