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Slice of MIT
Baseline Scenario
Uber-deflationista and bond bull Dave Rosenberg has this interesting piece of data in his “Breakfast with Dave” newsletter:
Have a look at the household balance sheet:It seems like we are really in Japan 2.0. With the exception that Japan 1.0, the original one, might actually blow up in the mean time.What do households own in Treasury notes and bonds? Try $800 billion.
- Households own $18.2 trillion of residential real estate, even after the value destruction of the past three years.
- Households own $18.1 trillion of equities, despite the vicious bear market.
- Households own a near-record $7.7 trillion of deposits and cash — earning next to nothing in yield.
- Households own $4.6 trillion of consumer durable goods.
- Households own $3.5 trillion of corporate bonds and municipal/agency paper.
Awesome inteview with Nomura’s Richard Koo (full text).
Maybe you didn’t know that:
The whole interview is really worth reading. Two ideas I found most interesting. First, in a balance sheet recession, companies and individuals need to pay down debts that are worth more than their assets, no matter how low interest rates are. In other words, the strategy shifts from profit maximization to debt minimization.
Second, to keep GDP levels constant, the government simply has to borrow the same amount that is being saved by individuals and companies. In other words, fiscal deficits will be financed by those same savings, with no need of external borrowers. That would explain how long-term interest rates in Japan declined to 1.4% over the past twenty years even with growing public debt borrowing.
My fear is that the public debt buffer only represents a way to postpone the day of reckoning as the obvious political least resistance path. The tipping point could probably be reached as the debt rollover risk becomes sensitive to demographic trends (average population getting older and spending its lifetime savings in retirement, health care expenses or support to unemployed younger family members) or companies switching back to profit maximizing mode or the public sector getting accustomed to higher level of spending, waste and corruption or simply a bout of bond market panic. An interest rate shock at high public debt level would quickly trigger a devastating snowballing effect.
Japan holds 10% of the stock of US government bonds. Once the Japanese internal demand for Japanese government bonds (JGB) runs out (because population is decreasing since 2005, because their state pension system since last year has become a net seller of JGBs, and so on), they will have to sell their holdings of US treasuries possibly triggering a worrisome domino effect.
Japan’s problem is deflation, not inflation as far as an eye can see. An “all-in” reflationary policy is what is needed.
Three concepts the BoJ could consider:
Our read is that the BoJ has not concluded that such bold steps are required. But as Mr. Bernanke intoned,3 no country with a fiat currency, which borrows in its own currency in the context of a current account deficit, should ever willingly embrace deflation. It is to be fervently hoped that the Bank of Japan’s rhetorical reflationary thaw of December, declaring it will not “tolerate” zero or below inflation, will give way to active reflationary green shoots by spring.
Weak sovereigns will buckle. The shocker will be Japan, our Weimar-in-waiting. This is the year when Tokyo finds it can no longer borrow at 1pc from a captive bond market, and when it must foot the bill for all those fiscal packages that seemed such a good idea at the time. Every auction of JGBs will be a news event as the public debt punches above 225pc of GDP. Finance Minister Hirohisa Fujii will become as familiar as a rock star.
Once the dam breaks, debt service costs will tear the budget to pieces. The Bank of Japan will pull the emergency lever on QE. The country will flip from deflation to incipient hyperinflation. The yen will fall out of bed, outdoing China’s yuan in the beggar-thy-neighbour race to the bottom. By then China too will be in a quandary. Wild credit growth can mask the weakness of its mercantilist export model for a while, but only at the price of an asset bubble. Beijing must hit the brakes this year, or store up serious trouble. It will make as big a hash of this as Western central banks did in 2007-2008.
I am afraid that Paul Krugman is right when he says that, although a few bullish news are to be expected, the economy is still fundamentally ill:
During the good years of the last decade, such as they were, growth was driven by a housing boom and a consumer spending surge. Neither is coming back. There can’t be a new housing boom while the nation is still strewn with vacant houses and apartments left behind by the previous boom, and consumers — who are $11 trillion poorer than they were before the housing bust — are in no position to return to the buy-now-save-never habits of yore.
What’s left? A boom in business investment would be really helpful right now. But it’s hard to see where such a boom would come from: industry is awash in excess capacity, and commercial rents are plunging in the face of a huge oversupply of office space.
Can exports come to the rescue? For a while, a falling U.S. trade deficit helped cushion the economic slump. But the deficit is widening again, in part because China and other surplus countries are refusing to let their currencies adjust.
I also believe that the United States have the luxury to afford to temporarily run even higher fiscal deficits to keep propelling a sick economy. Something that Japan is probably not able to afford any longer …
Betting on the currency of a country on the verge of bankruptcy is an interesting play. But traders are betting on the yen as we speak. It sure could work on a short term basis, but I still think that Japan will face the wrath of the bond market in the next 18-24 months.
But I am not a trader …
David Rosenberg says that, actually, Japan GDP was more or less flat nominally while deflation boosted real GDP 4.8% …
Speaking of Japan, while many pundits waxed over the “real” GDP expansion of 4.8% at an annual rate in Q3, the entire increase was due to the negative deflator. In fact, the economy continues to deflate at such an extent that GDP in nominal terms contracted at a 0.3% annual rate — the sixth quarter in a row of decline.
The Telegraph has a nice summary of the recent discussion on Japan public debt situation: It is Japan we should be worrying about, not America
Here are my previous blog posts on Japan.