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BNP Warns On Japanese Repression: Echoes Of The 1940s Fed

Tyler Durden's picture





 

In the 1940s, the Fed adopted pegging operations to protect the financial system against rising interest rates and to ensure the smooth financing of the war effort. In effect, the Fed became part of the Treasury’s debt management team; as the budget deficit hit 25% of GDP in WW2, it capped 1Y notes at 87.5bps and 30Y bonds at 2.5%. From the massive bond holdings of its domestic banks to its exploding public debt, Japan today faces a situation very similar to the US in the 1940s. With the market becoming dysfunctional as the BoJ’s massive buying operations drain the pool of available bonds, the BoJ’s overriding presence in the market each day has increasingly made the JGB market seem like a government-made market.

But a much bigger problem is Japan’s exploding public debt. With the debt already the largest of the developed nations, it could snowball out of control if an upturn in interest rates causes interest payments to escalate. So, even if 2% inflation is achieved, the BoJ’s zero-rate policy and massive JGB purchases will have to continue until the debt is made more manageable.

When the long-term rate climbs above 2%, the BoJ will probably adopt outright measures to underpin JGB prices to prevent turmoil in the financial system and a fiscal crisis - and just as Kyle Bass noted yesterday, they are going to need a bigger boat as direct financial repression in Japan is unavoidable.

Via BNP,

With the market becoming dysfunctional as the BoJ’s massive buying operations drain the pool of available bonds, the BoJ’s overriding presence in the market each day has increasingly made the JGB market seem like a government-made market. Those well versed in history may recall that the Fed’s policies in the 1940s to stabilise prices and yields on US government securities – the so-called pegging operations – also resulted in a government-made market. The Fed at the time was deeply entangled in the government’s debt management, so, despite the upturn in inflation, it had to keep long-term rates very low and continue to buy massive amounts of government securities as part of financial repression.

 

The Fed started down the road towards pegging operations when it intervened in the bond market in the spring of 1935 to prevent rising interest rates from degrading the capital of US banks (more than 50% of assets had to be “safe” government securities) and thereby destabilising the financial system. With the start of WWII, the Fed’s government bond buying morphed into outright support of bond prices (pegging operations), as the shift to a wartime footing necessitated low-cost financing of the war effort. Even when inflation picked up, the policies supporting government bond prices were not allowed to end, causing the Fed to come into repeated conflict with the Treasury Department over policy independence.

 

 

Ultimately, the Fed’s bond price-supporting policies enabled banks to reduce their long-term bond holdings substantially, reducing the impact of rising interest rates on the financial system. And after roughly 10 years, the Fed was finally freed from the constraints of this support programme because (a) banks came to favour ending the programme, as they were now in a position to enjoy the merits of widening margins of a steepening yield curve, (b) the US economy and fiscal conditions returned to normal, as public debt was significantly reduced thanks to improved tax receipts from the expanding economy and the “inflation tax” and (c) subsiding concerns about higher interest rates threatening the financial system and state finances allowed inflation to be perceived as the main problem for the economy and society. While the pegging operations may have been inevitable owing to special factors like WWII, the result was the sacrifice of price stability and the destabilisation of the US economy.

 

 

Japan’s situation today, from the massive bond holdings of its domestic financial institutions to its exploding public debt, has many similarities to the US of the 1940s. Of course, BoJ Governor Haruhiko Kuroda is adamant that the BoJ’s quantitative and qualitative monetary easing is meant only to defeat deflation and should not be construed as bankrolling the government’s spending. At this juncture, there is no clear line separating JGB buying to fight deflation from JGB buying to underpin debt management. But we think that once 2% inflation is attained and the BoJ finds itself prevented from seeking a way out, it will be clear that the BoJ has, indeed, embarked on monetisation.

 

The BoJ will first be confronted with concerns about financial system stability. If we assume that the equilibrium real interest rate is 1%, the realisation of 2% inflation will necessitate raising the long-term rate above 3%. But a long-term rate of just 3% could put financial institutions for small businesses, with their huge JGB holdings, at increased risk of insolvency, something that could induce turmoil in the financial system. At 4%, even regional banks could be in trouble. So, even after 2% inflation is achieved, concerns about damage to the financial system could force the BoJ to maintain its zero-rate policy and massive JGB buying.

