Japan’s Decline IS Elementary (Market Dynamics)

There have been a broad number of economists and apologists for the current policy approach being undertaken in Japan.  Now, I don’t entirely disagree with Abenomics.  In fact, there are components of it that I think are helpful.  But what I find particularly misguided is how the stock market is being targeted quite explicitly via the portfolio rebalancing effect.  It’s a version of what the Fed is doing in the USA though the Fed doesn’t buy ETFs as the BOJ does.  And as I’ve explained before, the power in central banking is not in the SAYING, but in the DOING.  Japan’s officials have not only said that they want equity prices higher, but they’re buying them as well.  This has given Japanese market participants a false sense of confidence.

And this is where some economists seem to get confused on the cause and effect.  For instance, when trying to pinpoint the cause of last nights 7% collapse in the Nikkei Dr. Krugman highlights three potential causes:

“1. Fears about weak Japanese and Asian growth.
2. Fears about Japanese debt– the bond vigilantes have finally arrived.
3. Fears about the resolution of the Bank of Japan, its willingness to persist in very expansionary monetary policy for a long time.”

One of those might have been a trigger, but the cause of the decline is ultimately the result of the market imbalances that have grown over the course of the last 6 months.  For instance, what caused the housing bust in 2006/7?   Who knows?  But the cause of the boom was quite obviously an irrational supply and demand for housing backed by debt accumulation/issuance that was unsustainable.  The environment in the Nikkei is not all that different.  And when a central bank commits to be “credibly irresponsible” it’s not unusual for market participants to take them at their word.  And the commitment to support equity prices gives traders a false sense of confidence which can then lead to a sort of ponzi environment which leads to a huge boom.

By committing to be “credibly irresponsible” the central bank can actually contribute to the boom which then creates the imbalance that results in the bust.  Last nights collapse in the Nikkei wasn’t caused by one of the three aforementioned fears.  It was caused by the imbalance that the BOJ has been a direct contributor to.  Now, hopefully, this isn’t the beginning of a much bigger slide, but if history is any guide then it’s likely that the rollercoaster ride will continue for years to come.  Personally, I find this concept of committing to be irresponsible a highly irresponsible form of policy that ultimately leads to increasingly risky environments and exacerbated boom periods that lead to exacerbated busts.



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Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  • GLG34

    I love it when economists pretend to be market experts.

  • John Wilkins

    Cullen: May I ask how you know the BOJ is buying ETFs? Did the BOJ announce that? I assume they are buying bonds just like the Federal Reserve, with reserve balances. But how do they buy ETFs? Cold they buy ETFs with reserve balances too or, in their case, are they really printing money and adding to their money supply when they buy stocks?

  • http://orcamgroup.com Cullen Roche

    The BOJ data shows that they’ve been buying….

  • Gene
  • Chad M

    The longer global central banks create these imbalances the worse the unwind will be. Some central banks such as S. Korea have warned about the imbalances they see building. Brazil has as well.

  • Anonymous

    If the DOW was trading around 9000 would assets be flowing into or out of the United States? If the currency depreciated would assets flow into or out of the United States? What would bonds yields be to a foreign investor if rates were on the zero bound and the currency was depreciating? Which direction would capital flow? If capital was fleeing your nation would you have inflation or deflation?

  • Johnny Evers

    I don’t see the comparison to the real estate bust. That was caused by excessive borrowing to buy real estate and real estate-based securities — debt accumulations that was unsustainable.
    But the BofJ isn’t going to get a margin call if the Nikkeii falls.

  • Reader since late 2010

    Gotta disagree. Johnny only one bully who can’t get a margin call, US Fed. Will the Yen always be able to buy Oil?? With the US, we will always be able to buy oil with USD else Arab Oil will become part of Greater Israel.

  • http://orcamgroup.com Cullen Roche

    It’s not the BOJ you have to worried so much about. It’s the lemmings who follow them into the market….

  • Reader since late 2010

    Did you see Michael Pettis latest article on NC ?? Looks like he’s come around to your view on the difference between National Savings and individual savings. It’s like everyone is making the same mistakes over and over again fighting WW 2 with WW 1 tactics. Feels just like 1987, I still remember the Friday before the big crash, George Soros had purchased thousand of S&P futures that cut the losses on the Dow to under 200 pt. he sold on the following Wed. for $ Billion lost.

  • Anon

    Good comments Cullen – absolutely agree. But for those of us who have studied markets (i.e. their movements) for some time, understanding “imbalances” is even simpler.

