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Is Japan the Next Black Swan?

Is Japan the Next Black Swan?

Forget Europe. That’s old news. The next surprise might just be a bursting of Japan’s bond bubble.  Nay, a bursting of Japan itself?

According to Fitch, gross general government debt of Japan is likely to reach 239 percent of GDP by end-2012, the highest for any Fitch-rated sovereign. Moreover, Japan’s Fiscal Management Strategy envisages declines in the government debt/GDP ratio only from fiscal year 2021.

Would you lend Japan money (or any country with these financials) at rates approaching zero?

Strong private savings contribute to the country’s persistent current account surpluses. But that’s all going to change as ageing baby boomers (who the government has been borrowing money from at near zero rates – its called financial repression) start to ‘dissave’. As they get older they will stop saving and start needing the cash to finance retirement and healthcare. The result is that the government will need to turn to foreign investors for cash and they are not going to accept zero rates when the country has debt of 240% of GDP.

According to Bloomberg: “How low can bond yields go without triggering a meltdown?

“This question gains urgency as 10-year government yields disappear before the world’s eyes. At 0.83 percent, the lowest level since 2003, they hardly compensate investors for the risks inherent in buying IOUs from the most indebted nation. Public debt is more than twice the size of the $5.5 trillion economy. Worse, it’s still growing. Fitch Ratings today lowered the sovereign-credit rating by one step to A+ with a negative outlook because of Japan’s “leisurely” efforts to cut debt.

“Ignore news that gross domestic product rose an annualized 4.1 percent from the final three months of 2011. The only reason Japan is growing at all is excessive borrowing and zero interest rates. The moment Japan trims its debt, growth plunges, deflation deepens and politicians will demand that the Bank of Japan do more. That’s been Japan’s lot for 20 years now.
Yet what if the BOJ isn’t just setting Japan up for the mother of all crises, but holding the economy back?

“A bizarre dynamic is dominating Japan’s financial system, one evidenced by two-year debt yields falling to about 0.095 percent. That is below the upper range of the BOJ’s zero-to-0.1 percent target for official borrowing costs. It’s below the 0.1 percent interest rate the BOJ pays banks for excess reserves held at the central bank. Such rates raise serious questions.

“The BOJ does reverse auctions where it buys government debt from the market. Last week, it failed to get enough offers from bond dealers. Now think about that: The BOJ prints yen and uses it to buy government debt from banks, which typically hoard the stuff. Last week, banks essentially said: “No, thank you. We’d rather have these dismal interest-bearing securities than your cash, because there’s really nowhere to put that cash anyway.” Banks certainly aren’t lending.

“Politicians are pounding the table demanding that the BOJ expand its asset-purchase program. That, of course, isn’t possible. The BOJ can hardly force banks to swap their bonds for cash. So Japan is left with a problem unique to modern finance. Banks like to keep more cash on deposit at the BOJ than they need to in order to earn a 0.1 percent rate of return, which is pretty good by Japan standards. To pay that rate, the BOJ creates new money, which does nothing to help the economy.

“This dynamic keeps Japan’s monetary engine in neutral at best, and at times running in reverse. Japan’s central bank is essentially now there to support bond prices. It’s a huge intervention that gets little attention. Headlines roll every time the Ministry of Finance sells yen in currency markets. The BOJ’s debt manipulation barely registers.”

Why today?

Last year it was Iron Ore and recently it was minings services for which we suggested conventional wisdom should be questioned.  I am posting this topic today because Fitch Ratings lowered Japan’s credit ratings citing rising risks to the sovereign credit profile due to higher public debt ratios.

The long-term foreign and local currency Issuer Default Ratings were lowered to ‘A+’ from ‘AA’ and ‘AA-‘ respectively. The Negative outlook on ratings was maintained.

“The country’s fiscal consolidation plan looks leisurely relative even to other fiscally-challenged high-income countries, and implementation is subject to political risk,” Andrew Colquhoun, Head of Asia-Pacific Sovereigns at Fitch.

The agency warned that a lack of new fiscal policy measures aimed at stabilizing public finances amid continued rises in government debt ratios could lead to a further downgrade.

Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 22 May 2012.


Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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  1. Hi Roger. What is the best way for a retail investor to take advantage of this impending scenario? Short Japanese stockmarket? Long A$ vs Yen? Long US$ vs Yen? I assume BOJ money printing will not translate into higher gold prices like the Fed.

  2. Hi All

    I would not lend money to any country in the world at the current rates at the moment.

    It’s ridiculous when Aussie bonds are thought to be attractive with a yield of circa 3%.

    Yep that’s going to end well. No way we can grow at circa low 3% 2013 and high circa 3% 2014. Just not going to happen.

    Oh and I am certain they will not raise the predicted revenue from the mining tax.( Much lower Iron and coal prices will happen than are in treasurer’s numbers) But shhhhh it’s a secret.

    The Maths don’t work, and we will have another deficit and add some more to our debt.

    The solution is easy. We just need to move the retirement age out a few years. I am not smart enough to calculate that but at a guess it would be 70-75 years of age.

    Yes easy to do but a vote loser so it won’t happen……I find that incredibly sad

    • I have been reading of the unrest in some European countries caused by the impact of austerity measures undertaken by governments in the Eurozone. These are not easy situations for those countries, and there doesn’t appear to be any easy solutions either. I feel lucky to be living in Australia, as we have coped very well with the global economic conditions, with low unemployment, banks that are well capitalised, and relatively low government debt levels. Ash is right though, the mining tax may not raise as much as predicted.

  3. The Japanese Government has some valuable assets it could sell, starting with the Post Office. What is that worth? Foreigners might be happy to invest in that, rather than in Government Yen bonds.

    • The Japanese Govenment does indeed hold some major assets Japan post by some metrics is one of the largest banks in the world, Japan tabacco is a massive company with a 50% Gov shareholding. The consumption tax is low at 5% so there is more room to mover there. Inheritance tax revenue will also rise as the population ages.
      Debt to GDP alone can be simplistic perhaps this is the reason the Yen hasnt crashed yet?
      Unlike Greece being a monetary sovereign nation there are some more tools at its disposal.
      Its still a basket case though.

      • Don’t forget the impact on GDP the lack of power generation and electricity rations that Tokyo will experience over summer. Going off nuclear energy is going to be very costly in lost productivity and higher power bills for Japan as they purchase more coal and gas from Australia.

  4. like in all west, keynesians are in charge for at least last 50 years.

    The numbers don’t lie they all headed for default.

    pension age will get increased to 70, 75, 80,.. pick any number higher than 65.

    other care will be reduced or diluted.

    and they will print money.

    if banksters lose power to politicians then you going to get my experience of a piece of paper with 500 000 000 ( 1/2 billion ) on it, and you can buy one egg with it.

    and for me if this going to last as long as in japan… and because people in charge are using same medication i do not believe it is going to be different result…

    inflation or deflation banksters win.

    for me island people chose correct option.

  5. With so much instability in the markets most of the countries
    have serious long term problems – Japan has been a basket case for a decade and are the rest of us going to follow ? is this our near term future. I hear and read comments – what a great buying opportunity with the share market down – well No what we need is stable markets where real people are only just surviving on fixed term deposits and pensions.We don’t need this rubbish. I am so disappointed with my Local -State and Fed. Govt’s. that I intend to protest by not voting again ever However my goal will be to give them all hell wherever possible – never have I seen all levels of Govt. so out of touch with the people. Well what about the opposition I hear you say – well what about them ?? More fools
    Europe is in trouble – But keep your eye on China, a concern “”

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