“What Happens if and When the Interest Rate Rises?”

I approach all of this macroeconomic stuff from a very different perspective than most economists.  As an investment manager I’ve had to learn how to connect the dots or die.  And scenario analysis like the following is one reason why I’ve had a pretty good track record over the years of avoiding bad predictions like “bond bubbles”, USA defaults, attacking of the bond vigilantes, hyperinflation, etc.  As an investment manager, I can’t just say things like “I am bullish on Apple because of their strong balance sheet”, then buy the stock and wish for the best.  The process has to be a prudent and in-depth analysis of potential scenarios and the various dots that could unfold.  And then I have to connect those dots, understand the risks and decide whether the risk is justified given the potential outcomes.   What is the risk to Apples balance sheet, what could cause XYZ to happen, how likely is XYZ, etc etc.

That’s why I am confused by economists when I see things like this by Nick Rowe discussing some macro things that he’s concerned about:

“3. The national debt in countries like Japan. When nominal interest rates are below the nominal growth rate of the economy, national debt is not only not a worry; it’s a good thing. It’s a sustainable Ponzi scheme, and the solution to a problem of dynamic inefficiency. Sure it’s a bubble, but economies where the interest rate is below the growth rate need a bubble. The trouble is, what happens if and when the interest rate rises above the growth rate, and we re-enter the normal world where the long run government budget constraint is well-defined, if the debt/GDP ratio is very large?” (emphasis added)

That’s like saying: “Apple is certainly in a bubble so what happens when their business collapses?”   Okay, totally plausible, but where’s the analysis?  Why will their business collapse?  Where are the details?  This reminds me of the endless comments from hyperinflationists over the last 5 years who respond to me saying “just you wait!  It’s coming”.  I am still waiting.  So a comment like the one above has absolutely no merit without further detail.  And in this case I am not sure Nicke Rowe has really taken the time to think through the details.  So let’s do it.  Why might rates rise in Japan?  Let’s consider some scenarios.

First, Japan is an autonomous issuer of Yen.  So their central bank can always control interest rates, unlike in Greece where the ECB is essentially a foreign central bank and interest rates are left to the control of the bond market because the ECB won’t commit to Greece’s solvency.  Like the Fed, they have unlimited quantity of reserves at their disposal allowing them to pin rates across the curve however they like.  If the Fed wanted to set the 30 year bond at 1% tomorrow they’d step up to bond market and say “say hello to my little friend” and they’d challenge bond traders to trade against their 1% price target.  The bond traders would lose.  In fact, they probably wouldn’t even step up to the plate because the communication itself would likely do all the heavy lifting.  Ben’s got a bazooka and every bond trader on Wall Street knows it.

So the question really is, what will make the BOJ raise interest rates in Japan?   Higher inflation in all likelihood.  And what will cause higher inflation?  Higher growth or possibly a stagflation.  Higher growth is obviously what Japan wants.  They’d love to have to raise interest rates because their fight with deflation is over and growth is booming.  So that would be a good thing.  In a stagflation scenario it’s possible that inflation rises for a multitude of different reasons (cost push shock from oil for example).  But this would also be an environment in which the BOJ raises rates because they are trying to simmer inflation.

What’s not going to happen in Japan is an environment where bond markets just say “oh screw these bonds, sold to you!”.  Why?  Because as long as growth remains muted and inflation appears low bond traders are going to continue to clip those coupons with the understanding that Japan can always be good on debt payments because they are an autonomous issuer of the Yen.  So, unlike Greece, the likelihood of rates surging because of default is very low unless Japan decides to do something silly and default by choice (which they could I guess).  But the other scenarios are due to inflation constraints and the BOJ willingly raising rates to combat inflation.

So, Dr. Rowe, scratch numero tres off your list and halt your worries.  Japan isn’t “running out of Yen” and rates aren’t going to rise because of the mythical Japanese bond vigilantes and their concerns over government debt levels (assuming there are even any left after they’ve spent the last 20 years jumping out of the windows of their high rise banks thanks to the many rising rate predictions from the various macro economic arms relaying “research” to their bond traders).  Rates might rise for other reasons, but the BOJ will attack that issue when and if necessary.




Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

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.

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  1. The reason why your track record of predictions is so good is because you’re taking these big macro concepts and breaking them down into a money making decision. That is, you really do the due diligence because you’re putting your money where your mouth is. The ivory tower guys don’t have to do that because once they’re tenured they can pretty much say whatever they want without a care in the world.

  2. Cullen,

    I don’t really get why interest rates have to stay low as long as you can issue your own currency. Doesn’t this argument assume that investors are not concerned with the alternative to default, which would be printing your way out of the problem, causing inflation and eroding the value of bond holders’ investment? Don’t therefore both alternatives lead to a similar outcome with regards to interest rates and risk premia, just that the default threat is more imminent and therefore considered earlier than the threat of the printing machine?

    Besides, I havnt studied the issue, but I’m pretty sure there must have been plenty of cases in history where countries defaulted even if they had their own currency?

    In my mind, I am very curious to see how long Japan can walk this tight-rope, when all the stars are aligned against this economy in the foreseeable future (particularly in terms of demographics).

  3. Right, but as I explained in the article, inflation will likely arise in one of two ways. The higher growth scenario (which will be good) or the stagflation scenario (which will be not so good). Either way, it’s an inflation problem. Not a sovereign debt issue that revolves around default.

