Those Japanese bonds are worthless

Jan 7, 2011

Baltimore, Maryland

Not much action in the markets.

So, how's our 'trade of the decade' doing?

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We haven't checked. But we think we're onto something. Remember the trade? Buy Japanese small cap stocks and sell Japanese government bonds. it's not that easy to do. It's just an idea...a concept... It's meant to get us thinking about how things work.

In the present case, the Japanese have the biggest public debt in the world - at 200% of GDP. Already, they're using almost 60% of their tax revenues just to pay the interest on the debt. How do they pay government expenses? They borrow more money!

This is not a healthy situation for the holders of Japanese Government Bonds (JGBs). They've got to expect that sometime in the next ten years the government is going to run out of money...or investors will run out of confidence...and interest rates will rise. When they do, bond prices will fall...probably collapse...and JGB holders will lose beaucoup yen.

There is no way that this crazy system of government finance can continue. The only reason it has come this far is that Japanese savers have no idea of what is going on. They've been saving for their retirements. And now, they are retiring in record numbers. Japan went over the demographic hump in 2002. Now, its population is falling. And there are more people retiring than there are entering the workforce. These retirees don't realize that the government has taken their retirement savings and spent the money. They think it is waiting for them, ready to finance their golden years.

They're in for a shock. And so are investors, when they finally realize that those JGBs are worthless.

Here's Bloomberg with more on the story:

"Japan's top government spokesman said the country's fiscal situation is "approaching the edge of a cliff," underscoring Prime Minister Naoto Kan's call for a national debate on raising the 5 percent sales tax.

Kan is "expressing his deep sense of crisis and resolution about the sustainability of social security as the aging population increases under a low birth rate," Chief Cabinet Secretary Yoshito Sengoku told reporters today in Tokyo. "The supporting fiscal conditions don't allow for any delays, it's finally approaching the edge of a cliff."

The prime minister last night said in an interview with TV Asahi that he would "stake my political life" on addressing Japan's rising social welfare costs and increasing public debt. The day before he said "now is the time" to face these problems.

Japan's public debt is set to exceed twice the size of the economy this year and reach 210 percent of gross domestic product in 2012, both estimates the highest among countries tracked by the Organization for Economic Cooperation and Development, according to the group's forecasts."

Now, let's imagine that we're right about this. Let's imagine that governments can't really run deficits matter how cooperative the population. They reach a point when the go 'over the cliff,' as Japan is about to do.

If that's so...

...well...where is the US in this story?

Stay tuned...

*** We just saw an estimate telling us that by the end of Obama's term the US will be spending a third of its tax revenues just to service its debt. Not at Japanese levels yet! But getting there. And after Japan bondholders go 'over the cliff' maybe lenders won't be so ready to follow the US over the edge too.

The US ratio of debt to GDP is very much in the range of all the mature economies - between 60% and 80% of GDP; not at Japanese levels either, yet. But wait. In the US, unlike say, France, state and local governments have their own debts, independent of the national government. How deep in the hole are the state and local governments? Truth is, nobody knows. The states report their liabilities in strange ways, often ignoring accounting conventions.

Just reading the paper gives you an idea of the problem. California faces a $19 billion shortfall this year. Jerry Brown is going to take the bus to work. That will save some money. Only $18,999,999,900 left to cut.

New Jersey's public pension system is $100 billion in the hole. New York's system may lack almost twice that much.

Illinois spends twice as much as it gets in taxes.

What's the total damage? We've seen various estimates. The number that sticks with us - probably because it is easy to remember - is $1 trillion. The other calculation that sticks in our mind is this: add state and local debt to national debt and you get a total as large as that of Greece - at about 130% of GDP.

Of course, we're only talking about OFFICIAL debt. Even that is a very squirrelly number. The Obama administration, for example, says its Obamacare program will result in trillions of dollars worth of SAVINGS to the US government. Do you believe that? You do? How about this -- we'll give you 50 cents for every dollar Obamacare saves the nation if you'll give us 25 cents for every dollar it ends up costing the nation. Deal?

There are also the unfunded liabilities and off-balance sheet debt. Those estimates too are all over the place. Professor Laurence Kotlikoff estimates the total US off-budget and on-budget debt at more than $200 trillion. Another calculation, cited by our friend Dylan Grice of Societe Generale, puts total US on-and-off budget debt at just over 500% of GDP. Curiously, comparing the US official and unofficial debt totals to other mature economies shows that the US is most like...


Both totals - official and unofficial - are at about the same level.

Which surprises us. We thought France was in better shape.

Oh well...if we go to the poorhouse together, let's get the French to do the cooking!

*** What about the other side of our 'Trade of the Decade?' We feel pretty good about the sell side -- selling JGBs. We have Japanese feds working for us on that one. It's bound to pay off.

But how about Japanese stocks? Last year the Japanese small cap index went nowhere. Hey, what's wrong with that? Nowhere is fine. Nowhere is good. At least we didn't lose money. And we've got another 9 years to go.

*** Maryland locked down key government buildings yesterday after a couple of employees burned their fingers. No kidding. It was a terrorist attack. Soon, we'll have to be strip-searched before we're allowed in a public library. That's a Prediction-Plus too. It may not turn out that way, but you're probably better off believing it will:

HANOVER, Md. (AP) - Two packages ignited when they were opened Thursday at state government buildings 20 miles apart, slightly burning the fingers of two employees but not seriously injuring anyone, police said.

