Japan

The WSJ is out with a short piece about new rumblings coming from Japan's $1.43T public pension fund, Japan's Public Pension Weighs New Investments. If I may be so bold as to impersonate the Japan deflation-blogger Mish for a moment, let's take a look at a few of the dynamics at play as reported by the WSJ. I'll provide some commentary along the way.

Markets and more generally the world are at a very interesting juncture. In physics, every system basically attempts to find a state of equilibrium. If a system that is in a state of equilibrium receives or loses energy from/to another system it can lead to a change in the state of equilibrium. Transitions at the micro level happen in steps even though looking at the world it seems like continuous evolution because what we witness is all the different systems that compose the universe in constant interaction. When a system is pulled with extreme force into two different directions it could appear like it is in a state of equilibrium, but the most minute change could lead to a drastic change in the system's state. An anecdotal example of this was offered to us a little over a decade ago when a group of illuminated brain surgeons decided to break the tug of war world record. For those like me who really don't understand what the world record of tug of war can be, it's just putting a record number of people pulling on each side. The experiment went wrong when after a few seconds of stand-still the tension in the rope exceeded capacity... the rope gave and sadly a few people lost their lives as each side of the rope backfired into the people pulling with extreme power. Why am I babbling about tug of war? Because the current state of the world economy is very similar to that world record attempt. The system is stretched in a lot of different directions: demand for resources, unemployment, conflicting stimulus policies chasing the same demand for goods, unsustainable amounts of debt... - Nic Lenoir

Today's TIC data came in showing a surprising and robust inflow of foreign capital into the US in the month of July, with a net inflow of $61.2 billion on expectations of $47.5 billion, and a solid jump from last month's $44.4 billion. On a gross basis, purchases of a total of $74.8 billion in US securities consisted of $30 billion in Treasurys, and $17.3 billion in Agencies, but more surprisingly $13.9 billion in Corporate Bonds and $12.5 billion in Corporate Stocks. The last two categories were outliers consider the prior two months had seen outflows in foreign holdings of both bonds and stocks (a total of $27 billion across the two categories for both months). What may or may not come as much of a surprise is that of the $74.8 billion in total Long-Term investments, pretty much all of it came from capital originating in Japan ($29.7 billion) and the UK ($30.9 billion). Ah, good old UK, which as a covert depot for central bank operations, is now no longer content with accumulating Treasurys at a torrid pace, now holding a total of $374.3 billion (a $12 billion increase M/M), but is also aggressively bidding up bonds and stocks. In July the UK (which itself can barely fund its own QE-prompted deficit funding), also bought $12.4 billion in corporate bonds and $2 billion in corporate stocks.

Only a partisan two-bit hack economist/liberal rag columnist from an Ivy League University with a Nobel Prize could look at the following two charts and conclude that the Japanese Government failed to revive the Japanese economy over the last twenty years because they spent far too little on fiscal stimulus. Japanese government debt as a percentage of GDP was 52% in 1989, prior to their real estate and stock market crash. Today it stands at 200% of GDP. Current budget projections show the debt reaching 250% of GDP by 2015. Meanwhile, Japanese consumers and corporations have been reducing their debt for the last 16 years. The net result has essentially been a 20 year recession. The pundits who never see a crisis on the horizon point to the fact that Japan has not collapsed under the weight of this debt as proof that the U.S. debt level of 90% of GDP has plenty of room to grow without negative repercussions. This is the same reasoning “experts” used in 2005 when they proclaimed that home prices in the U.S. had NEVER fallen on a national basis, so therefore there was no reason to worry about home prices. A basic economic law is that an unsustainable trend will not be sustained. When the 3rd largest economy in the world implodes, the reverberations will be felt across the globe.

• Yen tumbles as Japan FM Noda confirms currency intervention- first time since 2004.
• Singapore authority to intervene second time in a month to bring down the S'pore dollar.
• Yuan climbs to record as gains quicken ahead of US Committee meetings.
• API sees 3.3-million-barrel increase in oil inventory.
• China's steel output cut to continue through 2010: Industry Ministry.
• Fed differ on question of how weak the economic outlook should get before they move to take major steps to boost growth.
• Japanese shares rise as currency intervention drives down Yen; Gold climbs.
• OPEC sees no change to production quota at meeting in October.
• Retail Sales in US increase more than estimated in second monthly rise.

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.