  4. You are so right on how a investment managers responsibility is to side step hyperboles before making investment calls. Biggest trap is the consensus trap…perfect example in Indian market has been Infosys (Indian blue chip IT firm) for last one year..a year back 100% of Investment managers and analyst community was bullish on it (you can confirm from blo0m)…now no body seems to make sense of these 8-10% gap downs on results

    I remember around 2011 year beginning I was meeting some very very big fund managers (assume among top 5 in AUM), and was discussing with them my bearish view on IT sector specifically Infosys. Since I was representing a small brokerage, they brushed me aside saying they have big brokers lined up who can explain the Infosys to each letter and comma.
    (Btw funny thing was that my own firm was firmly against that bearish view and my analyst, better if I don’t say anything:) )
    This same discussion, I had with other fund managers as well who were paid to serve their unit holders but instead served the brokers, their masters and own ego’s:)…such is the nature of the industry…..I love analysts, specially sell side, who have got it once right (luck, coincidence, brain …or whatever) and then they get their bias so entrenched that it stinks of mediocrity at times. If you notice beginning of 2011 Infosys has 99.99% (as corrected by an old friend) of analyst rating it Buy….i mean can it get any more contrarion…when the whole I’m-So-Smartly-Dumb community of analyst (there were some exceptions I know) are on one side, its easy to see whats happening….now the same funds who have kept Infy as their highest weight must be having nightmares…
    I still don’t get it how do these fund managers (majority I m saying) get the right over money of common public to invest , when all they do is follow the herd:)

  5. The government/central bank of an autonomous currency issuer CAN keep the interest rate lower (even much lower) than inflation. It’s happened in the US and in UK after WW2 when DESPITE the strong growth there was financial repression for about 25 years. It’s happening now in China, India, Turkey… A lot about has been written by Rogoff and Reinhardt that are really good economists because they just look at historical data without ideological hints. Debt ALWAYS matter, I agree with Steve Keen. And a goverment has to protect himself first so real interest will be positive just in two cases 1) debt is low enough and the government want to promote private wealth accumulation instead of public debt reduction via financial repression 2) there is strong deflation, so a 1% bond ensures positive real interest like in Japan

  6. Cullen:

    Sure, Japan can print yen, which makes it very different from (say) Greece. Thank God!

    Sure, if aggregate demand increased in Japan, forcing the Bank of japan to need to raise interest rates to prevent inflation rising too much, but also getting Japan out of the recession, that would be a good thing. I hope it happens, and the sooner the better.

    But there might be (or might not be, it depends) one unfortunate side-effect of that recovery. If the increase in demand was big enough, relative to the recovery in the growth rate, it is possible (not certain) that the rate of interest would need to be increased to a level *above* the growth rate of the economy. Which is a worry if you have a debt/GDP ratio north of 200%. Japan would have to cut spending and/or increase taxes by a lot, to pay the interest on the debt, to stop the debt/GDP ratio rising forever to infinity.

    You might enjoy my latest post on this subject: http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/07/trill-perpetuities.html

  7. Hi Nick,

    I think you’re blowing the interest payment problem a bit out of proportion. The current interest payment expense is just 10.9% of the general account (9.8T of the 90T total). Not miniscule, but it’s not exactly a budget buster. And it’s minor compared to GDP (what, 2% or something?). But even if rates double or triple from here we go to something closer to 25% of the current budget. Again, not minor, but it’s not going to slaughter their economy. Additionally, we should expect the automatic stabilizers to do much of the heavy lifting you’re calling for as tax receipts are certain to rise substantially if the economy booms.

    But again, I’d add that this is a “problem” Japan would now love to have. Finding ways to slow down their booming economy means they’re no longer in the deflation trap….Hell, I wish the USA was so fortunate to have this problem of too many tax receipts, too much growth, and a Fed who can’t grind this freight train down to a halt to save their life….We can only hope….So, if economic booms keep you up at night then I am afraid you need some Ambien and perhaps develop a drinking problem to wash those pills down! I am not a Doctor though, I just play one on the internet. :-)

  8. From what I understand, your argument is that a central bank can always control interest rates if it can print money. I think I disagree. I say think, because I don’t KNOW anything. I’m a trader, I try to assess probablities adn look for assymetric opportunities. Which some investors seem to think Japan may be.

    Here’s why I THINK I disagree with you:

    So the CB of japan can simply be given the go ahead to print unlimited money out of thin air, should the need arise (which you say will not happen, ever).

    First of all, shit happens. We cannot – CANNOT – know this for sure. If something should trigger a rising interest rate environment in Japan, they’re screwed.

    What might this be? You mention sound inflation and stagflation scenarios as two possibilities.

    Furthermore, your argument seems to be that should the need still arise, they can suppress interest rates indefinitely through this money printing. Sounds good in theory.

    You write:

    “What’s not going to happen in Japan is an environment where bond markets just say “oh screw these bonds, sold to you!”. Why? Because as long as growth remains muted and inflation appears low bond traders are going to continue to clip those coupons with the understanding that Japan can always be good on debt payments because they are an autonomous issuer of the Yen”

    First of all, they are not making good on their debts. Printing would weaken the currency, and the creditors get an inflation haircut. This may or may not matter to a Japanese investor, depending on his or her needs, mandate and investment alternatives.

    What could trigger inflation without growth too:

    The stagflation scenario:

    Consider the severe oil price shock and subsequent cost-push inflation shock you allude to, triggering higher rates and forcing the CB to print to keep rates down.