 

In the US in the 1940s, with the Fed’s aggressive purchases, financial institutions greatly reduced the durations of their bond portfolios and were more resilient to rising interest rates.

 

 

The actions by the BoJ may work the same magic here. According to our estimates, if the BoJ continues to buy long-term JGBs at the current pace, at the end of 2014, it will hold roughly 40% of the entire 2- to 10-year market – the core assets of regional banks – compared with just 10% at the end of March 2013. Banks’ portfolio durations will be significantly reduced, making them more resilient to rising interest rates. This should alleviate fears of a financial crisis somewhat.

 

 

But a much bigger problem is Japan’s exploding public debt. With the debt already the largest of the developed nations, it could snowball out of control if an upturn in interest rates causes interest payments to escalate. So, even if 2% inflation is achieved, the BoJ’s zero-rate policy and massive JGB purchases will have to continue until the debt is made more manageable. This means that the BoJ’s balance sheet won’t be determined by price stability. As Thomas Sargent and Neil Wallace noted in Some Unpleasant Monetarist Arithmetic (Federal Reserve Bank of Minneapolis, Quarterly Review, autumn 1981), the BoJ will face being fiscally dominant.

 

Currently, with volatility continuing in the JGB market, if the upturn in the long-term rate persists, the BoJ will probably have to enlarge the scale of its annual purchases at a later stage. Then, when the long-term rate climbs above 2%, the BoJ is likely to adopt outright measures to underpin JGB prices so as to stave off turmoil in the financial system and a fiscal crisis. For example, like the Fed in the 1940s, the BoJ may fix the 3m and 1y rates, thereby effectively setting ceilings on the 5y and 10y rates. While this could ensure financial institutions earn carry, this would be nothing other than the start of financial repression.

 

The US was able to liquidate the massive debts built up from the Great Depression and wars thanks to robust post-war growth, coupled with the negative real interest rate engendered by financial repression. Today, however, as we cannot expect economic growth to be as robust as it was then, we may have no choice but to adopt financial repression, so that our public debts can be liquidated via an inflation tax on depositors. Considering Japan’s huge public debt, it seems inevitable that even after the inflation target is achieved, the zero-rate policy and massive JGB purchases will have to continue for a long time as part of financial repression.

 


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Fri, 05/24/2013 - 12:14 | Link to Comment The Thunder Child
The Thunder Child's picture

OT

World Wide March Against Monsanto

TOMORROW 2pm Everywhere

Get out and let your voices be heard, help to stop GMO and the takeover of our food supply!

Monsanto can be stopped, the first victores have all ready been won

http://www.politicolnews.com/hungary-burns-all-monsanto-gmo-corn-fields/

Fri, 05/24/2013 - 12:38 | Link to Comment Kiss My Iceland...
Kiss My Icelandic Ass's picture

 

 

'Bout time. Damn.

Fri, 05/24/2013 - 12:47 | Link to Comment q99x2
q99x2's picture

Can we Protest against Eric Holder the Terrorist at the same time?

Fri, 05/24/2013 - 12:52 | Link to Comment The Thunder Child
The Thunder Child's picture

There will be many battles, I hope Eric get's his sooner then later. As a Canadian my solidarity and support is with the american people that are awake, not the US government.

Fri, 05/24/2013 - 15:57 | Link to Comment Cole Younger
Cole Younger's picture

The U.S. government and federal reserve are the terrorists...They allow this crap to occur..100% the governments fault...

The politicians and government is the only enemy of freedom...financial or otherwise....

Fri, 05/24/2013 - 17:03 | Link to Comment falak pema
falak pema's picture

so elect another bunch thats honest; its easy the US is a democracy.

Fri, 05/24/2013 - 12:16 | Link to Comment Stuart
Stuart's picture

The Japanese better start buying real gold and fast.

Fri, 05/24/2013 - 13:09 | Link to Comment bank guy in Brussels
bank guy in Brussels's picture

The Japanese are much more a 'community' than in the Western developed nations

For the last 23 years since the crash, the government has kept them in jobs and did not abandon them

They will go along with the financial repression for the 'common good'

---

Funny in the above quote from BNP (Banque National de Paris):

« ... this would be nothing other than the start of financial repression ... »

The 'start' ? Ha !

