Is Japan's bond market in revolt?

Our own funding crisis could very well be precipitated by trouble elsewhere. And there are signs that Japan's bond market may be rejecting the nation's monetary policy.

By Bill_Fleckenstein May 17, 2013 4:35PM

Pedestrians are reflected in a window as they look at stock boards in Tokyo on May 15 © Junko Kimura/Bloomberg via Getty ImagesI was fortunate to spend a recent Saturday with my anonymous friend, to whom I refer in my columns as the Lord of the Dark Matter, and I wanted to share the key points of our conversation.

 

He believes that we need to stay focused on Japan because its stock and currency markets are acting as if they (preemptively) are rejecting the concept of money printing.

 

The yen has tanked 15% and Japan's bond yields have climbed from 0.50% to 0.82% (more than 60%) since Japanese quantitative easing commenced in November. That increase in volatility alone might begin to cause problems for Japanese derivative books.

 

Bonds? Aye!

When you are in a country such as Japan, where interest rates have been zero for a long time, you can be sure all manner of volatility has been sold (at the wrong price) in an attempt to enhance yields. So if volatility and interest rates increase, we could see quite a lot of chaos precipitated from Japan, just as when the housing bubble burst and it wasn't just declining housing prices that caused problems. (It was also the levered-up exposure to mortgage-backed assets and other crazy products.)

 

Thanks to the policies of central banks, we live in a world where there has been a mad scramble for yield, which means too much leverage has been employed and no one is paying attention to credit risk (or the absolute level of interest rates, for that matter). As said more cleverly by LODM, "the world is short gamma." That means that if the situation starts to get out of control in Japan, there will be big ramifications, there and here.

 

My, gamma, what big teeth you have

I don't want to get ahead of myself, because if the Japanese bond market revolts soon, it won’t be just a funding crisis, but a preemptive one as well. My thesis has always been that inflation will eventually cause bond buyers to take the printing presses away from central banks. That is, the funding crisis would be a reaction to inflation.

 

If Japan’s bond market trouble is imminent, it would be a proactive strike on the part of bond investors. Therefore, I am not quite sure a funding crisis can occur in the short run. But, given the insanity of the Japanese debt market and the monstrous size of the monetization program, we have to be alert to new developments.

 

We all know that the policies being pursued by governments and central banks are insane and ultimately disastrous, but they won't stop without being forced to. This is also why I would expect the Bank of Japan to do more rather than less at the first sign of real "front page news" trouble.

 

And what might the BOJ have up its sleeve to fight this unwanted development? The LODM suggested that if the Bank of Japan were really clever and wanted to stabilize the longer end of the bond market, it would do something like cap 10-year Japanese government bonds at 100 basis points, which isn't very far from where they are today. In that way, given the BOJ's inflation target of 2%, it would guarantee negative real returns and dampen volatility. Obviously, that wouldn't change the eventual outcome, but it would likely buy the BOJ some time.

 

Say a few 'Abe Marias' while they're at it?

Of course, nothing like that has been announced. But the point of this exercise is to acknowledge the fact that Japanese Prime Minister Shinzo Abe and his cohort at the BOJ are not going to give up easily. Capping the 10-year for a while is something they can do, and for all I know there are other clever maneuvers they could also try. At any rate, this is potentially a very serious problem, as JGBs comprise about 900% of Japanese banks' Tier 1 capital. Thus, authorities there are going to move heaven and earth as they fight the bond market.

 

So far, however, world markets have concluded that the BOJ's actions have been a thing of beauty (i.e., the Federal Reserve on steroids), as the Nikkei has levitated 45% this year with no negative ramifications. Thus, I don't want to become too alarmed, and I have taken no action regarding the potential for a Japan-centric financial nuclear event. But I wanted to call it to everyone's attention.

 

This process has just begun, and there is no point in getting excited too soon, but it is a very important development that bears watching.

72Comments
May 17, 2013 9:48PM
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It's government control of the money supply which is causing this mess.

 

If you want to stop this mess, you've GOT to take away government's power to control the currency.

 

In ALL history there is NOT ONE record anywhere of a government that has NOT debased or inflated its currency out of existence.  NOT ONE.