One of the two packages that ignited was addressed to Gov. Martin O'Malley and the other to the state transportation department. The State Fire Marshal's office did not find any explosive material in either.

"When both packages were opened there was a reaction that caused a flash of fire, a brief flash of fire, smoke and a smell," state police spokesman Greg Shipley said. "This is not to be compared with a significant explosion that you think of when you say that word."

The employee who burned his fingers there was taken to the hospital, as were three other people who were concerned because they were near the package when it was opened.

Mailrooms at state offices across Maryland were being quarantined until it could be determined if any other packages had been sent.

"It happened quite quietly, actually," Conroy said.
She said employees were allowed back into the building around 3:30 p.m.

The FBI's joint terrorism task force was assisting in the investigation. A U.S. Homeland Security Department official said the department was aware of the incidents and monitoring them.


The World Goes Crazy

"...with all the thought and good intentions that we provided...we achieved absolutely nothing. Nothing that I did and very little that old Ben [Strong, head of the US Federal Reserve] did...produced any good effect...or any effect at all. Except that we collected a lot of money from a lot of poor devils and gave it over to the four winds."

In three sentences, Montagu Norman, ex-chief of the Bank of England, described the handiwork of a whole generation of his fellow financial plumbers. This was the generation that made central bankers what they are today. Before 1914 they were expected to do nothing, that is, neither to aid the economy nor harm it. Since 1945, hardly a day went by that they do not clog a pipe or inadvertently blow up a gas main.

This was the generation of Hjalmar Schacht in Germany and Emile Moreau in France, while the aforementioned Ben Strong represented the US and Norman himself, wearing his velvet cape and traveling under a pseudonym, stood up for England. This was the generation that financed war well and the peace badly. Borrowing heavily from the Americans, the British and the French were able to keep WWI going long after they were effectively bankrupt. Then, rather than write off the bad debt, everyone waited for someone else to pay it. The Americans watched the mail for checks from the British, while the British sent polite reminders to the French, who tried to foreclose on the Germans by invading the Ruhr; this got them no money, but it had the unintended consequence of boosting Adolph Hitler's budding career in politics. The debts were bad; the busted-up Reich couldn't pay anything near the amounts demanded. And the more grease the Germans scraped up and sent west, the more their own economy creaked and weakened; the more they tried to pay the less they were able to pay.

This was the generation that took its currencies off the gold standard in order to run up debts that they couldn't pay...and then went back on the gold standard, as if they meant to repay them...and then off again in order to renege.

And this is the generation that is autopsied in Liaquat Ahamed's book, "Lords of Finance." It is meant to be a book about finance. But the central figures seem scarcely able to add and subtract. The Germans faced a $12 billion reparations bill, equivalent to about $2.4 trillion today. There was no way they could pay. Pretending that the money was forthcoming then was as vain and pernicious as expecting the Irish to make good on their bank debt, or expecting Americans to honor their $200 trillion worth of financial commitments, today.

At least the Frenchman, Moreau, had his priorities right. He ducked meetings and dodged international monetary conferences so that he would be in the country for the opening of hunting season or so he could run for mayor of his home village of St. Leomer, with about 200 residents. Later, he left his post completely, in order to earn more money at the Bank of Paris and the Low Countries.

His German counterpart, Horace Greeley Hjalmar Schacht, should have taken up hunting too. Instead, he took up Hitler. But that was after he was famous for having solved Germany's hyperinflation problem. The mark had fallen to 4.2 trillion to the dollar in November, 1923. The trouble with the mark was obvious. There were too many of them; Schacht's predecessor, von Havenstain, had anticipated quantitative easing by 9 decades. Schacht took over at the Reichsbank and on the 20th of November introduced a new currency, the rentenmark. Von Havenstain dropped dead the same day. At least Mr. Schacht was a smart fellow. Like Norman, he occasionally was afflicted by an honest insight: "The whole modern world is crazy...everybody here is crazy," he said. "And so am I...I am compelled to be crazy."

But the remarkable thing is Ahamed's conclusion. On 502 pages we listen to central bankers and economists quack like ducks. On page 503, the author reveals that he is deaf. He tells us that the world is a better place thanks to them. All the evidence of the previous pages argues against it. None of them increased world output by a single sou or pfennig.

Take Mr. Strong. Would things have gone better if he had not died in 1928, as the author suggests? He imagines that Strong would have intervened more forcefully in 1931, forestalling further bank failures. He seems to have missed the lesson of his own book -- that bad debts should be allowed to die quickly. Besides, in his own telling of the story, it was Ben Strong who was more responsible for the Great Depression than anyone else. He lowered rates in 1927, even though the stock market was already running hot. "One of the most costly errors committed by [the Fed] or any other banking system," Adolph Miller testified before Congress in 1931. The error led to a bubble...which was followed by a bust, which his successors - who again refused to let bad debt die -- turned into a long depression.

Good work, boys.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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1 Responses to "Those Japanese bonds are worthless"

S.R. Jagganmohan

Jan 7, 2011

Painstaking work of an article on history of money and debts up to the preasent times. Terrific in content. And terrifying 500%.

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