    Would the Yen not then sink versus other currencies as this money printing occurs, thereby forcing interest rates higher still, and could this not aggravate the budding bond crisis?

    Would people then not consider selling these bonds and look to alternatives, since the real return on these bonds would be lower as inflation occurred, and the upside is so limited?

    I am not convinced that they would not. And if they did, Japan is proper f##ked, as Tommy from Snatch would put it.

    Couldn’t one risk be that you have a death spiral of sorts on your hands if the currency weakened, triggering bonds to sell off and yields to rise, forcing the CB to print, further causing the yen to weaken and investors to sell and so on?

    Also, equating Japan with the US just because it is a sovereign state with the right to print seems weird. Remember that Japan’s budgetary situation is not remotely comparable with that of the US. The US is the poster child of fiscal health compared to Japan. For example:

    Japan spent 20% of govt revenues on 1nterest expense in 2010. Their govt debt to revenue ratio is 1900%, almost 20 times.

    A 100 Bps increase in Japans weighted-average cost of capital would equate to an increase in interest payments of about 25% of central government tax revenue. If Japan paid what France paid to service loans (15 months ago, not today), this would require 100% of central govt revenues.

    So it would not take much in the way of rising rates to cause a hell of a lot of trouble.

    My main point is that believing a CB has total control over the economy is naive. CB’s track records are not that great when it comes to acting appropriately and on time. In Japan’s case, failing to act appropriately at a critical time could trigger a problem that is unfixable, it seems to me.

    As I said, I don’t KNOW shit. But JGBs don’t seem like such a good investment to me.

  9. Anyway, hope you’ll take the time to reply Cullen. Would be interested in seeing someone convincingly taking apart the Bass argument, I haven’t seen it done yet – but that doesn’t necessarily mean it can’t be done, I guess.

  10. From a cultural perspective, Japan would be the last place I would expect bond vigilantes. As Cullen says, the Yen is a creature of the people, and in Japan, people are the creature of the state which is a creature of the corporation. On the opposite end of the spectrum is France and Britain.

  11. Nick if you’re still reading. You studied in the UK. With regards to bond vigilantes, do you know the UK in 76 felt the need to be bailed out by the IMF (as an autonomous currency issuer)? Cheers!

  12. Not related to this post, but from a few days ago when Cullen made the argument that a strong housing market was inconsistent with recession.

    From Bloomberg this morning: “Warren Buffett, the billionaire chairman of Berkshire Hathaway Inc., told CNBC that economic growth in the U.S. is slowing even as the housing market shows signs of rebounding.”

    Maybe it’s time to throw out the old playbook. Maybe we can we have a recession even though housing is getting better.

  13. That’s like saying: “Apple is certainly in a bubble so what happens when their business collapses?” Okay, totally plausible, but where’s the analysis? Why will their business collapse? Where are the details?
    As an investor, you don’t need to answer that question. You don’t put more than 5 percent of your money in Appley because it could collapse. You don’t need to know why it could collapse, you just need to protect yourself.
    As to why do bubbles burst — well, they just do. A bubble is when something is priced way, way beyond the fundamentals. You can make money on bubbles, but you will alse lose big at some point if your money is tied up in one.
    You also need to realize that there are more possibilities out there than you can possibly imagine, and that flat statements like, ‘Japan can continue on this path indefinitely’ could cost you someday. You are making a long-term call there; just don’t get married to that idea.

  14. H, I never said Japan couldn’t collapse or that the CB has “total control over the economy”. Plus, I am not long JGBs nor do I recommend anyone be long JGBs. In fact, I don’t give investment advice here so that’s that.

    Short comments:

    “Printing would weaken the currency, and the creditors get an inflation haircut. This may or may not matter to a Japanese investor, depending on his or her needs, mandate and investment alternatives.”

    Japanese investors have literally been saying this for 20 years. Where’s the inflation? There’s an obvious hole in this argument.

    “CB to print to keep rates down.”

    CB’s don’t “print to keep rates down”. They swap assets. Big difference.

    I don’t think you’ve entirely digested my points or monetary system perspective. Maybe read the primer first?

  15. He’s not married to the idea, hence the acknowledgement that a pickup in economic activity would lead to inflation, which would cause the BoJ to raise interest rates. As long as Japan continues down the debt deflationary path, which it is 22 years into, the zero interest rate regime will continue. I’d rather be long zero coupon Japanese bonds (I’m in it for the price movement) and short the Nikkei rather than the other way around.

  16. Different situation there. The UK had running inflation and no political power to either restraint the worker unions and their demands for even higher wages or enforce higher interest rates to dampen inflation. In fact, inflation was so high it had become a danger for other monetary systems (US, etc).
    The easy way out was to convince the population that the country was broke and needed a bail out from the evil IMF. Politicians could stay in office and had a good excuse to refuse the union demands without being the party pooper who raised interest rates and crashed the economy.
    The US chose a different path few years later with Paul Volcker at the helm of the fed.

  17. They also had an IMF loan so their policy options were constrained. Not sure of their institutional structures either. And don’t get me wrong. I am not saying that having your own CB and Tsy makes you immune to real resource constraints or real economic constraints. But it sure helps in establishing working policy in tough times.

  18. Thanks, that’s pretty interesting. I guess it reinforces Cullen’s view that currencies are creatures of the people; in this case, the politics and perhaps the people’s expectation that exchange rates were fixed, forced the government to act in an “irrational” way.