 

So remember that when governments start screaming that it's not their fault for all the inflation, that THEY ARE LYING

 

They control the money supply, so if there's inflation it's THEIR fault, and NOBODY else

May 17, 2013 8:14PM
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Bill, you also touched on Mortgage-backed securities. This past week, the Federal Reserve Buy-Back policy was challenged and rightfully so. Consider a factual case once known as the Fizzle to the Sizzle or how Norwest Bank collapsed under the weight of servicing loans with too low of yield to cover the cost to service them. The ARM Rates back then fell under 4%. The cost of billing statements, postage there and window envelopes alone on billions in loans is substantial. Add delinquency notices and you bear additional costs. Ultimately, Wells Fargo bought a compromised Norwest for that reason. Today, the mortgage rates on FIXED credit are below 4%. In less than 5 years into any recent mortgage, we're staring down insufficient yield to cover costs. The Fed has created another substantial bubble with the credit purchased so far and most of it doesn't perform as agreed to. Cutting off Buy-Backs may seem like cutting the rescue rope on banks, but they haven't stopped doing the bad things that got them in this mess in the first place. This isn't looking or going well for Bernanke (who didn't table the cut-off plea). That's because he isn't a lender and doesn't grasp credit ramifications whatsoever. Because he doesn't we will all be forced to learn this lesson the hard way.
May 17, 2013 9:22PM
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 No economic system ever survive in history without a war. History always show us when the number one country starts to showing their cracks in their economic system, war will follow behind. No one knows what to do but to keep kicking the can until the military are in position to fight (chess match). Keep your eye on Syria, they claiming that they are using chemical weapons back up with Russia. So the fuse has been lite and soon we are about to see a chain of events that will get everyone involve.The rich and powerful crashing the economic system because of  their GREED, so they could go under ground bunkers when the sh*t hit the fan and the rest of us left with the mess that they made. That's the way the rich and powerful strategy in fixing the system. Dam them all. We been set up to fail !! They just keep printing
May 17, 2013 8:13PM
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Wishful thinking, again. All that needs to happen is for interests to get out of control, and by out of control, I mean going up 3-percent above the desired 2-percent and Japan will not be able to even pay the interest on their debt. When that happens there is nothing Japan can do but default. Game Over.

 

"This thing will get out of control. It will get out of control and the [whole world] will be lucky to live through it."

May 17, 2013 5:09PM
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Right on, Bill. It certainly makes sense that our constant infusion of fake cash into our dead cat stock markets is prompted by how intrinsically we are hooked into Japan's sinking ship. Unfortunately, all we are doing is insuring that when they fall and fail, we go down harder and explode more brightly. Tray tables up, seat belts fastened, best to fold into a tuck position until whatever survives comes to a full halt. A reminder that what's left of your seat can be used as a floatation device.
May 17, 2013 9:42PM
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Which is why I keep telling people to buy and hold gold, silver, any precious metals, food,

water, and guns.

 

It's one thing for one country to inflate its currency at light-speed, [think Weimar Germany, France during the revolution, the US during its revolution, etc.]. It's totally a whole different ballgame when most of the world starts doing it.

 

Even if law and order in the whole world doesn't collapse, some countries will, and in the countries that survive we're probably going to see a LOT of people getting hurt and even starving. I even see some politicians and bankers being hung from lamp posts, and you know what?  The politicians will deserve everything that happens to them.

 

I for one am not going to shed one tear for them.

May 17, 2013 8:25PM
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"No one talks about derivatives how disastrous this can play out."

 

 A "derivative" is created when there is a large amount of credit requested. Instead of the lender using his own funds, he creates this contract that involves using other people's funds and a promise of a specific return in a given period of time. The problem is- that a greater portion of outstanding derivatives are funded with monies from other derivatives and the accomplished returns are fully based on QE money infused by Central Banks. In a nutshell... this significant chunk of what ails the globe is totally fake and both borrower and lender owe and are owed bogusly. Once we collapse, 99% of these contracts which claim priority fulfillment in all liquidations, must be challenged for validity. We need to be vigilant to call them out and require substantiation. Since none can, they will cancel out rather than fulfill... breaking nearly ALL old money fortunes as they do.