    Forget what’s been driving a certain market for a moment. Prices are set by the interaction of buyers and sellers – money doesn’t “flow into” stocks – its an exchange of cash for shares. When a market has been rising strongly for a while, there’s been a clear willingness by investors to pay a higher price to induce someone to sell their shares. As the trend runs, more people (“speculators”) are buying based on the sole objective of flipping the shares to someone for a profit (and many use margin to do it). You get a situation where a large number of share owners are focused on ensuring they “lock in” their profit when the “time comes”. In other words, you get a situation where literally millions of investors are just waiting for the right time to sell – these are the same investors who are bidding the prices higher to begin with.

    There comes a point when for whatever reason (or for no reason) the former buyers become sellers – the tens of millions of investors look to lock in their profit all at the same time. Of course, someone needs to step up and be the buyer for the transaction to take place and the price adjustment necessary to “clear the market” is potentially large.

    That’s what we saw in Japan overnight. And we will see in in the USA market soon as well – spec long futures positions are getting extreme, margin debt is getting extreme thus that pool of investors waiting for the “right time” to lock in their profit is getting extreme.

    (Best of luck to everyone picking when it will occur.)

  • Nils

    Most people here probably aren’t day traders, but something that can be really educational is too look at the Level 2 Screen for a few stocks, you can see in real time how this plays out.

    It’s especially interesting when panic starts setting in and spreads are widening. You can see the smart money and computers pull their bids, market stops getting hit and the stock dropping like a stone.

    What we saw in the Nikkei was a lot of weak hands getting shaken out. A lot of people are very nervous (nobody really trusts this market) and are just waiting for the top. Then everyone runs for the exits.

    In the US market at least it seems a lot of positions are being unwound, at least for the options market.

  • ChasW

    Feb 27, 2015

  • shawn

    J. Gundlach thinks late this year or early next.

  • Anon

    Exactly – someone has to buy the shares that others are trying to unload. When there’s a bit of panic in the air, its only natural that would-be buyers hold back or disappear, or at least realise that “I can stick my bid in at a lower price and probably get done”.

    I remember my days as a stockbroker. When the market had been running well, not only did client buy at market, they also wanted to put orders in below the market. As soon as a bit of weakness appeared, they would all call up to either cancel their limit buy orders or at least reduce them. Multiply that by millions of people (not to mention the robots) and you understand why the market tends to fall hard for a few days at some point after a big run…

  • Adam P.

    Pettis is saying the same things over and over. He was very consistent during these years. I think is one of the very best and I’m an avid reader of him. I’m also very much in line with most of CR and of course they share a lot about the origin of this worldwide crisis even if they don’t know each other.

  • InvestorX

    What is the unit of the Y-axis?

  • InvestorX

    Does it mean the BoJ has bought $16bn+ of ETFs?

  • fin

    me too. Though Pettis has more a kind of historic view but TCP is more on current market.

  • http://animaladas.blogbyt.es/ Muriel Velez

    “We are seeing just another example of how the central planners intervene in the precious metal markets by selling paper to drive the price down during month-end option expiry. This maneuver maximizes the profit for their agents – those bullion banks facilitating the gold price suppression scheme – so that the calls they’ve sold to investors and financial institutions expire out of the money. It also ensures that as many call buyers as possible lose money, which helps the central planners foster a negative sentiment for the precious metals.

  • http://pragcap Michael Schofield

    Martin Feldstein says CBs are out on a limb and judging by the action of the last few days he is probably right. The markets seem to be saying “give us crack or else”. The horror…the horror

  • Andrew P

    Me thinks the Bernank will be out of office first, just as Greenspan got out when he saw the housing bubble slowly becoming a train wreck. Bernanke’s term expires in January. But Greenspan got out a full 2 years before things started to go south, with Bear Sterns, and 2 3/4 years before the actual crash. I don’t think Bernanke will be as lucky, but the wild card is Obama. If he sees an advantage to having a financial panic right before the Midterm election in order to scare the public into voting for Democrats, he has the power to prick the bubble and get it on. If he wants to kick the can and keep the public in “feel good” mode, he can do that too. It all depends on how his strategy for the midterm evolves by next summer.

  • http://brown-blog-5.blogspot.com/ Tom Brown

    Sounds like Glasner is implying Bernanke scared the market:


    Sumner has a post on Ben too, but doesn’t mention Japan:


    BTW, buried in the comments there is a plan by commentator Morgan Warstler (whom some here may recall from his obnoxious comments usually involving the word “HEGEMONY!!!” in all caps and lots of exclamation points… … and of course he likes to deride “dirty hippies” every chance he gets … Ha! Anyway he has a softer tone, explicitly trying to “win progressives over” to his market based full employment plan… which even includes a way to deal with the “criminally lazy”:


  • http://brown-blog-5.blogspot.com/ Tom Brown

    “The BOJ needs to do much more.” … is Scott Sumner’s conclusion. He says Abenomics is working, but only a little:


  • http://brown-blog-5.blogspot.com/ Tom Brown

    More opinions on Japan! … this is very interesting:

    Ambrose Evans-Pritchard: “As for the countless readers demanding an apology from me for backing QE, Abenomics, and all the sins of monetarism: I defy you all.”