  19. This is a big piece of MR. The govt cannot force currency acceptance on the people. Quantity value is largely out of the hands of a govt and in the hands of the market. So don’t get me wrong. I am not saying that a govt can force currency viability. Most certainly not.

  20. Cullen,

    How does the currency value factor into your analysis of an investors willingness/unwillingness to hold YEN denominated assets?

    From the standpoint of a domestic holder, I guess it wouldn’t matter that much, however any nominal coupon value would be wiped out with even a pretty small depreciation in the YEN for a foreign holder of the assets.

    Doesn’t the deficit and debt they are running suggest a weaker YEN at some point?

    I am not exactly sure what the mechanism for a currency devaluation (a general change in perception?) would be in the Japanese case but that would be my fear as a holder of the bonds.

    Thank you.

  21. H, I never said Japan couldn’t collapse or that the CB has “total control over the economy”. Plus, I am not long JGBs nor do I recommend anyone be long JGBs. In fact, I don’t give investment advice here so that’s that.

    Short comments:

    “Printing would weaken the currency, and the creditors get an inflation haircut. This may or may not matter to a Japanese investor, depending on his or her needs, mandate and investment alternatives.”

    Japanese investors have literally been saying this for 20 years. Where’s the inflation? There’s an obvious hole in this argument.

    “CB to print to keep rates down.”

    CB’s don’t “print to keep rates down”. They swap assets. Big difference.

    I don’t think you’ve entirely digested my points or monetary system perspective. Maybe read the primer first?

    Hi Cullen, thanks for your response.

    I didn’t say you recommended JGBs.

    Let me also clarify – to make a difference, the argument I was trying to make, not very articulate there, sorry about that: the CB would have to print (swap) in much more significant size to make a difference regarding inflation.

    They have not printed enough to dent deflation. Hence no inflation, no weakened currency. Yet. Enough printing, and investor sentiment may change.

    Investor sentiment changes, currency weakens, bond market dynamics may change. Maybe. As I said, I don’t know. And neither do you, methinks.

    Anyway regarding the printing issue: In an earlier post from 2010, a comment below stated:

    “QE is not printing money, providing the Fed’s balance sheet is appropriately shrunk as the purchased assets mature. That is where we dont yet have any clarity.

    If buying treasuries, gse debt, etc helps lower rates and pump liquidity into the system, then maturing or selling these assets should have the reverse effect.

    If the economy remains sluggish, the Fed is then forced into a cycle of ongoing asset purchases and an ever expanding balance sheet. As the Fed’s balance sheet becomes ever bigger, the impact on the economy of unwinding all those purchases becomes unthinkable.

    At some point the Fed may simply write off a bunch of its assets to get off the treadmill. That is the point at which QE becomes printing money.”

    Would you agree with this statement? If not, why not?

    I promise, I will read your primer! Starting right now.


  22. Cullen: OK, that’s a reasonable argument. My Japan worries are a whole order of magnitude lower than my Eurozone worries.

    And the UK had a debt/GDP ratio around 200% a few times in history. Basically, any time we got into a serious fight with the French or Germans, which happened quite a bit. But managed to pull through without defaulting (though helped a bit by inflation the last time around).

    But every year that goes by without a proper recovery in Japan, the debt/GDP ratio keeps rising. Your numbers would look a lot worse 10 years from now, if there’s no recovery. The longer this lasts, the more worried I get. And I’m worried it might last.

  23. I studied mostly philosophy in the UK. In 76 I was in UC Berkeley, so don’t remember it very well. But wasn’t the UK on fixed exchange rates then? And that’s why it needed the IMF? I think it was. Fixed exchange rates make a big difference (see Eurozone). You can’t print forex, so you have to borrow it if you need it. The IMF was the lender of last resort for foreign currency reserves.

  24. Then Japan is toast because rising interest rates (in the current deflationary mindset) will be seen as a bearish sign and that will send investors fleeing.

  25. Mish is wrong. The BOJ can set the interest rate on Japanese debt at whatever they want. They are autonomous in Yen. Mish is making the bond vigilante mistake. It’s been wrong for 20 years and will continue to be wrong.

  26. Why are you talking about default or running out of yen in relation to the original article by Rowe? He mentions neither.

    I agree high inflation with no growth is worse than high inflation with growth, but how does Japan grow with such high debt loads? Stagflation is much more likely, and that is what I believe Rowe is concerned about.

  27. Patrick, If he meant that he wasn’t very clear about it and he shouldn’t have used the term ponzi scheme. He clarified his comment here and I think we largely agree. Either way, I am not sure what you keep trying to get at here. You’ve offered practically zero proof of your claims like “how does Japan grow with such high debt loads?” This is a baseless statement. Japan’s GDP has almost doubled since their debt bubble imploded in 1990. That’s 3% growth per year. So your statement that high debt levels implies no growth is just totally wrong.

  28. Let’s look at it from practitioner’s point of view. A country that runs current account deficit HAS to balance it somehow, it is an accounting entry. Usual way is to sell sovereign bonds to foreign counterparties. It also might be cash instead of bonds. But, obviously, in order for the foreign counterparties to keep Japanese currency/bonds, they should expect to have some appropriate rate of return on it. If the resulting return is below expectations, the counterparties would immideately exchange Japanese currency they receive trading into let’s say USD. Thus, under the condition of current account deficite and fixed interest rates, Japan would start to loose the reserves. Since their resevres are big, they would be able do persist in this for quite some time, but at some point they will have to revert to current account surplus, or they would hit the wall!

