5/30/2013 10:15 PM ET|
What our crash could look like
Japan's 8-day market plunge offers a glimpse into what might happen when the Fed stops pumping money into the financial markets.
Now we know what the crash that we're all so afraid of once the Federal Reserve stops flooding the financial markets with cash will look like, and how it will begin.
The 7.3% plunge in the Nikkei 225 index on May 23 --- with a total drop of 13% from the May 22 close to the May 30 close -- is a dry run for that future crash.
So, let's not look a gift crash in the mouth.
Let's see what the Japanese dry run tells us about what we might expect in a Fed-ends-QE3 crash. And what this Tokyo tale tells us about why it might not happen here at all.
First, we have nothing to fear but fear itself -- which is the problem.
You'll note that the May 23 plunge began with worry in the bond market that spread to stocks. That makes sense, since the monetary policies at the Bank of Japan (and the Federal Reserve) have been designed to suppress yields. The fear is that when intense pressure -- like that exerted by the Fed's $85 billion a month in purchases of bonds and mortgage-backed assets -- is eased, the markets will see a huge reaction.
Note that we're talking about "fear" here. Emotion. Extreme emotion.
Extreme emotion swings to excess.
The trigger here was a move in the yield of 10-year Japanese government bonds to 1% during trading on May 23.
The fear was that this was just the beginning of an uncontrolled, and uncontrollable, move up in 10-year yields.
Just one month ago, the yield on the 10-year Japanese government bond was 0.59%. In rough terms, the yield doubled in a month. Wasn't this the beginning of a move that would take yields not just to 1% but also to 2% or higher?
The halt in trading for the 10-year government bond fed into those fears. Trading wouldn't have been halted unless something really bad was about to happen, would it?
The sky hasn't fallen
In the moment, no one really focused on retreat in the 10-year yield to 0.86% by the end of the day or the fact that the 10-year yield had been 0.85% a year earlier and the sky hadn't fallen.
Second, the more everyone feels that we're in uncharted territory -- and the more untested the guides -- the easier it is for fear to grow.
Japan's dry run for a crash -- which officially moved to 10% correction territory with the May 30 drop in the Nikkei -- offered fear the best of all growth media. The Bank of Japan's efforts to weaken the yen, increase economic growth and revive inflation in a country where deflation is deeply ingrained rely on a program of asset purchases that will pump an unprecedented amount of money into the Japanese financial system.
The amount envisioned is roughly equal to the Federal Reserve's ongoing program of asset purchases, but the U.S. economy is more than three times larger than Japan's. There are doubts about the effects of the Fed's effort, so imagine the suspicions about a program three times larger taking place in a country accustomed to deflation and where previous efforts to revive the economy have fizzled.
And, of course, there's the overarching unknown of the exact effect of extreme levels of government debt in Japan. There is a general consensus that running the world's highest debt-to-GDP ratio -- 215% as of the end of 2012 and a projected 230% by 2014 -- isn't a good thing.
The Japan bears argue that Japan is bankrupt -- a term of limited utility when applied to a country that can print money. The Japan optimists (I'm not sure there are Japan bulls in any meaningful sense) say that because of the country's huge reservoir of savings, it has more time to fix its debt problem and that the Bank of Japan effort might even work.
No one knows, of course, but the arguments of the Japan bears "feel" right. Saying "No one really knows" isn't exactly calming.
Plus, the guy running the Bank of Japan, Haruhiko Kuroda, has been governor of Japan's central bank only since March. Kuroda isn't exactly an unknown in Japan's financial circles; he was the top currency official in the Finance Ministry from 1999 to 2003, for example. But he has never run a bureaucracy as complicated as the Bank of Japan. He also has limited experience in speaking to the financial markets and with his track record, he isn't likely to immediately calm them.
At the Finance Ministry, Kuroda was in charge of an earlier effort to drive down the yen. That leaves the market wondering if Kuroda is more than just a one trick, drive-down-the-yen pony.
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It sounds like Jubak is soft-peddling this one. We are now a global economy, with the US at the head of it all; Japan is just one facet. If the Fed reduces or even stops with the QE's, Wall Street is not going to be calm, cool and collected. Add in our behemoth debt and the problems in the Eurozone, I don't think it will be so much of a 'crash' as it will be a big "cluster-f&%#".
And the sad part is, I think China will come out of this on top, with a gold-backed currency, replacing the dollar as the world reserve.
Gold isn't looking too bad right now, is it?
When the FED stops buying mortgage backed securities, real estate will fall like a rock as once again the "speculators" head for the exits back into commodities. Oil will skyrocket again, and all the sheeple that over extended themselves because they actually believed thier home was worth what the paper said it was will pull back again, in shock. All the consumers who purchased big trucks and SUV's will once again pull back and auto/truck sales will plummet once again. We don't produce as much in this country as we used to, and with Europe in a depression, emerging markets slowing down globally, and China turning to domestic consumer for growth, there is no one to buy what we do produce. I am not an expert on economics, but I do watch the news, not the crap they feed us in this country, but news and financial news from other countries. The entire global economy is sitting on top of a bubble that is being pumped up by the world's central banks, it's only common sense that it cannot go on forever.
I think ThrowAwayYourTV pretty much said it all. Definitely a good article by Jim.
And of course, we all know the United States is going to default on EVERYTHING. Treasuries, savings bonds, Schwarzenegger IOUs. Everything.
I'm going out, get six new credit cards, and PARTY IN VEGAS!!!!!!
We have nothing to fear but the FED itself.
For four years, the Fed has been keeping rates near zero and printing trillions of dollars to spur the economy. It isn't working. Savers need interest on their CD's and bonds so they have income to spend.
The fed is like a landscraper that has spent the last four years pouring fertizilizer and weed control on our economic lawn, yet four years later our lawn (economy) is nothing but a barren match with some sprouts of weeds. And yet Wall Street wants more. It isn't working.
Please Ben Bernanke, get out of the way and let the free market and capitalism work on it's own.
I remember the part of the American dream that included having a false economy based on currency manipulation and depreciation of the nest eggs of the elderly! ............. Let the good times roll!
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