Japan

Dylan Grice loves debunking popular delusions. Perhaps that is why he has picked precisely that phrase as the title of his periodic research piece at SocGen. In his latest piece Dylan asks a question so simple and profound that it should immediately force all Keynesians to provide a definitive answer, or else they should all be fired for being nothing else than card-carrying shamans of the world's most destructive religion (and if you thought the Catholic Inquisition was bad, you obviously have never been drawn and quartered by four of Bernanke's most vicious and bloodthirsty printers). Here it is: "For all I know, Keynesians might be even right in thinking policy makers can fiscally jolt economies back to life, allowing them to recover back to their ‘default mode.’ But their assumption is that ‘default mode’ is positive growth. But what if it isn’t? What if the ‘default mode’ is falling output because the population is declining? Japan might just have spent the best part of twenty years trying to fiscally stimulate its way out of a demographic compression. If this is correct, and population decline has blown the hole in Japan’s government balance sheet there’s still plenty of damage in store because the demographic compression isn’t over yet." Zero Hedge has long contended that Economists dwell so high up in their ivory towers of (flawed) theoretical construction, that they always ignore the simplest things that have the most profound systemic impact... such as demographics. Consider the creation of the Social Security Trust Fund, which would have been perfectly solvent in perpetuity... If only people died quietly as they were expected to do so in 1930s, some time in their mid- to late-60s. Now it is insolvent. Keynesianism, as an economic theory itself, is an anachronistic artifact of another time. As such, Dylan's question is arguably the most critical one that Krugman, Koo, and even the Kretins (sic) from the Fed should answer before they propose any additional and infinitely more destructive theories, and conduct any more failed experiments on a world population of roughly 7 billion people.

The "talkers" are talking. I'm listening and trying to guess what it means.

With millions of words already uttered and/or written on the topic of an inevitable convergence between the fates of the US and of Japan, there is a certain fatigue in the Broca area when merely the topic of deflation is uttered, which causes frontal lobe Na/K pumps to immediately downshift to half capacity. Which is why we have decided to present this far more easily digestible presentation of 39 pretty and contrast-colored slides prepared by Bank of America, titled "Is the US Becoming Japan" for all those who are of the visual learner persuasion and happen to still wonder how long before a Shinto shrine is erected in the middle of Las Vegas.

If? And, of course, the reason given for the upcoming intervention, is the good old "speculative" wolfpack. The kneejerk reaction in the Yen is lower, but quite muted. The market seems to be expecting much more from the BOJ than mere ongoing rhetoric. Having seen the disastrous example of the failed SNB intervention, the central bank-vs-everyone else game will be far more interesting this time.

Much has been said about the comparison between Japan and the US on a macro level, as both countries succumb to the deflationary forces of social-wide deleveraging. Yet few have analyzed the transition of the US into Japan from the perspective of corporate credits. Below is BofA's Jeffrey Rosenberg, arguably the firm's best analyst, sharing what he sees as the arguments "for" and "against" the credit markets on America's one way road to Japanification.

My conclusion is that the only possible way for the Nikkei to appreciate (in JPY terms, as quoted) and the Nikkei to depreciate in USD terms is for USDJPY to appreciate. People have been talking a lot recently about the BOJ possibly stepping up in the market to stop the JPY appreciation but it is believed and they have hinted that these levels are not necessarily a concern for them yet. However GDP data disappointed quite a bit, and this could be the boost in terms of public opinion and political capital for intervention. Whether it is by buying calls on Nikkei or buying USDJPY between 85.00 and 85.40 with a stop on a daily close below 83.50, I think this is a great opportunity especially for traders who are already short US/European equities and/or short AUD and emerging currencies. A breakdown of this USDJPY / S&P correlation would be very interesting. USDJPY also trade in line with 10Y US yields traditionally, and they on the other hand keep dropping like a stone. Something has to give here and personally I believe it could well be the JPY. I feel better about this call since everyone I floated the idea to seemed to think I am crazy. Usually contrarian trades have a way to come to fruition when no one thinks they will. I would keep an eye on the 10Y Japan CDS as well for confirmation. To me it looks like Japan is about to make a move in the race to the bottom.

We previously presented a piece by SocGen's Albert Edwards that claimed that there is nothing now but to sit back, relax, and watch as the US becomes another Japan, as asset prices tumble, gripped by the vortex of relentless deflation. Sure enough, the one biggest bear on Treasuries for the past year, Morgan Stanley, is quick to come out with a piece titled: "Are We Turning Japanese, We Don't Think So." Of course, with the 10 Year trading at the tightest level in years, the 2 Year at record tights, and the firm's all out bet on curve steepening an outright disaster, the question of just how much credibility the firm has left with clients is debatable. Below is Jim Caron's brief overview of why Edwards and all those who see a deflationary tide sweeping the US are wrong. Yet, in what seems a first, Morgan Stanley presents two possible trades for those with access to the CMS and swaption market, in the very off case, that deflation does ultimately win.