Financial repression has been going on now for a looong time ... just about everywhere

As Ambrose Evans-Pritchard said in a day online fielding live questions, this precisely will continue to be the 'solution' today's financial crises ... He said something like, « Financial repression and inflation, works like a charm, always has ... »

Fri, 05/24/2013 - 12:16 | Link to Comment Volaille de Bresse
Volaille de Bresse's picture

BANZAI! 1945 style!

 

Except this one the Jap kamikazes attack their own country! Nippon ichiban!

Fri, 05/24/2013 - 12:36 | Link to Comment knukles
knukles's picture

Lemme update this for y'all...

"In the 2010's, the Fed adopted pegging operations to protect the financial system against rising interest rates and to ensure the smooth financing of the Endless War on Terror effort. In effect, the Fed became part of the Treasury’s debt management team..."

Honey, didn't we see this one before?

Fri, 05/24/2013 - 12:54 | Link to Comment disabledvet
disabledvet's picture

i don't recall the war effort back then being the exclusive purview of the financial establishment and various "trading strategies." back then policy makers actually cared about jobs, working class people, the economy, the voter, benefits, being something other than totally useless. no wonder only 20% of the people even vote. anywho obviously Japan is a mess and the policy going forward obviously cannot be changed that does not mean "policy success." as with Cyprus obviously the ZH'ers are empathetic...but this place doesn't suffer fools either no matter what their nationality. http://www.youtube.com/watch?v=Bz61YQWZuYU

Fri, 05/24/2013 - 12:18 | Link to Comment EscapeKey
EscapeKey's picture

Anybody know what this is about?

 

 

Latest News

  1. 12:15p

    BREAKING

     

    Barrick Gold, Silver Wheaton shares halted

 

Fri, 05/24/2013 - 12:31 | Link to Comment maskone909
maskone909's picture

War is a-brewin

Fri, 05/24/2013 - 12:34 | Link to Comment Bastiat
Bastiat's picture

Let me guess:  ABX gobbles up SLW?  Also there is an issue with ABX begin unable to deliver silver sold forward to SLW due to a large mine being impaired.  Probably something to do with the latter.

Fri, 05/24/2013 - 12:38 | Link to Comment Ham-bone
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Chile Halts Pascua Lima mine....hitting wires now.

Chile halts Barrick Gold's Pascua mine: reports

 

Fri, 05/24/2013 - 12:39 | Link to Comment EscapeKey
EscapeKey's picture

http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/chile-blocks-pascua-lama-mine-fines-barrick-for-environmental-violations/article12129034/

Chile’s environmental regulator has stopped construction and imposed sanctions on Barrick Gold Corp.’s $8.5-billion Pascua-Lama project, citing “serious violations” of its environmental permit.

The $16-million fine is the maximum allowable under Chilean law. It was applied Friday because the world’s largest gold mining company acknowledged that it failed to keep its promises to build systems for containing contaminated water.

Fri, 05/24/2013 - 12:48 | Link to Comment Dr. Engali
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This is why the miners underperform.

Fri, 05/24/2013 - 12:41 | Link to Comment oddjob
oddjob's picture

SLW is basically a Goldcorp entity, not sure if they would allow Barrick to buy it.

Fri, 05/24/2013 - 12:25 | Link to Comment Kreditanstalt
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Unless of course everyone except the banks and the BOJ decide they want no part of "financial repression" and flee either to overseas assets or to gold...

What would be the "market value" of a paper asset the stock of which is held by only banks?

 

Fri, 05/24/2013 - 12:28 | Link to Comment Ham-bone
Ham-bone's picture

they will close the doors and weld them shut...using capitol controls, tax repression, and depreciation / manipulation.  Those in control will not give up willingly...ever.

Fri, 05/24/2013 - 12:25 | Link to Comment Ham-bone
Ham-bone's picture

that which we call a "peg" by any other name is still a bitter default...little people's of Japan, they are coming for you.

Fri, 05/24/2013 - 12:26 | Link to Comment Element
Element's picture
Oh dear ...  
Tremors felt in Moscow as 8.2 quake rattles Russia's Sakhalin region

http://rt.com/news/quake-asia-tsunami-warning-729/

Fri, 05/24/2013 - 12:38 | Link to Comment knukles
knukles's picture

HAARP

Fri, 05/24/2013 - 13:24 | Link to Comment Non Passaran
Non Passaran's picture

Sure, 620km below the surface

Fri, 05/24/2013 - 19:43 | Link to Comment Element
Element's picture

gah! thanks NP, that salient bit of info was not in the initial report I saw ... then went to bed. 