  29. And that’s a point where we’ll continue to disagree.

    Interest rates are the product of supply and demand. “Mr. Market”. When the demand for money declines as a result of a “recession” or as a result of increased productivity rates go down. When money flees a market (T-bonds, JGBs, Greece) then the price of money (interest rates) in that market goes up.

    Deflation is a reduction of money & credit. So, the result will be (inevitably) rising interest rates. Currency user or currency issuer. No matter what MMR or MMT thinks.

    Remember: Stocks tanking or rates rising is actually deflationary because the value of money rises against those assets (stocks, bonds).

  30. First, this has nothing to do with MMT so I don’t know why you keep mentioning them. MR agrees that quantity value is an important component of currency viability. Maybe you should read my updated primer or wait next week for the inflation part?

  31. Is the BOJ currently buying bonds on its own? How much of the debt is on their balance sheet?
    The MISH piece reported that Japanese pensions are beginning to be net sellers instead of buyers of G bonds. So I wonder if the BOJ is starting to pick up the slack itself.

  32. Look, under current account deficit conditions a country (Japan) HAS to balance it somehow! The foreign counterparties receive Yen in trade. Then, they can can keep it, or buy Japanese sov bonds, or convert Yen into something else. Do you agree with me here?
    I used USD as conversion basis because it is world reserve currency. If foreign counterpartice do not want to keep yen/jap sov bonds, they would convert yen into usd. For balancing purposes, and to keep exchange rate stable, the USD japanese reserves have to go down.
    If this scheme continues for some time, japanese usd reserves would go to zero.

  33. Cullen-
    “I approach all of this macroeconomic stuff from a very different perspective than most economists. As an investment manager I’ve had to learn how to connect the dots or die. And scenario analysis like the following is one reason why I’ve had a pretty good track record over the years of avoiding bad predictions like “bond bubbles”, USA defaults, attacking of the bond vigilantes, hyperinflation, etc. As an investment manager, I can’t just say things like “I am bullish on Apple because of their strong balance sheet”, then buy the stock and wish for the best. The process has to be a prudent and in-depth analysis of potential scenarios and the various dots that could unfold. And then I have to connect those dots, understand the risks and decide whether the risk is justified given the potential outcomes. What is the risk to Apples balance sheet, what could cause XYZ to happen, how likely is XYZ, etc etc”

    Now I’m confused.

    You posted a graph of the Icelandic 15 and said it was wrong and called it barbaric to “allow” this decimation of that population. So if your a money manager set to profit and analyze why you should invest how do you justify doing all that work to discover you should not invest in X because it is not worth X and then say I’m wrong for saying it’s wrong to allow the work you just did to come to fruition? If your discovery has you not investing in X(iceland) how do you justify it being ok to halt that which your work says should occur?

    Further-didn’t Iceland now put themselves in a position in which they can devalue there currency making exports more attractive and imports more expensive. 10 yr. Icelandic govt. bonds issued below 6% with unemployment down to 6.3% and GDP growing? Isn’t this the perfect MMR society. Control and rebuilding faith in the economy. Isn’t Iceland the Success story of Europe?

    So I ask you. As an investment manager how do you rationalize telling me I’m wrong when I had nothing to do with Iceland. It is someones job to win and someones job to lose. As Howard Marks said,” we profit from others mistakes”. By preventing me from profiting short in a country or stock you’ve rigged a market under the guise your helping out the people. When history is crystal clear on Iceland. They are the envy of Europe and learned valuable lessons. Further this is the Krugman argument which scares the public into burdening society with someone elses losses which as an investment manager neither one of us would have invested in…because…..they are supposed to go down.

    Help me on this one. Been here with you for 3 years??? I guess it’s about time we disagreed.

  34. First Mish is an idiot, his small time celebrity status has clearly gone to his head. 2nd I’ll take the other side of your trade, I’ll buy the Yen and Japanese bonds you are selling because you wrong. I don’t like simplifying the world into that binary but you, and Mish, are simply wrong. 3rd from reading your posts, and I’ve been following you loosely for some time now, I feel you’d be much better received trolling the pages of ZeroHedge.

  35. Beg my pardon, I got lost in all these responses to responses. Did you respond to my post or to somebody else?

  36. Japan hasn’t had a normal recovery because they never addressed the underlying problem of private sector debt. The easiest way for the private sector to delever is if debt is written down and/or the government runs a large budget deficit. However the Japanese haven’t done much of either; default is seen as a lose of face, the Japanese are obsessed about loosing face, and the government has run a relatively small cyclically adjusted deficit.

  37. Japan is a fascinating case . . . and there’s certainly no shortage of investment managers that lost a bundle shorting JGBs the past 15 years. But 3% avg GDP growth sounds pretty darn high . . . I know they’ve been dealing with mild deflation for years but I thought nominal GDP was only up only marginally since their ’89 peak??

  38. this comment is me trying to wrap my head around “what if” interest rates rise when a Gov has high debt/gdp ala Japan

    1. interest rates only rise because the BOJ chooses to raise them

    2. the fear is excessive interest payments on the debt somehow crushing the economy, and/or causing the BOJ to run out of money, and/or causing
    massive inflation as the BOJ pays out huge sums

    3. the reality, BOJ will only raise rates when the economy is booming – and in a booming economy tax receipts rise, and entitlement payments shrink (welfare, food stamps, UE benefits) both of which reduce the deficit, and therefore debt payments

    4. not mentioned above, but the Gov could also cut spending and/or raise tax rates which removes money from the economy even while higher interest rate payments to bond holders adds money

    In summary – what is there to fear?