Inflation continues to ebb away. In Japan core CPI deflation, at -1.5% is the worst on record. While in the US, the corporate sector is seeing its weakest pricing power on record ? even worse than that seen in the deflationary maelstrom during the Asian crisis (see chart below). We have consistently articulated the view that the severity of the current situation will only be appreciated when this current cycle ends in failure ? and that is not too far away. That will be the time that equities will plunge to new lows. And that, not March 2009, will provide the buying opportunity of a generation to hedge against the coming Great Inflation. - Albert Edwards

Whether one believes in inflation or deflation, one thing is certain: in many ways the current US experience finds numerous parallels to what has been happening in Japan for not one but two decades. While major economic, sociological and financial differences do exist, the key issue remains each respective central bank's failed attempts to reflate its economy. While long a mainstay of Japan, if the first failed version of our own QE, which pumped $1.7 trillion of new liquidity into the system, is any indication, future comparable efforts by our own Fed will be met with the same outcome (and hopefully with the same political result: the half life of an average Japanese prime minister is 6 months - if only our career politicos knew their tenure in office could be capped at half a year...). There is of course the "tipping point" optionality discussed earlier by Ambrose Evans-Pritchard, when comparing the hyperinflationary timeline during the Weimar republic, which noted that it took just a few months for the economy to slide from a period of price stability to outright hyperinflation. Either way, for an ironic look at the Japanese deflation scenario, targeted more at novices although everyone will likely learning something from it, we present the following informative clip from, ironically, the National Inflation Association, which asks whether Japan is a blueprint for America's imminent lost decade(s).

The Japanese economy operates on the assumption, soon to be proved false, that the government will always be able to borrow at low interest rates. As internal demand evaporates, the government will have to start hawking its debt outside Japan — in a more realistic world, where interest rates are a lot higher.

Investors are understandably scared of the sovereign debt crisis unfolding in Europe. Amid their angst, however, they are ignoring a more likely, and significantly larger, debt catastrophe that is about to hit the nation with the second-largest economy in the world — Japan. Two decades of stimulative, low-interest-rate fiscal policy have made Japan the most indebted nation in the developed world, and as new Prime Minister Naoto Kan recently said, in his first address to Parliament, that situation is not sustainable. Japan has little choice but to raise interest rates substantially, with dire consequences far beyond its shores.

 I have not written articles in a few months, except for the one I wrote for the July issue of Institutional Investor magazine, on Japan (I’ll post a link once the magazine comes out)..  I am sure Freud, after spending a few minutes in my subconscious, would provide some disturbing explanations.  But as Freud said, sometimes a cigar is just a cigar.  I've just been enjoying summer with my family.  

Not even the Japanese want to buy their own stocks, with foreign institutions accounting for up to 60% of trading volume on a good day. Local investors would much rather buy emerging market funds, currency funds, bond funds, anything but their own equities. This explains the miserable 1.15% yield investors get on ten year JGB’s. A new kid has shown up in the neighborhood called China which has usurped its traditional role. A massive accumulation of debt and a thousand “bridges to nowhere.” Obama take note.

A week ago Hungary had the unfortunate mishap of telling the truth when it compared itself to Greece, resulting in a massive selloff of the Forint and leading to fresh lows for the euro. Today, it is Japan which is using the very same strategy in an attempt to devalue its own currency. So far it's working. The BBC reports that Naoto Kan has been a little truthier than the G-20 plenary sessions generally allow. We now look for the PM's reign of truth to be even shorter than that of his thousands of predecessors during the past couple of years: "Naoto Kan, in his first major speech since taking over, said Japan
needed a financial restructuring to avert a Greece-style crisis."Our country's outstanding public debt is huge... our public finances have become the worst of any developed country," he said." Obviously, none of this is news. However, the market certainly does not appreciate when it is told that what it sees day after day in the non-mainstream media is actually the truth and nothing but the truth. What next - Tim Geithner coming out to say that a downgrade of the US is actually long overdue?

The latest example of selling not being actually "selling" comes courtesy of a Deutsche Bank oven mitt. Bloomberg reports that "Deutsche Bank AG sent a spate of erroneous sell orders for Japan’s Nikkei 225 Stock Average futures contracts because of a system malfunction. The erroneous orders sent stocks on the Nikkei 225 into a brief plunge seconds after the market opened at 9 a.m. The average sank as much as 1.1 percent to 9,658.44 before rebounding to about 9,743. The gauge was at 9,691.08 as of 1:54 p.m. in Tokyo." We are trying to remember when the last time that a "fat finger" was responsible for panic buying. But when every single HFT algo is programmed to only buy on no volume, the possibility of that happening is slim to none.