Dangers of unbridled debt - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 24 June 2015
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- By Bill Bonner

Bill Bonner
Paris, France

Dear Diary,

Neither stocks nor gold moved much yesterday.

"Wait and see," is the order of the day. The Greeks, for example, were given 48 hours to come to terms with their creditors. We wait to see what will happen.

We wait to see what happens in the bond market too. Have bonds topped out? Hard to say. For 6 years the Fed and other major central banks have made a bad situation worse. They've added trillions in debt to a debt-drenched economy. Until very recently, the price of debt has gone up. Surely, that is going to reverse. But it wouldn't be surprising if the whole shebang blew up first. Stocks crashing, the economy sinking into deep recession -- government bonds could spike up, not down, as people rushed to protect their money by giving to the feds. After all, who's more likely to pay back a debt than a counterfeiter?

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And what could bring on such a financial crisis? Rising yields! If there is one thing a debt-saturated economy cannot stand it is the cold draft of higher interest rates. It can't afford them. At 1%, it will begin to sniffle. At 2%, it will develop a cough. At 3%, it will begin running a fever. And at 4%, it will get the shakes and shivers.

Then, with candles lit and the family coming to say good-bye, investors will rush to government debt for safety - until the bonds crash too.

While we're waiting, let's check on our Trade of the Decade. You'll recall, back in 2010, we had to come up with a new trade. Our 'Buy Gold/Sell Stocks' trade of the previous decade did very well (gold was the best performing investment of the 2000-2010 period) but it was time to move on. Gold was no longer cheap. And stocks were moving up.

We looked around. What was cheap? What was expensive? And there, hiding in the corner, was the poor, forlorn and neglected Japanese stock market. After a bear market 20 years long it was still trading below 10,000, down from 39,000 in 1989. We knew nothing about Japan nor anything about Japanese stocks. But they looked like they needed a friend. And since we are always kind to the underdog, the diehard, and the lost cause, we decided it was time to give the Nikkei a friendly pat on the head. "Buy Japanese stocks," we said.

What to put on the other side? What bothered us was the yen. What if we were right about Japanese stocks, but the yen went down? Besides, in the race to destroy their currency and their economy, the Japanese were far in the lead. They had already run up government debt of more than 200% of GDP. And with the population getting older, and China becoming more and more competitive, it was hard to see how Japan's debt problem could be resolved happily. More than likely, the Japanese would be forced to print money to cover their deficits, which would raise Japanese debt levels even higher and eventually drive investors out of bonds. Where would they go? Into stocks!

So, we killed two birds with one stone. Not that we have anything against birds. We don't have anything against Democrats and Republicans either. Still, if you have a stone in your hand it's a pity not to put it to good purpose.

We're now half way into the decade. How's it working out?

A headline in yesterday's news:

"Japanese stocks highest since 2000."

Turns out, the Nikkei index has doubled, from under 10,000 in 2010 to over 20,000 today. A 100% profit.

But how about the other side of the trade? How 'bout dem bonds?

According to our reading of the chart, it looks like the Japanese 10-year JGB has been hit hard by the Abe's government. Shinzo Abe came into Japan's top office promising to get the economy up off the floor. This he would do, he claimed, with 'three arrows.' The first was monetary policy (essentially, devaluing the yen). The second was fiscal policy (digging an even deeper debt hole for the government). And the third? "Structural reforms," which could be any damned thing they could think of.

We could have given Abe a much better program: balance the budget, make the yen convertible to gold, and repeal all legislation that affects the economy. The place would have boomed. But nobody called us.

Instead, Abe went ahead with his own goofy program. The economy slumped - down 7.1% in the 2nd quarter of 2014, down another 1.9% in the 3rd quarter, and down still another 6.7% in the first quarter of 2015.

Good work, Abe!

Japan's debt is a losing proposition - at least in dollar terms. If we read the chart correctly (which we never take for granted) JGBs have lost about 2/3rds their value in the last 5 years - in dollars.

So far, so good. Both sides of the trade working well. Five years left to go.

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

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