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Additional thoughts on Japan and US interest rates
I was on CNBC a few days ago discussing the Japan debt situation, here are my talking points and some additional thoughts a lot of them I did not have a chance to cover in the previous note or the interview.
- Over 90% of Japanese debt is financed internally.
- Japanese debt-to-GDP is 170%, probably even higher than that after you factor in $200 billion plus in stimulus, second only to Zimbabwe .
- Japan has the oldest population in the developed world. Its savings rate has been on the decline since the early 1990s. At its height it was in the mid-teens, now it’s in the low single digits. As people get older they make less money and have higher medical expenses, thus they save less. Also, Japanese are xenophobic – no immigration; population is shrinking.
- At the same time, as the consumer savings rate declines, there is less demand for government debt.
- It is really an issue of supply and demand: to attract investors Japan will have to raise interest rates.
Why does it matter?
- Japan is the second largest foreign holder of US debt (holdings as of July: China $800b, Japan $720b, and the UK a distant third at $200 billion. (However, a year ago Japan was the largest holder of US debt). Japan is an export-based economy. As exports collapse, it has fewer sales in US dollars and less money to park in US dollars. This issue will get resolved if the global economy starts growing again, but the next issue won’t.
- Higher Japanese rates will have significant consequences: they will attract capital away from US debt, and the US will have to raise rates to be competitive. The US Treasury will not be competing against 0.5% interest rates anymore.
- It will put the end to the giant carry trade – Japanese corporations will have little incentive to park their money in the US dollar, as their borrowing costs in Japan will exceed or equal the interest rate they are getting in US dollars.
- Higher interest rates will puncture a huge hole in the Japanese fiscal budget. A 1% increase in rates will cost Japan $60 billion (it has about $6 trillion of debt, is my guesstimate), about 4% of the Japanese budget.
If the US consumer stays a net saver, this would offset these trends at least partially, but before consumers start buying government debt they have to chew through a huge pile of higher-interest consumer debt (credit cards, home equity, car loans etc.).
How much, How long?
- How much will Japanese rates rise? I don’t know; it will depend in large part of what the new Japanese government does about their deficits.
- How long? This is likely to be a drawn-out process. The Japanese consumer savings rate has been in decline for a long, long time. Also, a large portion of Japanese government debt has long-term maturities.
After I wrote the above points, a reader forwarded the following note from Dennis Gartman, which somehow leaves me feeling this whole discussion about China, Japan, and our debt becomes meaningless (sorry for wasting your time):
And the #1 holders of US treasury securities, more than 6 x’s as large as are China’s holdings, and more than the total of the Brazil, the Caribbean banking centres, OPEC, the UK, US Pension funds, States and local entities, “other investors,” Japan, China and US Mutual funds combined, is none other than the US Federal Reserve Bank system. So, when we become too egregiously concerned about the concentration of Treasury debt held by the Chinese, or the Japanese or the Russians et al, we should remember that it is the Fed who trumps’em all and trumps’em hard. We thought ya’ll’d find this interesting; certainly we did.
Twitter thoughts (follow me on twitter ):
- Excellent paper explaining reasons for the decline of the Japanese savings rate http://bit.ly/1rjgyT
- Microsoft proves again that it has no taste – none. Windows 7 party videos are tasteless. http://bit.ly/thSIw
Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at #0066cc;">Investment Management Associates in Denver, Colo. He is the author of #0066cc;">"Active Value Investing: Making Money in Range-Bound Markets" (Wiley 2007). To receive Vitaliy's future articles my email, #0066cc;">click here.
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.10 -0.011 / -.011 11:30 6-Month 0.000 04/01/2010 0.14
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.15 -0.023 / -.023 11:19 12-Month 0.000 09/23/2010 0.34
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.35 -0.03 / -.031 11:13 2-Year 1.000 09/30/2011 100-07
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.89 0-03½ / -.055 11:26 3-Year 1.375 09/15/2012 100-01+
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1.35 0-06+ / -.070 11:31 5-Year 2.375 09/30/2014 100-23+
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2.22 0-14 / -.093 11:38 7-Year 3.000 09/30/2016 101-01½
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2.83 0-20+ / -.101 11:38 10-Year 3.625 08/15/2019 103-13½
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3.22 0-23½ / -.086 11:38 30-Year 4.500 08/15/2039 109-01½
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3.98 1-09 / -.070 11:38
How about a Wells Fargo 2044 at 9.75%
http://www.investinginbonds.com/corporatebonds/mostactive1.html
No thanks?
How about if we promise to fund the SPY with the proceeds?
why would you provide this info to CNBS? why throw pearls to swine? if i did not see that you where a charterholder, i would have never even thought to give you an ounce of credibility. i would urge you discriminate which info mediums you use in the future. imo, CNBS, no longer has value, and i think it may be a going concern in its current path.
You are both wrong. The Social Security Trust Fund holds 2.5 Trillion of Treasury IOU's They are the largest holder of the debt. Not China, Japan or the Fed.