    I guess Bond Vigilante and his ilk just flat out disagree with #1. But if you agree with #1, then what am I missing from the fear mongerers?

  39. Looks this up myself. Short answer: Their balance sheet is much larger than the Fed’s.
    I still don’t have a clear idea if those positions of any central bank or authority have to be unwound, carried forever or just made to disappear.
    Good thread.

  40. Japan doesn’t need foreigners to buy bonds any more than we need China to buy our bonds….and foreign demand for the currency will remain strong so long as Japan continues to make things that people want.

  41. My point was simple. If we can avoid having an entire country fall into depression because of the irresponsible actions of the minority then we should enact every weapon at our disposal to do so. If John Paulson wants to bet on aramgeddon because 25% of the population goes crazy and the govt protects the other 75% by implementing some firewall then I say screw John Paulson. An investment manager should also understand that govt’s exist as a tool to help us achieve prosperity. They’re not just the referees. They are at times the most important player on the field.

  42. Depends on your time period. Since 1996 GDP is basically flat. I chose the bubble peak, which was 1990. You could cherry pick a bunch of different years, but the fact is, since the debt bubble topped out the country has actually grown quite a bit.

  43. A ponzi is a criminal fraud enterprise masquerading as investment, which eventually results in a collapse of the scheme and revelation of the fraud, not a default. I can see a scheme that could be loan based, but it’s still fraud rather than default. Saying ponzi is not the same as saying default.

    What I keep trying to get at is that it seems whenever somebody posts about high debt and potential problems you return to default, regardless of whether they said anything about it. I am challenging your theory, and I’m also wondering why you are so focused on default, even when nobody suggest it.

    I saw your conversation with Rowe and it doesn’t seem either of you have changed your opinion to me. He acknowledge you have a reasonable argument (which I agree with), stated that he is currently more concerned about the EU than Japan, but still considers Japanese debt and deficit a problem.

    Regarding “how does Japan grow with such high debt loads?”, it’s not a claim, but a question. You can even leave out the debt portion, how does Japan grow it’s economy at anything but a snails pace? I don’t see much growth potential for Japan, you indicated that as one of the two cases, so if you see a path please elaborate. The reason I include debt is because with higher debt comes higher debt service, particularly with increasing growth/inflation.

    Where do you get your 3% number? According to this site their GDP has grown about 0.6% per annum since 1980, which includes the pre-90s bubble, so it would be lower since 1990:


    “Historically, from 1980 until 2012, Japan GDP Growth Rate averaged 0.5300 Percent reaching an all time high of 3.2000 Percent in June of 1990 and a record low of -3.9000 Percent in March of 2009

    Different page same site shows Japan GDP at very slight growth over that same timeframe:


    As does this site (which provides both nominal and real numbers):


    I never said no growth, I said low growth.

  44. It seems to me we are talking about different things here. Being China, or anybody else who runs surpluses, they have to either keep a currency which they got in trade or to buy something with it. In the case of China, it chooses to buy USTs as of now. Japan is running surplus now too, and also buys USTs. If it is going to run deficit, it will have to either sell it’s own bonds or to sell USTs it keeps as reserves.

  45. Patrick, I appreciate your role as devil’s advocate, but my focus has always been inflation. That’s been my point from the beginning. It is everyone else who talks about default. I keep saying the real constraint for an autonomous currency issuer is inflation and that pointing to high debt levels is meaningless without context. You seem to agree with me on that so I don’t even know what we’re going back and forth about….

  46. What about Argentina? They attached their currency to Dollar and it lead them straight to hell. But they controlled inflation. And they entered the crisis with growing economy, which was pumped by the cheap dollars.
    Or home prices in Canada? The market is growing just because the bubble gets bigger and bigger. It is moderating the inflation, but it will die on the household debts. Or at least this is what I would presume.

  47. I definitely agree that high debt levels is not inherently a doomsday scenario, for example we had debt levels similar to what we have today after WWII and we went on to one of our greatest periods, but those times were very different from what is going on today.

    Context is absolutely important, but I consider a conversation about debt levels in Japan to be full of context.

    When I see comments about how central banks can set interest rates at anything they want, I consider it to be the same as saying they have godlike powers.

    I agree that the debt loads do not have any predictable affect on bond yields, it’s a straw that broke the camel’s back effect. Everything is fine until it wasn’t, and then all of a sudden everybody sees it and a crisis rears it’s ugly head. Just like what happened in the EU, and just like what happened in the U.S. and the world when the mortgage bubble collapsed.

    I’ve read part IV of Understanding MMR and in it you seem to say that deficits do matter, so it confuses me when you post articles that seem to say the exact opposite… Perhaps I’ve misunderstood the point of your original post, if so, then my bad.

  48. Cullen

    I don’t have an opinion of Paulson or what he does. But again in Icelands case allowing those who invested to lose benefited it’s economy, current and future 352,000 icelanders. The depression lasted 18 months. By 2010 they were growing unsaddled with someone elses mistakes. The opposite is true. This was never about helping the people it was and still is about protecting invested interests ONLY. That is why it made sense then and has worked. Unemployment in Iceland is 6.5% as of 2012. Better than the U.S and it’s bloody cold and not that desirable place to live. Remarkable.
    But..Heres what gets me about this argument the FED, Policy makers or Wall St. uses to justify covering their mistakes. It is what you just said,

    “that govt’s exist as a tool to help us achieve prosperity. They’re not just the referees. They are at times the most important player on the field.”

