Putting the “Collapse” in Japanese Government Bonds in Perspective

It’s no secret that I am skeptical of the approach to stimulus via Abenomics.  I think it’s potentially creating a very dangerous disequilibrium in markets like their stock market that could cause more economic turbulence than stability.  But one thing I definitely don’t think is that Abenomics is going to bankrupt Japan or cause the bond vigilantes to suddenly spring to life.  And that’s what many have been implying in recent days.

So I’d like to briefly put things in perspective here.  The chart below is a 30 year chart of the 10 year Japanese Government Bond yield.  As you can see, we’ve experienced a sharp decline from 8% to under 1% at present.  That little tiny box in the bottom right hand corner shows the “spike” that many are now discussing as a sign of impending doom.  I blew it up for you so you could see what’s happened – we’re all the way back to levels seen….in January of this year.

I’m being a bit sarcastic here of course, but in all seriousness – don’t panic over the yield spike.  In the grand scheme of things it takes more than a magnifying glass to actually notice it….

jgb

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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  1. I don’t know who’s more confused. The people who think Japan’s economy is now recovering or the people who think it’s collapsing.

  2. I don’t disagree with your statement, but the numbers are a little off right?

    http://www.investing.com/rates-bonds/japan-10-year-bond-yield-streaming-chart

    From my data, it looks like the yield hasn’t been this high since last March. Still nothing to write home about.

    As for whether or not Abenomics will work — I think it just might. Nissan is already launching an ambitious goal of doubling their North American sales by price cutting thanks to the weak Yen. This could lead to a very real increase in revenue to back up the higher stock market valuations.

    • But is the weaker yen sustainable? I don’t really have an opinion, but I’m in no doubt that much of the current weakness is due to financial speculators rather than due to true fundamental factors of “money printing”.

      What a disaster that woud be – Nissan staffs up, invests up, cuts prices based on projections of an even lower currency and then boom – the currency rises.

      Cullen is absolutely right to worry about “dangerous disequilibrium” – its really hard to know how all this will play out, but the risk for everyone is high…

  3. The point isn’t the fact in itself but the psychology behind it. If the yield rises above 2%, Japan is bankrupt. And that seems to be a realistic scenario. So fear arises and we all know that fear often leads to wrong decisions and herd behaviour…

    • This is depressing to read…
      Not because you are right but because you have understood nothing.

      • I know MMT and that a default in Japan is technically not possible as long as the BoJ buys the debt. My point is, that there are enough people believing Japan is going broke and that this belief will lead to a certain behaviour. Example:

        Christine Hughes of Otterwood Capital Gives Detailed Warning on Japan: JGB interest rates only have to rise to 2.8% so that all tax revenues are used for debt service – much less if the economy falters of course.

        http://www.planbeconomics.com/2013/05/must-watch-christine-hughes-of.html

        By the way: imho MMT is a theory and as with all theories, there might be something not adequatly taken into account. It’s always dangerous to believe that you have found THE truth…

        Feel free to throw stones at me.

  4. Probably the most important effect of Abenomics will be the resurgence of protectionism.

    • I agree as well. Is Japan breaking from the plan in order to restore its economy? If Japan succeeds does Germany fail? Does Merkel get bounced in the upcoming elections?

  5. Optics: if you plot the interest rate on a log scale, the graph looks rather different!

    • I was thinking the same thing.. The percentage gain on JGB interest rates of the past few days seems pretty significant.

    • Exactly. Posting a 60 year chart is a bit disingenuous. The fact is that 10 yr JGB yield was 0.40% a month ago….its now almost 0.90%. may seem insignificant nominally but thats a doubling of yield in a month …..all while the BoJ has been buying those same bonds.

  6. We all know that technically Japan can’t go bankrupt. Government yelds will stay low forever, but the country is going to risk a currency crisis. Speculators can drive yen/$ to 120 easily; at that point IF Miss Watanabe decide to move her money in foreign assets everything will unravel in a few days and in that case there is almost NOTHING that the BOJ can do, so Japan could go bankrupt in another way. We’re not in unchartered territory, things like this happened in the past. Instability is raising by the day. We will never see QE5.