Katsenelson picked up some bogus numbers from CNBS and Gartman and ran with them - My problem is that they don't even pass the smell test and he should have known better.
Go to page 11 of this report ( http://www.whitehouse.gov/omb/budget/fy2010/assets/borrowing.pdf ) for a breakdown of intra-governmental debt including $2.45T for Social Security - In fact the aggregate of foreign held debt is the single largest component http://www.treas.gov/tic/mfh.txt
let me add that I think doing so would accomplish two things...
1) buy the public (lets face it our population can be bought, emptpromises work, image what this would do)
2) free up the cash to buy treasuries
and something else i cant remember...
sadly i think smething like this will happen, but it will be tied to some level of "loyalty" program...as in loyal to a party, never question the gov, service (organizing), etc, etc garbage...
convert tarp payments to "wipe the slate clean" of at least all us credit card debt, print what is needed to do so...then they can push us to become savers and buy us debt....
if accounting tricks work for some, they should work for us all....
Thank, this helps.
Japan and China are exponentially more difficult than here. Mostly cultural and political. Japan and to a lesser extent, China, the demographics of the two countries are doomed.
Given the new gov't there in Japan, I'd say more of the same with a few more lamps added to the room giving no more light just the appearance of wattage.
China, with all its SOE it is truly a morass with politcal/geographic nightmare to preoccupy them for a long time. So more of the same just the appearance of getting filled up- like a Chinese dinner, you are hungry in 1 hour.
The Fed has an enormous problem politcal now and monetary soon as there is any pressure leaning towards an audit. This is like a silver bullet to Dracula. They cannot raise rates here, what, for a year. They cannot not address the QE without a mop. They cannot forget that last time this happened, when you raise taxes and global trade crawls, you have a depression.
Thanks for the ideas and numbers.
Wouldn't this have long-term negative impacts on the yen?
I think you would do your readers a great service by, instead of quoting Dennis (CNBC shill) Gartman, providing some insight into the mechanics of the debt.
Just as an example the Federal Reserve holds as of June 30, 2009 $656.5 billion (5.5%) of federal debt(1) while China holds a mere (sarcasm) $800 billion and Japan $724 billion(2).
At the end of September total debt stands at $11.8T of which debt held by the public (including the Fed, foreign and domestic interests) totals $7.5T (63.5% with about half foreign held) and that held by Intra-governmental entities (primarily trusts for entitlement programs) totals $4.3T.
Some insights into the intricacies of debt to GDP and the overall fiat circle (jerk) of debt would be a great topic for someone here to elaborate on.
(1) http://research.stlouisfed.org/fred2/data/FDHBFRBN.txt
(2) http://www.treas.gov/tic/mfh.txt
see also
http://www.treasurydirect.gov/govt/reports/pd/mspd/2009/opds082009.pdf
+10
Agreed. Interest rates will rise only when/if the Fed decides to stop monetizing the debt.
A related question I've been pondering for sometime is how long the Fed will be able to continue this game of suppressing rates. I thought I'd share some interesting excerpts from Mises' "The Causes of the Economic Crisis". When reading this, remember that 'the banks' he refers to correlate to the Fed today, as the Fed has a monopoly on interest rates.
"The crisis breaks out only when the banks alter their conduct to the extent that they discontinue issuing any more new fiduciary media and stop undercutting the "natural interest rate." When they do this, and why they do this, is still to be examined. Forst of all, however, we must ask ourselves whether it is possible for the banks to stay on the course upon which they have embarked, permitting new quantities of fiducuary media into circulation continuously..."
"They cannot do this... ...It is precisely because, and only because, no end to the prolonged flood of expanding fiduciary media is forseen, that this leads to still sharper price increases and finally, to a panic in which prices and the loan rate move erratically upward."
"Sooner or later, the crisis must inevitably break out as the result of a change in the conduct of the banks. The later the crack-up comes, the longer the period in which the calculation of the entrepreneurs is misguided by the issue of additional fiduciary media. The greater this additional quantity of fiduciary money, the more factors of production have been firmly committed in the form of investments which appeared profitable only because of the artificially reduced interest rate and which prove to be unprofitable now that the interest rate has again been raised. Great losses are sustained as a result of misdirected capital investments."
My takeaway: If the Fed really does stop the treasury purchases and MBS purchases over the next several months as they say, our economy will be thrown into the necessary but painful debt deflation spiral required to heal our economy for the longer term. If the Fed instead chooses to continue monetizing debt, we travel further down the dangerous road of 1923 Germany and the death of the dollar.
What the quote from DG does not elucidate is that the
$4.3 T Intragovernmental agency debts held by the
Treasury and curiously counted as assets were spent on the budget and are unfunded to the tune of $100 T with no
collateral; therefore practically worthless except for
taxing power crowded out by rollovers of mostly
short-term debt and compounding interest on the
debt, currently fourth largest budget item. In other
words, the largest Ponzi scheme in the history of the
world, with an all too predictable outcome...
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