    He describes Richard Koo (an “arch-Keynesian”) and Kyle Bass’s take too… neither of which he agrees with. Koo says it could be the “beginning of the end” of the Japanese economy due to a “loss of faith” in the Japanese gov. Bass too is not happy with the rise in long term yields, but comes at it from a “diametrically opposed theoretical viewpoint” according to Ambrose.

    Then there’s Nick Rowe (more in line w/ Ambrose and the MMists on this… no surprise there):


    Rowe attempts to explain the apparent paradox of long term bond yields climbing as the BoJ increases purchases. All the MMists agree: the BoJ needs to do MORE! Climbing yields is a sign that Abenomics is working (but is Abe still on board?). Sumner gives his familiar refrain: “never reason from a price change.”

  • http://brown-blog-5.blogspot.com/ Tom Brown

    …outside in the distance a wildcat did growl
    Two riders were approaching, the wind began to howl! ;)

  • http://www.fanbrowser.com/ Cowpoke
  • http://www.highgreely.com jldasch

    When I see people repeat things without thinking and then claim they understand I get worried. “ But the cause of the boom was quite obviously an irrational supply and demand for housing backed by debt accumulation/issuance that was unsustainable. “

    In aggregate this is wrong on more than one level. First, the only balance point is at the sustenance level, when people have only the shelter that keeps them alive. Anything more than this is unbalanced, so using the concept of balance is wrong. Our system always operates far from the equilibrium position, the only place where the concept of balance holds. Second, the debt service load relative to income, was only about 70% of it’s peak (reached around 1982) and lower than it was at any time from 1975 to 1994. People, in general, don’t buy a house based on the debt to income ratio, they buy it based upon the debt service load to income ratio, and that, in general historically, is how loans are approved.

    Certainly, a segment of the market engaged in buying housing that they could not meet the debt service load for, but for the majority of housing this was not the case. If the concepts of balance and equilibrium held in economics, then this segment would have corrected and the overall market would have returned to equilibrium. But because we are operating far from equilibrium positive feedback can easily dominate (a system at equilibrium has only negative feedback) as it did in the housing crisis.

    Also, clearly, the idea that it was irrational is wrong. One can make a rational argument that because mortgage debt service levels were lower relative to income than they had been from 1975 to 1994 the overall market was in fact not in an unsustainable position. In fact, it is clear this type of rational analysis was done by banks (or they would not have held any loans or MBS), and it’s also roughly what Bernanke thought, as he noted that while there were issues with the sub-prime market, with employment good and debt service levels not excessive, the market was not in danger.

    So Cullen essentially gets this whole thing exactly wrong. In general, one can usually make a rational analysis for economic conditions that is logically sound. This is what being rational means. Even a market crisis can be understood rationally, you just write down the differential equations and solve them. It’s that when operating far from equilibrium people can make rational decisions that have different outcomes. But as long as the thinking is logically sound, it’s rational.

  • http://orcamgroup.com Cullen Roche

    I won’t respond to the comments about equilibrium since you keep raising the same strawman about how I view the world through some sort of equilibrium (even though I keep telling you that you’re misconstruing my views).

    Instead, let’s just inject a bit of facts into the discussion as opposed to your vague comments about equations, equilibrium and all the other things you claim to have solved, but don’t actually apply a shred of proof to.

    The household debt service ratio was higher in 2006 than at any point in the last 30 years. So, your entire accusation and comment falls apart based on a lack of very basic statistical understanding. I find it extremely odd that you continue to write these very confident accusations without any real rigorous and verifiable statistical data to back them. Your entire thinking appears to be based on understanding the verifiable facts, but most of your comments actually involve zero facts and lots of wordy generalizations. I am not being critical, but constructive. Next time, before you decide to write (another) comment claiming someone is “exactly wrong” you might want to look up some actual statistical analysis rather than just making these sorts of general claims.

    Source: Federal Reserve http://www.federalreserve.gov/releases/housedebt/

  • http://brown-blog-5.blogspot.com/ Tom Brown

    Thanks Cowpoke. Seems Mauldin is in the camp opposite to the MMists. BTW, here’s David Glasner today with a follow up directly addressing what he thinks happened in Japan last week (again, he thinks it goes back to Bernanke’s statements):


  • LVG

    Did you just start reading this website a few months ago and decide that you didn’t like what was being said? You seem to have missed 4 years of updates on things like debt to income rattios and Cullen’s almost perfect track record predicting how the balance sheet recession would play out. There’s maybe a handful of people who have predicted the last 4 years as well as Cullen has. And you come here with these pompous comments claiming he’s wrong without even having familiarized yourself with the basics.