    If that is the case..then why are we here? Why if the govt.s job is to be the referee have they not done it? Why if there job is to maintain stability in the financial system, surpervise and regulate banking institutions and maximum employment have they NOT DONE ANY OF THAT? Why if this is the referees job to do did doing exactly what they advise not doing(allowing Iceland or Greece or X bank) do what they can not. In doing what Iceland did…they accomplished the very Objective of What the Federal Reserve System can’t seem to do? This is the george costanza conundrum.
    But more…I agree with you that the referrees should be there however should they let it get to this point(where iceland ended up) it’s too late. To come in claiming your there to help…I say..your too late. Then to claim Iceland, or any other govt. has a duty to not allow a depression I say your right. So where the FKKK where you? Where were you Ben and ECB for the last 12 years? The referees were not minding the store and now it’s looted. And now they want to be captain save a ho? I’m a bad guy because I’ve been telling these guys to do the right thing and now that the bill is coming due I should not be allowed to profit from 20 years of flawed assumptions and can kicking?

    If your going to be a referree than your job is 24-7 365 days. It’s not only when an election comes up or when the can can’t be kicked. It started 20 + years ago. I won’t here they are here to help. If they were here to help we would never have needed them today. A good referre goes unnoticed during the game. These guys…..there everywhere now. Messing up the game they messed up.

  49. Just to keep an open mind, and in the context of the thread above on the UK, we should be careful to fully understand the motivations of the government. For example, for whatever reason, the government felt they wanted to defend JPY/USD (e.g. corporations were massively long USD unhedged, oil/LNG shock [although this is always a special case]) then interest rates would increase. Sometimes these things start off innocently; the gov encourages corporations to invest overseas and do so via unhedged leverage, then … ooops!

  50. Right, but you seem to be contradicting that by this post, and others, that imply that central banks can control interest rates no matter what their debt/ deficit loads are.

  51. Look, I am by no means saying that having a printing press is some guarantee to lifelong prosperity for all involved. I am just saying that having a unified Tsy and CB gives that country weapons that it might not otherwise have. If you read my paper you’ll see tons of mention about production and the fact that a country is really only as good as the goods and services it makes. The tools it uses to protect these goods and services from various risks are all of secondary importance….So let’s keep things in context here before people go jumping to conclusions thinking I am saying “printing press = victory”.

  52. They can. An autonomous central bank has limitless reserves. If they want to set the overnight rate at 0% and leave it there forever they can do that. This is just a fact of life. There might be environments where that would not be a prudent policy, but it doesn’t mean they can’t do it permanently.

  53. To say that debt/ deficits matter and to say that CBs can control interest rates is contradictory. They cannot both be true at the same time.

    Further, overnight rates are not the entire story of interest rates, and probably the least important of all rates. I am talking about bond rates, the full spectrum, short term to long term.

    If debt and deficit matter, then CBs do not have unlimited control over rates.

  54. Please explain why they cannot both be true.

    The entire curve is hinged from the overnight rate because that’s the rate from which banks set their spread. This is banking 101. It’s BY FAR the most important rate. As evidence, the credit markets in the USA didn’t seize up in 2008 because 30 year bonds weren’t liquid. It froze up because the overnight market froze up. The overnight market is BY FAR the most important market in any credit based system because that’s where all the most liquid loans are being made.

  55. If the overnight rate was enough to control rates then why operation twist? There would be no need for it.

    The overnight rate is one of the inputs into rates, but it’s definitely not the only one. If it were all banks would have the exact same rates on like instruments.

  56. I didn’t say it was the only one. I don’t think this conversation is going anywhere. Thanks for chatting Patrick. I’m sure there will be a next time. :-)

  57. The overnight may be the most important rate, but it is only one of many inputs into the full range of interest rates. It may Controlling the overnight rate is not the same as controlling interest rates.

    If the overnight rate is the only rate that matters please explain how the FED could set the 30year rate to 0 through the overnight rate.

    Unlimited control of rates and debt mattering are contradictory for this reason:

    Set all rates to 0, and debt can grow to infinity as simply rolling over the debt would be sufficient.

    Saying they have unlimited control over the rates is the same as saying they have unlimited control over the buyers of their debt, which is the same as saying they have unlimited facility to sell debt.

    That is why unlimited control of interest rates and debt / deficit mattering are contradictory statements.

  58. Patrick, it’s not easy to have an honest debate with you if you keep taking my comments out of context. I didn’t say the overnight rate was “the only rate that matters.” I also didn’t say all rates could be set at 0 permanently. I said ” If they want to set the overnight rate at 0% and leave it there forever they can do that.” HUGE difference.

  59. Something has gone wonky with the comments, my previous was an attempt to re-post a comment that seemed to disappear, but I now see it above. It was not a response to your comment which appears directly above it.

    But… I don’t think I’m taking your comments out of context at all.

    “Like the Fed, they have unlimited quantity of reserves at their disposal allowing them to pin rates across the curve however they like.” (a quote from the content of the original post)

    How is that any different than saying they can pin all rates to 0? If they can pin rates however they like, then they can pin them to 0. It may be taking your comment to the extreme, but it is not out of context.