    • Its ever easier for the central bank to control the exchange rate than it is for the mot control interest rates – ask the Swiss and the Chinese.

      If for whatever reason the Japanese need to control their currency, they just need to name the price and the speculators will do the rest!

      • WRONG ! CB can control appreciation like China or Switzerland but it’s much harder controlling depreciation like Argentina.

  7. I understand the MR framework, as it exists today, to be the correct framework for these times; that may change and hopefully MR will change with the times and avoid the ossification that has turned other concepts into schools of thought with the accompanying rigidity, defensiveness and dogma.

    Japan is unlikely to be helped much by monetary policy, QE or Abenomics; only fixed investment, R&D and fiscal policy can achieve sustained improvement. Ditto the US and Europe.

    Capital market prices move in accordance with a hierarchy of forces. As news and data comes in, the different forces compete for supremacy. For some time, the US federal budget deficit has trumped all other forces: interest rates stay low because Treasury cannot accept higher rates. For the exact same reason; the BOJ will persist only as long as solvency is not a threat.

    Kristian

  8. Sure Japan can print all the money it wants. But happens if nobody is willing to accept it as paymnet. Why would Middle Eastern countries accept worthless yen for their oil? Why would Tiffany take worthless yen for their jewlery? To say that Japan can’t go bankrupt is only true if thier currency is worth something to OTHER people.

    • What you’re describing is a crisis like a hyperinflation/default scenario. The thing is that so-called central bank “money printing” doesn’t necessarily lead to that… This recent piece by Cullen is a great place to start:

      http://pragcap.com/why-sovereigns-default-on-local-currency-debt

      Keep in mind that when central banks “print money” (actually reserves) that money doesn’t necessarily make it out into the “real economy.” Here’s an illustration of that with QE in this country:

      http://brown-blog-5.blogspot.com/2013/03/banking-example-4-quantitative-easing.html

      And the three places central bank reserves can actually go:

      http://brown-blog-5.blogspot.com/2013/04/the-three-places-reserves-can-go.html

      Keep in mind that the BoJ “printed money” for decades, while their government deficit spent… and instead of hyperinflation and default they experienced… deflation! Only recently have they been successful in devaluing the yen.

    • The value of the Yen is primarily based on the output it affords you. So, people will want Yen because there is trillions in output backing that currency. As long as the Yen is not suffering from a very high inflation because spending outstrips productive capacity then people will desire Yen for payments required in Yen. Of course, they could experience an exchange rate crisis, but that would be rather similar to the causes of an inflation and tends to be rooted in spending relative to output. Thus far, there is no sign of such a thing occurring.

      • Self reinforcing devaluation (aka feedback) can be unpredictable, extremely difficult to stop and destructive. Yes, you’re right, up to now it’s not happening but there are some glitches in the system. When a 10y bond moves from 0,5% to 0,9% it doesn’t mean that the gov will be bankrupt next year but it’s a red spy; furthermore, how many trillions in interest rates swap have been subscribed ? By whom ? Who will pay the difference ? BOJ has created a BIG discontinuity, will it be a singularity ?

        • I don’t think Cullen is saying QE doesn’t cause problems or can’t. I think what he’s saying is that Japan isn’t going to default because of bond vigilantes.

      • Cullen, you go back and forth in logic. In the BSR discussion you ignore flows and here you argue based entirely on flows. The flow argument is correct, but asset values have a role because they can enable future flows (think great farmland as a classic example, even if it’s not under current production).

        The underlying real and potential assets of an economic entity do have real value even in the rare case there is no current output (think oil fields or patents).

        To put this in perspective, a highly valuable patent (with no current or near term revenue stream) that the holder only would accept BitCoin payments for is possible.

        Of course I realize that the efficient market hypothesis requires that agents will accept payment in any form of money they feel affords them either an advantage or at least not a disadvantage. But it’s important for a careful thinker to explore all of the potential paths in any situation.