That's actually an exceptionally energetic quake for that depth, they're usually much less energetic as you get towards 700 kms depth ... no wonder it was felt over a wide area, refraction-focusing effect kicked-in.

Fri, 05/24/2013 - 13:12 | Link to Comment thisandthat
thisandthat's picture

How did they felt a magnitude 1 tremor in Moscow? Should be imperceptible.

Fri, 05/24/2013 - 13:24 | Link to Comment Non Passaran
Non Passaran's picture

TFA says 8.2.
What's your point again?

Fri, 05/24/2013 - 13:46 | Link to Comment thisandthat
thisandthat's picture

 

How did they felt a magnitude 1 tremor in Moscow?

Say again?

ps: btw, it's no pasarán; "non passaran" doesn't exist in any language.

Fri, 05/24/2013 - 13:21 | Link to Comment Non Passaran
Non Passaran's picture

Dodgy garbage article.

Fri, 05/24/2013 - 12:33 | Link to Comment madbraz
madbraz's picture

Yawn.  From a 5 year perspective, japanese yields are significantly lower than were they were in years past.

 

Kyle Bass is a loser.

 

 

Fri, 05/24/2013 - 12:43 | Link to Comment i_call_you_my_base
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How big is the fund you run? How did you fare across 2006,7,8 compared to Bass?

Fri, 05/24/2013 - 12:43 | Link to Comment Tsunami Wave
Tsunami Wave's picture

Your trolling is pathetic. Yawn.

Also, when those swaps rates move, Japan will be toast before they realize it. It's actually very predictable.

Yawn indeed.

Fri, 05/24/2013 - 13:14 | Link to Comment madbraz
madbraz's picture

Japan is toast already, they have been for the last 25 years.  

 

Yes, institutional buyers in Japan will sell their JGBs and buy something else, stocks maybe, because they have never had that option before in the last 20+ years and they haven't figured this out yet.   It's net negative.

 

The bonds are paper, they are money - that's it, nothing else.  Doesn't mean it's good, doesn't mean it's bad, it's the only currency that will be available tomorrow to pay bills, insurance claims, withdrawals.  As there is no growth, all else falls in value at a higher rate as they don't own the printing press.

 

Japan has found out that growth is not the sustainable state of the economic environments we have built.  Stagnation is.  Interest rates have nowhere to go in this environment and it has nothing to do with QE or any other gimmick that makes a player go out and buy stuff because the central bank "told" him to do so.

 

In the minds of the japanese holders of JGBs, they have defaulted already.  Think of this, grasp it.  It has nothing to do with yields going up.   Everything else is a distration, a political game.

 

Fri, 05/24/2013 - 13:30 | Link to Comment Tsunami Wave
Tsunami Wave's picture

So... youre basically saying that Japan's endgame
Is inevitably default? So do you think then that Abe's 2pc inflation rate target, his increasing QE purchases, and very slight reduction of the government paying for social security and other services will miraculously create the growth Japan needs to grow out of its 200+ pc debt/GDP????? So uhhhh when Japan decides to print over a quadrillion ¥ more to pay alone for its slowly but-eventually-catching-up interest on its debt which counts for 1/3rd of its tax receipts, all will be rainbows and unicorns???? Nope.. You're wrong.

Fri, 05/24/2013 - 13:39 | Link to Comment madbraz
madbraz's picture

OK then, continue with your fantasy.

 

This is all central bank speak.   Japan does not need to "grow" out of it's 200% debt/GDP.  The only thing that concerns Japan is remaining a viable competitor in the global trade market.  That's it.

 

They could owe 1000% debt/GDP to their own people, it wouldn't make a difference.  Sure as hell would suck if you are japanese, but other than that printing more or defaulting is just semantics for the issuer.

 

 

 

Fri, 05/24/2013 - 13:58 | Link to Comment Tsunami Wave
Tsunami Wave's picture

Paul Krugman, is that you? Did you know that if you owe 10%, or 10,000,000,000,000% debt/GDP, you still need to pay the money you owe back? Eventually, the bond market, global trade, companies moving in and out of your country and even your own corrupt political system will all call out your charades and want nothing to do with you? Go ahead, live in your weirdo fantasy land. You're an obvious troll.

