According to many, we are leaving behind the hostile, unruly, nearly catastrophic financial crisis which began in early 2008, and replacing it with a new era of sublime, totally tamed, and completely captured capital markets. All this, courtesy of our brilliant public authorities, who so astutely and capably swooped in to save the day for us all.
USA! USA! USA! capital markets comeback pompoms, we have arranged a special effects holiday treat to bring you on-board the super flagship of State. We sure hope you enjoy the show. The relentless media driven smoke & mirrors, incessantly producing red white and blue Wonder Bread & hypnotic Carnival Cruise circuses, are in full force this weekend. Capped off by the fanatical Obonga inauguration palapalooza, which has everybody in America enthusiastically and stupefyingly, utterly stoned silly. I curiously ponder what the venerable, eloquent, deep thinking MLK would really feel about all this spectacularly superficial, overly hyped, completely bogus, self satisfied apple pie splendor. But, I digress. Sorry, I just couldn't help myself. Back to the party line......
- The original culprit, the devastated & destructive housing sector has now bottomed out, and there should be further constructive smooth nailing ahead.
- The all important U.S. equity markets have soared back towards the heavens, like an unGodly shiny new Sphinx, up over 120% from the harrowing SPX 666 Lucifer hell hole, since the money mayhem of March 2009.
- The sick expiring latin PIIGS, instead of ending up on Iggy's breakfast plate, are being fattened up at the ECB trough with copious free flowing OMT hog feed.
- The chief EU emergency room cardiologists, have miraculously breathed life back into the flat-lining EKG of the EURO heart attack patient, using the latest LTRO defibrillation techniques.
- The global Inflation lion has been skillfully slayed, and the neatly folded Origami paper tiger is about to ferociously roar once again in China.
- The Bond bubble will gently deflate its overly pressurized pent up air, right into an eagerly awaiting, warm and welcoming, stock market hot air balloon.
- Even the dismal job market is being jack hammered back into satisfactory street shape.
"The new Japanese government, led by Prime Minister Abe and former Prime Minister and now Minister of Finance Aso, have very explicitly demanded that the Bank of Japan target 2% inflation. They have made clear their intention to replace the governors of the current BoJ board with members who agree with this policy. They have the political clout to do so. Whether at the upcoming meeting or after April, when a new head of the BoJ is appointed, that is going to happen. These moves mean there will be a massive printing of yen. In response, the yen has already weakened by over 10%.
You can control the quantity of money or the price of money but not both. (Yes, I know that one influences the other, but I am referring here to large-scale printing of money.) One has to assume that the law of gravity will not be repealed and that investors will want something more than 2% on the ten-year bond if inflation is at 2%. If the ten-year bond were to rise by 2%, Japan would soon be spending over 50% of its tax revenues on the interest carry alone. I submit that this is not a workable business model.
Why now and not sometime during the past ten years? I see a number of factors coming together this year:
1. The Japanese had a 15%+ savings rate in 1990. That is now down below 1%. (Exact numbers are difficult, because Japanese data on this topic has severe lags, and thus my number is an extrapolation but a reasonable one, I think.) Due to the nature of their retirement system, they have channeled the vast bulk of these savings into JGBs. When the savings rate goes negative or is no longer sufficient to buy all the issued debt, the choice will be to monetize the debt or cut spending. The latter choice does not appear to be part of their national conversation. Cutting spending by the amount required will mean a serious recession and further deflation, an option the new government explicitly rejects.
2. Both the trade deficit and the current account have recently turned negative. The vaunted Japanese export machine seems to have hit a wall, and this will limit options in controlling the price of the yen, even if the government wants to. Understand, inflation targeting is also currency-valuation targeting. They clearly want the yen to devalue. I have been writing for years that the yen would eventually be 125, then 150, then 200 to the dollar. It has been 300 in my lifetime, and unless the Japanese change direction, there is no reason it can’t get there again. This means that Mrs. Watanabe will see her energy bills double. This will call into question the Japanese decision to close their nuclear energy plants – something that Abe is already reconsidering.
Think the Koreans will be happy when you can buy a Lexus cheaper than you can buy a Kia? (Disclosure: I love my Japanese Infiniti, the first “foreign” car I have bought, except for a two-month dalliance with a disaster of a Volkswagen 30 years ago.) Think Samsung and LG will be happy when Panasonic and Sony can eat their lunch pricewise? Welcome to the era of real currency wars."
This note is worth about $11 today. In the future? Not so much.