Sunday, November 1, 2009

Japanese Demand for U.S. Debt Is Bound to Weaken Dramatically

By way of the always dramatic and usually accurate Ambrose Evans comes this piece that ties in with my view that markets are not recognizing the severity of the Japanese situation and how this will impact future purchases of U.S. Treasury securities.

It is Japan we should be worrying about, not America

Japan is drifting helplessly towards a dramatic fiscal crisis. For 20 years the world's second-largest economy has been able to borrow cheaply from a captive bond market, feeding its addiction to Keynesian deficit spending – and allowing it to push public debt beyond the point of no return. 

The rocketing cost of insuring against the bankruptcy of the Japanese state is telling us that the model has smashed into the buffers. Credit default swaps (CDS) on five-year Japanese debt have risen from 35 to 63 basis points since early September. Japan has suddenly decoupled from Germany (21), France (22), the US (22), and even Britain (47). 
Implications: The Japanese carry trade is likely to continue losing favor, leading to a strengthening impact on the Yen and weakness for the Dollar.


Secondly, the rapidly deteriorating situation makes it increasingly a fait accompli that the Japanese will not be able to continue their Treasury purchases at a time the U.S. desperately needs their support in the wake of the Fed's completion of their $330 billion purchase program.
Simon Johnson, former chief economist of the International Monetary Fund (IMF), told the US Congress last week that the debt path was out of control and raised "a real risk that Japan could end up in a major default".
The IMF expects Japan's gross public debt to reach 218pc of gross domestic product (GDP) this year, 227pc next year, and 246pc by 2014. This has been manageable so far only because Japanese savers have been willing – or coerced – into lending for almost nothing. The yield on 10-year government bonds has been around 1.30pc this year, though they jumped to 1.42pc last week. 
"Can these benign conditions be expected to continue in the face of even-larger increases in public debt? Going forward, the markets capacity to absorb debt is likely to diminish as population ageing reduces saving," said the IMF. 
The savings rate has crashed from 15pc in 1990 to near 2pc today, half America's rate. Japan's $1.5 trillion state pension fund (the world's biggest) has become a net seller of government bonds this year, as it must to meet pay-out obligations. The demographic crunch has hit. The workforce been contracting since 2005.
The pillars of the government debt market are crumbling. If Japan's bond rates rise to global levels of 3pc to 4pc, interest costs will shatter state finances. 
Japan is descending into a debt situation where it is only a matter of when not if.
No one knows exactly when a country tips into a debt compound trap. But Japan must be close, even allowing for the fact that liabilities of the state Loan Programme (FILP) have fallen by 40pc of GDP since 2000. 


"The debt situation is irrecoverable," said Carl Weinberg from High Frequency Economics. "I don't see any orderly way out of this. They will not be able to fund their deficit. There will be a fiscal shutdown, a pension haircut, and bank failures that will rock the world. It is criminally negligent that rating agencies are not blowing the whistle on this." 


"This is incredibly dangerous," said Russell Jones from the RBC Capital Markets. "The rate of deflation is shocking. The debt dynamics are horrible and there is the risk of a downward spiral." 
And some particularly ominous conclusions that portend where we think U.S. strategy is headed:
It wasted its immense fiscal firepower, scattering money for 20 years on half-baked spending projects to keep the economy afloat. QE was too little, too late, and this is the lesson for the West. We must cut borrowing drastically over the next decade, and offset this with ultra-easy monetary policy. Does Downing Street understand this? Does the White House? Does the European Central Bank? Clearly not.

 

No comments:

Post a Comment