        • The real problem is that you don’t understand my points so you build strawmen arguments to defeat them. The BSR concept does not ignore flows. That’s ludicrous. One of the central points of the cause of the BSR is a lack of flow in the system which causes the credit system to buckle in the first place! Saying my work ignores that just proves that you haven’t even begun to understand the concept!

          Last week you were saying that I work from an equilibrium position. These are huge misunderstandings of my work. I am not sure where you’re getting this from but I would expect a scientist like yourself to actually base their accusations on some real evidence as opposed to flimsy assertions such as you’ve made here and in other posts repeatedly.

          • In the past you used the phrase “disequilibrium” to describe your thoughts on recent Fed actions (which you have now refrained from). So how could I not think you viewed financial markets from an equilibrium position. How can one have “disequilibrium” without a belief in “equilibrium”. We are, (and hopefully) will always be far from the equilibrium position.

            I don’t think it’s a strawman argument. But I will try and clarify.

            The problem I have with the BSR argument is this. A balance sheet is simply the integral over all time of all flows into any single financial entity. The flows from any single entity depend upon this. But integration is only valid when you are integrating over the same independent variable. In economics this is a more complicated concept, but you can’t integrate over household debt levels for all households in any meaningful way. A simple hyperplane to separate these two would be households that had no issues servicing their debt and those that did.

            Yes, the flows in one part of the system stopped because the underlying asset values went down. But agents in the system with good flows have taken advantage of the situation, partially reflected in the large increase in AAA borrowing by companies with access to that market.

            There is a component of credit flows that depends upon the balance sheet (more properly estimated underlying asset liquidation value) but it is also dependent upon flows independent of asset values. In the end, some people will make decisions based upon the integral of flows (balance sheet) but smart people will make decisions based upon reality (real flows).

            • A system in disequilibrium can remain in disequilibrium to varying degrees. It does not have to reach equilibrium so your assumption was false. I have never written about the economy being in a state of equilibrium nor have I ever implied that the system could or should reach an equilibrium. Frankly, I find the concept void of value.

              The other point you’re discussing is basic stocks and flows in economics. Stocks need flows like puddles need rain. I’ve never claimed otherwise and no one with an economics education past 101 would claim such a thing….These might not seem like strawmen arguments to you, but I think it’s a huge misunderstanding to assume that the Balance Sheet Recession is a narrow view of stocks just because the word “balance sheet” is in the name….

    • LOL, people worldwide want Yen because they need it to buy Lexus/Toyota (biggest selling cars worldwide), Sony HDTVs, playstations, Nissan, Panasonic (one of biggest makers of batteries), etc

      ie, the value of a currency or gift card/gift certficate is what it can buy ..and Japan produces trillions of things the world wants that only yen can buy since Japanese companies want payment in yen in Japan

      the same is true of US dollars, where the US is still the biggest produce & exporter of food, especially wheat, corn, & soybeans

  9. I expect one last MAJOR leg down in japanese yields. After that I think we will see japanese yields rise. No matter how much the BoJ prints or moentizes. No matter what MMT or MR predicts or thinks. It will be the death toll for Japan.

    “Morituri te salutant”

  10. Investors simply pulled money out of JGBs and put it in stocks, assuming those stocks will go higher even more. Like investors in 2011 thought that silver & gold would continue to go higher. But both crashed after a peak. Same story for japanese stocks. So, investors will get burned again and flee back into JGBs, pushing yields even lower. Simple supply & demand.

    But yields on JGBs WILL go higher (in 6, 12, 18, 24 or months). Broken record ? Absolutely, but I simply WILL NOT believe the MR narrative.

  11. Hi Cullen, big fan of the MR framework and your site – it has been far more practical than my economics degree. Please remain scientific in your approach, it’s refreshing in a world of dogmatic zealots.

    I haven’t found much that I disagree with here, however I find myself unable to understand the exact process by which the BoJ (or the Fed) can manage ever increasing debt and yields without creating large imbalances. I think it might be of benefit (if you haven’t already) to do a more detailed post on what the unintended consequences might be and whose balance sheet takes a hit if CB’s buy up assets in unlimited quantities. This debate creates cognitive dissonance for me, because both you and Kyle Bass are responsible money managers and very smart – I don’t expect either of you have come to a conclusion without doing your due diligence, however one must be incorrect.