May 18, 2013 2:44AM
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since Japanese investors hold the debt and not foreign governments I believe they will  ride the course as loyalty in Japan is legendary
May 17, 2013 10:06PM
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V-L must be taking his meds today. Making sense and not belittling others

 

"The thing to do is to terminate executives and hire workers"

 

My optimistic hope is what you said above. This would be a game change. I would like to see the gov focused spending toward infrastructure.  America is full of hard working people. spending would accelerate but not with debt.

 

but at this point we may need a highway to mars

 

May 17, 2013 8:00PM
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Looks like unraveling could begin w/Japan. No one talks about derivatives how disastrous this can play out. The Fed is printing to implosion of current dollar to bring in Amero or UN monies,all devalued. The current system was set up in 1913 by the foreign banks to control the US w/debt. They were behind the crashes in 1907  and depression. To control this nation and politicians. Wake up next financial disaster could begin in Aug/Sept China's hosting a BRICS summit to bring in other nations into there gold based financial entity and turn nations from USD reserve currency.
May 17, 2013 11:03PM
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Japan is a bug in search of a windshield.
May 17, 2013 7:51PM
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 I thought Japan decided to pattern the U.S.S.A. in printing counterfeit money(?).  Greece, Spain, Japan ...all trying to grab ahold of our sinking ship.
May 17, 2013 10:43PM
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I think Bernanke is turning Japanese. I really think so. Remember the 80s song "Turning Japanese" by the Vapors? Apparently it's his favorite song and it's been heard playing over and over at the fed's worthless meetings of late. So they twiddle their thumbs and sing along to the catchy tune. And now he's running the BOJ too.
May 17, 2013 8:55PM
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What V_L is saying might be true, but if Bank of Japan is helping out with Japan's government bonds, any effects that might turn out bad is only something to wait and see, like Bill stated.
May 19, 2013 10:16PM
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It seems more and more the stage is being set for the cycle of the world governments economies booms and busts to take the people of this planet on the to the next chapter of this "Civilization"This country was at a great height Christmas 1945 we had by a narrow margin defeated a great evil that threatened to sweep the world. It is 2013 now . We again have a Gang of Ruthless Financial and Government dictators looking to stir the pot in their favor and sweep over the World. I do think  with all the instability  worldwide problems and dangerous power and speed of technology we are going to be in for quite a ride And it may not be a very good one....... Excellent article Bill, very dangerous times we are in , definitely will be watching....
May 17, 2013 10:33PM
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BOJ is The Federal Reserve on steroids.  odd thing is that this year the dallor index is all time highs
May 18, 2013 6:17PM
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Japan has the oldest population in the world. Their attempts to bale water from their sinking ship may work for ahwile, but reality will catch up to them.  Same with Europe and to a lesser extant America.  If we have to pile up debt to cover our bills now, whats gonna happen as the baby boomers retire?  Our economys have atrophied and they will eventually shrink as the ratio of people taking increases relative to the people producing.  Every worker in Japan will soon have a bunch of  retired people to support not to mention their own children.  Racking up debt and printing money are short term fixes.  I believe the money printing is just the next step of this long term problem.  You can only borrow so much, then you start printing.  Japan, America and Europe will print our deficits untill they cant do that anymore either.  Then we will all have to face reality.

May 19, 2013 11:35PM
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Great article Bill.  Printing presses worldwide at warp speed, Bonds are getting crushed, Sovereign Gov't Funds are getting crushed, and real estate continues to blow up in local/regional markets.  Debt bombs/bonds everywhere have nothing to back them up!
May 17, 2013 11:08PM
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Suggested YouTube video: Search for: Dominoes physics (Domino Chain Reaction)
May 18, 2013 12:58PM
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"you can be sure all manner of volatility has been sold (at the wrong price) in an attempt to enhance yields."

 

I wake up every day expecting to hear about some schmuck in an insurance company somewhere who decided to hold the bag for it all for a few $100 million bonus in his pocket. Let’s just hope it isn’t AIG again.

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This column is a synopsis of Bill Fleckenstein's daily column on his website, FleckensteinCapital.com, which he's been writing on the Internet since 1996. Click here to find Fleckenstein's most recent articles.

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