  60. He never said they couldn’t do that, but it would be stupid because then loans would be free. You’re misconstruing his comments.

  61. It’s not misconstruing.

    Governments do stupid things all the time, but it’s irrelevant whether the act itself would be stupid, the debate is whether governments have that ability at all.

    The extreme stupidity of setting rates to 0 in perpetuity is consistent with the theory as presented. My argument is that it is not possible as any government that attempted it would be forced out of such a policy at some point, which means that part of the theory is flawed.

    If I am right then it invalidates a small portion of MMR theory, which is good as then the entire theory can be improved. It doesn’t invalidate the whole theory, as there’s lots of good, valuable and correct parts of MMR.

    If I’m wrong then those who believe I am should be able to show how I am.

    These are the types of efforts that improve a theory, either by proving individual points, or showing the gaps that can then be filled in.

  62. The Fed could set the long bond at 0%. But that would be stupid. Just like the Tsy has the right to just mint a gazillion dollar coin, deliver it to the Fed and spend all the money in one sitting. This would also be stupid. It would all be stupid and it doesn’t invalidate or validate anything. I appreciate your critiques Patrick, but you’re really reaching now.

    Also, there’s nothing theoretical in MR (or very little if any theory). It’s purely descriptive.

  63. Glad this has sparked an interesting discussion.
    Unless I am misinterpreting him, I think Alan Greenspan, former fed chairman would disagree with many of the thoughts I often see on this blog. You can start around minute 8 and then pick up again from 18-20. Do you disagree with Mr. Greenspan or am I misinterpreting your statements?


  64. We had a recession in 2001, and a very weak economy in 2002 and early 2003, even though the housing market was quite strong at the time. Especially in California and the West in general – big increase in unemployment, state government financial mess, and a booming housing market.

    So that was definitely a case of weak economy/strong housing market.


  65. How would the fed set the long bond to 0 in perpetuity, or even for the short run? Particularly without consequence?

    It’s not a matter of whether it’s stupid or not, it’s a matter of the whether they have the power to do it.

    Stating that they unlimited power to set interest rates is a theory statement, it is not descriptive.

    It is also not descriptive to say one need not worry about Japan’s debt load, it is theory. In fact any statement about worry is theory. Descriptive is stating how things are now, but worry is all about the future, and thus in the realm of theory.

  66. 1. You’re putting words in my mouth here. I never said the fed should set the long rate at 0% (although they could and it would cause hyperinflation). The example I generally use is 1% or something near cash, but not a cash equivalent. It would do this in the same way it achieves the overnight rate. By naming a price and defending it if necessary with its bottomless reserve supply.

    2. They ABSOLUTELY have the power to do it. Setting the long rate is no different than setting the short rate. Even Bernanke has specifically stated this in speeches as a policy option.

    3. The Fed has unlimited reserves. There is zero question about the Fed’s ability to set the price of govt debt. This is not even debated by anyone who understands central banking. Again, you’re just ignoring basic facts.

    4. I never said one “need not worry about Japan’s debt load”. I said it needs to be put into context with the current environment. I have no idea why you keep putting words in my mouth. I haven’t said half the things you comment on.

    You seem insistent on misconstruing my words and ignoring basic banking realities. I appreciate your comments and I am being patient with your persistence, but you’re just ignoring everything I write for the sake of defending your original points.

  67. Free-floating pound from 1971 (officially) to 1988-1990 with the introduction of the EMS.
    No peg in 1976 mate.

  68. 1) I’ve never suggested that you said they should set the rates to 0, I’ve stated clearly that your stetements are the same as saying that they could do so, which you clearly state you believe they can in your point number 2.
    2) Bernanke saying something does not make it true. If the FED, or any CB, attempted to do such a thing the market would move elsewhere and they would lose much of their control.
    3) Having unlimitted reserves is not the same as unlimited control over interest rates.
    4) you said: “So, Dr. Rowe, scratch numero tres off your list and halt your worries.” which seems to be based on what you said “their central bank can always control interest rates”. His number 3 is “The national debt in countries like Japan.” Where is the misconstrual? What words have I put in your mouth? If you aren’t saying there’s no need to worry over Japan’s debt then what are you saying, and how is it related to Rowe’s original posting?

  69. Why anyone gives this guy a platform is beyond me. His entire framework was disproven overnight. He never thought housing was a problem until the tail end of the bubble, he never thought derivatives (options and CDSs) posed a problem, he thought the private sector didn’t need regulation for it could regulate itself, the list can go on and on. It would’ve been much better if he were a private sector market participant (asset manager, trader, individual speculator) because he would’ve caused much less damage to the broader economy for he would’ve gone broke long long ago.

  70. @ #1:Yes, I disagree. It’s a matter of demand & supply.
    @ #3:You’re missing an ageing population that also sucks up a lot of taxpayer’s money. In a booming economy demand for capital increases and that leads to higher interest rates. Yes, the deficits decrease in a booming economy but they don’t disappear because rising (tax) revenues always lead to higher gov’t spending.

  71. I’m sorry but your response did not answer my question whatsoever.

    Personal Attack Fallacy “A personal attack is committed when a person substitutes abusive remarks for evidence when attacking another person’s claim or claims. This line of “reasoning” is fallacious because the attack is directed at the person making the claim and not the claim itself. The truth value of a claim is independent of the person making the claim. After all, no matter how repugnant an individual might be, he or she can still make true claims.”