    Some questions I’m unclear on:

    QE creates a risk on atmosphere and drives people into higher yielding assets, it also (relatively) shrinks the pool of assets that one can invest in, therefore rising asset prices are a natural consequence. If the Fed moves to control the entire yield curve by taking government securities out of circulation, won’t this create a situation where a large bubble forms in risk assets, which must inevitably be reversed?

    As I understand it, private investors who sell to the Fed during QE (and receive a deposit in place of a bond) must then decide what to do with their money – is it not logical that they will simply bid up another bubble in asset prices, causing greater instability over the longer run?

    In regards to financial repression: if central banks attempt to create inflation and keep rates at essentially zero, investors will likely move out of those assets. What stops them, in today’s interconnected global economy, from simply purchasing overseas assets and enjoying both a positive yield/carry and a profit from the move in FX? And, to take this a step further, wouldn’t this in itself exacerbate the move in inflation via a depreciating currency?

    I guess what I’m really getting at, is how does a central bank control the yield curve, inflation, and the currency in a world where capital is fairly mobile?

    And finally, I have one more hypothetical question (sorry for the long winded approach). Economics is often discussed as if we exist in a test tube. I find that one main difference in views on government debt comes down to optimism/pessimism. More specifically, the pessimists often believe that developed economies have already reached peaked growth rates, and therefore our debt position is illogical as organic growth will become harder and harder (and the debt larger and larger) as we try and exist in a system that was designed for constant growth.

    The optimists might see roughly the opposite, that growth will pick up again to recovery rates of 3-4%, and so debt/GDP will come back down to more historically normal levels as we realign with potential GDP. The government should therefore logically counteract private saving by running a deficit, and this will help put us back on a path to potential GDP, and eventually everything will return to normal.

    Hypothetically, if we woke up tomorrow and found that the oil production rate had begun contracting, what do you think the market reaction would be? Do you think this would cause another energy crisis, and if it did, what do you think would be the effect on the Fed’s ability to continue both ZIRP and QE? Would they not need to raise interest rates structurally (similar to the 70′s) until people moved into renewables or changed consumption patterns?

    Just hypothetical of course, but eventually something like this may occur so I think it is relevant. Anyhow thanks for taking the time, I know this was a long post…

    • CJ,

      Long question so I am just hitting some bigger points. If you want or need more detail maybe condense your comments into the forum where I can get around to it when I have more time.

      The Fed can determine the yields at any point on the curve because it is the reserve monopolist. If it wants to buy every 10 year bond at 1% it will just announce it.

      The problem with govt spending is that it could be potentially inefficient. For instance, if the US govt just paid 300MM people to sit on their couches we’d have high inflation because we’d have no one producing goods and services and everyone spending more money on the same amount of goods and services.

      An oil supply shock MIGHT force the Fed off of their ZIRP position. But I presume a big oil price shock would cause a recession which essentially takes care of itself.

      Cullen

      • Thanks, and sorry it was a pretty long winded set of questions so I’ll narrow it down to just one oil related question.

        My intuition follows it is not actually the high oil price that causes the recession, but rather the tightening response that does so by halting credit expansion. If the Fed did not tighten in response, do you think this would still cause a recession?

        • Gosh, hard to say, but 100% year over year increases in oil almost always cause a recession. As does an inverted yield curve. So I think there’s probably truth to both ideas. I always say that the Fed controls the yield curve, but can’t control the economy. So, the Fed has powers, but is not omnipotent and can’t control many of the real economic forces that are outside of its powers. And ultimately, the policies set forth are determined based on their view of the economy so they’re always at the mercy of the economy regardless of where they can set prices.

          • Thanks for your response, its definitely quite hard to say which is the greater cause (personally I love the yield curve).