Fri, 05/24/2013 - 14:11 | Link to Comment madbraz
madbraz's picture

Ouch, anger management.

Fri, 05/24/2013 - 13:28 | Link to Comment maskone909
maskone909's picture

"in the minds of the japanese holders of jgb's"

so what you are a mind reader now?

this is some of the most subjective malinformed crap i have ever read in the comment section.

Fri, 05/24/2013 - 13:52 | Link to Comment madbraz
madbraz's picture

Well then, if you are Japanese, why do you keep buying the bond?  Someone has to buy it and someone always does, right?  Enlighten me, wise one.

 

Look at 20 year charts of the japanese yield curve and you'll see - this cannot be discussed while the 10yr JGB is at 0.83% and five years ago it was a full 1% higher than that.

Fri, 05/24/2013 - 12:42 | Link to Comment Dr. Engali
Dr. Engali's picture

25 years later and they are still going through this misery. They could have defaulted long ago and been past this mess. 

Fri, 05/24/2013 - 13:33 | Link to Comment Tsunami Wave
Tsunami Wave's picture

Yeah.. You would think so. They survived much worse... They're very resilient. But I don't know. Maybe no one wants to be the prime minister to take the nation through its pain period.

Fri, 05/24/2013 - 12:52 | Link to Comment NipponMarketBlog
Fri, 05/24/2013 - 13:09 | Link to Comment Atomizer
Atomizer's picture

Let’s just create a new SIV Portfolio deemed as ‘ Economic Sustainably & Cooperative Rehabilitation Programme.’ [ESCRP]

Blend in high doses of Sushi Bonds laced with our special mouth watering geisha ingredients that might add some spark in achieving your prosperity goal.. Mmm, mmm, mmm.

Fri, 05/24/2013 - 14:57 | Link to Comment moneybots
moneybots's picture

"While the pegging operations may have been inevitable owing to special factors like WWII, the result was the sacrifice of price stability and the destabilisation of the US economy." 

Financial fraud always does cause damage.

Fri, 05/24/2013 - 16:17 | Link to Comment besnook
besnook's picture

look, the math doesn't work. the only way the math works is a quadrillion yen coin literally or a .gov issued currency(like a greenback) or what japan has now. as long as they keep the debt internal the yen is a quasi greenback in the form of a model that can be perpetuated into infinity as long as japan owns the debt. japan can write all the iou's it wants as long as it owes it to themselves. yes, it will have an effect on the preceived value of the yen externally to the benefit of japan and it might cause some inflation, specifically in energy and imported food and crap but the average japanese person has a good chance of benefitting from increased trade, mo' money. if .gov can convince the locals to let tepco turn the atom splitters back on the petro trade will give way to a positive current accounts balance and all will be right in japan.

 

the usa and europe are in much worse shape because of all the external counter party risk.

Fri, 05/24/2013 - 19:09 | Link to Comment bentaxle
bentaxle's picture

So Abe is going to create stagnation and take Japanese standards of living backwards to match say Chinese levels so they can compete. QE should, of course, create inflation and to some extent it does but, like it or not, people are not willing to rebel against fiat and the inflation created is awkward rather than unbearable.

We might want debt default and bankers crushed. But they don't. Seems to me the Central Banks are in control whatever ZH likes to think.

Fri, 05/24/2013 - 22:48 | Link to Comment RMolineaux
RMolineaux's picture

This item opens up a line of inquiry that deserves more attention. 

The period of the late 40's and 50's in the US was one of very low interest rates and rapid economic expansion at the same time.

There was some inflation, and eventually the Fed took control of interest rates (on behalf of creditors) in the Treasury/Fed accord towards the end of that era.  But now we are again in a very low interest rate period but there is little inflation.  Could it be that using interest rates to "control" inflation is merely a pretext, allowing the Fed to act on behalf of creditors? Think about it.

Inflation really took off in the US in the 60's when Lyndon Johnson pursued his guns and butter policies during the Viet Nam war. Trade unions were also much stronger then, and the pace-setter automobile settlements increased wages faster than productivity.

It continued into the seventies when Paul Volcker, as Fed Chairman, inposed draconian money supply limits and interest rates soared.  Interest rates subsided after a short period, but did not return to post-war levels until 2009.

At a time when disparity of incomes are at shameful peaks, perhaps we need to look more closely at the contribution of interest rates to this phenomenon. 

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