      • Cullen,

        I have the same questions as CJ….although he framed the questions much better than I could have. I would be very interested in hearing a more thorough response if you have time. I seem to hear the “Fed controls rates and can always print therefore no default” argument from MMT & MR (yes, I’m aware that you believe the two are very different)…..I think this amounts to arguing an irrelevant technicality (credit risk). I think everyone agrees that technically the Fed could monetize all $16T of current debt……..but that doesn’t answer the question…….how could the Fed do it without creating massive imbalances as CJ put it?

        • See my other comments. I actually think that the govt can cause huge imbalances. For instance, deficit spending tends to exacerbate structural current account balances. This results in a deterioration in the nation’s competitiveness. One who was vehemently anti-govt could ratonally argue that this is what’s happened in the USA over the last 20 years. I absolutely don’t deny that there are real constraints that result from govt spending or Fed policy. In fact, I vehemently disagree with MMT’s position that a current account balance is a “real benefit”. Being able to print your own currency doesn’t mean there is no balance of payments constraint. And that’s ultimately the big risk to nations with a free floating currency. Particularly if they abuse the printing press. Personally, I don’t think Japan or the USA is falling into the trap, but I could be wrong. MRists don’t say there will be no problems in these economies. But like the MMT people, we understand that Japan and the USA won’t fall victim to bond vigilantes or default unless they choose to. The BOP constraint is a little different, but still a default of sorts. And I recognize it as a very real risk.

          • Ok, thanks for the reply. I guess the part I’m still hung up on is; I don’t see how you can recognize that the irresponsible policies can have negative consequences and yet not believe that the recent action in Yen and JGB’s are the first sign of these consequences resulting from BoJ policy.

            I may be beating a dead horse here but I am sincerely interested in understanding the opposing view (trying to combat my own confirmation bias). Below is a logical scenario/sequence of events in my mind, if you have time can you please point out where I’m wrong or what I’m missing?

            Assumption: the only private capital currently invested in JGB’s was/is doing so based solely upon Japans historic persistent deflation (otherwise, why hold a security yielding only 0.86%?).

            1) The BoJ said they will do what it takes to reach 2% inflation……if I am a Japanese investor and I’m currently holding a ten yr JGB yielding 0.86% why in the world would i keep that bond when the BoJ just told me that I’m either going to take a loss or suffer through a negative real yield until maturity?

            2) Assuming that the BoJ convinces investors that they will reach 2% inflation target (recent GDP report lends credence to the possibility)…then its only logical that private bond holders will bail…creating a negative feedback loop in which fleeing private capital pushes yields up which forces BoJ to monetize more to push yield back down.

            3) Ultimately, if the market becomes convinced that the BoJ truly can create inflation…couldn’t that be the spark that ignites velocity of money? 20 years of increasing monetary base and finally a spark of velocity would cause inflation wouldn’t it?

            4) Finally if MV does pick up……who in their right mind would want to own either Yen or JGB’s?

            What I’m getting at is……how can Japan possibly get through this without creating massive inflation? (assuming they really do achieve their target and they keep a constant bid under JGB’s to keep rates low). Is your position that the BoJ wont actually create the inflation they are shooting for?

            • I have said that I don’t think the BOJ’s policies are going to help the economy and might actually cause more harm than good. But I don’t think it’s going to cause the BOJ to “run out of money”. There’s a distinction there that most people don’t understand….An inflation constraint, a BOP constraint and a solvency constraint are all very different things. The prior two I acknowledge in Japan, but guys like Kyle Bass are saying Japan will suffer a solvency crisis. I don’t buy it.

    • Just thought I should clarify if this wasn’t immediately clear – I’m well aware and in agreement that countries aren’t bankrupt and can technically do unlimited operations to control various economic measures. My questions are more concerning where theory meets real world obstacles/political opposition and individual motivation of speculators leading to adverse consequences.

    • Excellent question. I am also curious to hear someone finally address the consequences of massive printing. It gets a bit tiring hearing people repeat that debt denominated in”a free float currency” cant be defaulted upon…..This part is obvious….im not even sure why MMT & MR guys always lean on this irrelevant technicality……the REAL question is……how can CB’s monetize all of the debt without major consequences?

      • I wouldn’t say that MR guys repeat the bit about “free float currencies” without putting it in the proper perspective. A big part of my disagreement with MMT is based on the real economic constraints. Even a free floating country can have a balance of payments crisis or suffer from a real output crisis. That’s why I place output as a centerpiece of MR’s presentation. We MUST be cognizant of producing high quality output as opposed to merely assuming that printing money will solve all of our problems. I think it’s the MMT people who seem to take an excessively demand side view of things without properly appreciating the supply side views. I always say that the beauty of being an MRist is that we can view the economy for what it is rather than what we want it to be. So, an MRist would have been a supply sider in the 2003-2007 period and didn’t turn demand side until 2008/9. We appreciate both sides of the coin in other words and appreciate the reality that a printing press is no substitute for high quality output.

      • As Cullen has explained countless times, and anyone with a modicum of mathematical ability understands, there is no such thing as “massive printing”. This is a concept that appeals to the real ignorant wackos out there. Technically, printing money requires a government to print money to pay bills with no backing financial asset (a bond).

        The wacko world has embraced this irrational view of the monetary system that is based upon ignorance. Cullen has provided a view that describes, at some reasonable level, the realities of the system. Of course you don’t have to believe Cullen, and in fact you shouldn’t. You should do what Buddhism has always advocated. Figure it out for yourself. But for much of the monetary world you will inevitably find that MR is a good foundation.

        The debt issue is not simple, but some things about it are not that complex. Debt levels have increased (vs GDP) over the past 3 to 5 decades, something that the debt wackos harp on all the time. But the flows of funds to service these debts, as a share of GDP, has gone way down.

        Since money creation in our current system only occurs through the net imbalance in the birth and death ratio of bank credit creation the ideas of debt monitization are completely irrelevant to any intelligent discussion of the current system.

        • Wow, profound reply.

          ” there is no such thing as “massive printing”.”

          - HAHAHA ironically this is precisely the type of argument that i was referring to. Are you just arguing definitions? Call it what you want….tell me that its only numerical inputs in a computer and that as excess reserves it will never make it into the system. You dogmatic beliefs seem to have you focused on arguing technicalities rather than the more important concept. You don’t seem to fully understand the economic theory that you subscribe to which is rather comical.

          BTW, I am not against MMT or MR, or Austrian Economics or Keynesian economics or any other THEORY for that matter. I am interested in studying them all and picking out what i find useful. I think its funny when a person subscribes solely to one theory and believes that economics is a science.

          • Billie,

            I think the point he’s trying to make is that money creation in our system starts and ends with banks creating money as debt. That is, the real money printing is done by banks when they create new loans. Loans create deposits and banks make loans without real govt constraint. They’re not constrained by their reserve balances. The only real constraint is their capital levels (are they solvent in essence).

            The govt does not actually print money except in a literal sense. They provide physical cash to banks so their customers can draw down bank accounts for transactions. But this is mostly a facilitating feature of bank money. The govt doesn’t actually print money in the sense that most people imply. When the govt taxes and spends they simply take bank money from someone and spend it. When the govt runs a deficit they sell a bond, redistribute the bank money from person A to person B and give person B a t-bond. Technically the only thing they “print” is the t-bond in this process.

            Have you read my primer? It might help you understand the perspective a bit better. Let me know if you have any questions.

            http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1905625

          • Look at the chart of the debt
            http://www.financialsensearchive.com/Market/griess/2010/images/0323_clip_image001_0001.gif

            -total nominal at top shows debt has always increased nominally –chart at bottom shows percentage –ie, the economy(money supply) GREW to make the percentage smaller even as the total nominal debt kept increasing …

            ie, the ‘debt’ savings bonds has always been paid with more money creation –that is how an economy grows –by increasing the money supply to fund more spending & hiring/production because all spending becomes income for someone else , especially important for a growing population

            –GDP grows hugely while the gov debt has always grown at a smaller rate or stayed level but NOT going down

            http://www.financialsensearchive.com/Market/griess/2010/images/0323_clip_image001_0001.gif