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Japan and the Printing Press


txlaw
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A nice little summary of the new Japanese prime minister's focus on money printing:

http://dealbook.nytimes.com/2013/01/22/back-in-power-abe-aims-to-spend-japan-back-to-economic-vitality/

 

The critics:

For Mr. Abe’s critics, his pump-priming could energize markets and buoy the economy in the short term, but would eventually push Japan even further toward the fiscal brink. Interest rates may be low now, they say, but will rise with inflation — or even spike — if investors start to question the effectiveness of Mr. Abe’s growth policies or grow too jittery about government debt, which is now more than twice as big as Japan’s entire economy.

 

Even a moderate rise in interest rates, critics warn, could weigh heavily on a debt-servicing burden that already makes up a quarter of Japan’s annual budget. The country’s widening trade deficit and a graying population that is eating into its savings are further worries.

 

The supporters:

Mr. Abe’s supporters, on the other hand, argue that Japan will better stoke investor confidence by finally beating deflation and generating growth, not by simply tinkering with budgets. Those advocates, referred to as the reflation school or “refle-ha” in Japanese, argue that aggressively aiming for a healthy level of inflation targeting — and the weaker yen the policy has already brought about — will galvanize exports, revive production, spur profit, expand employment, raise wages and drive up tax revenue in a virtuous cycle of growth, one that will more than make up for the higher debt-service costs.

 

Moreover, if there is moderate inflation with no large rise in borrowing costs, Japan could inflate away some of its debt, they say. Leading the charge on the economic growth front is a star-studded panel of eight chief executives and an academic who will join cabinet ministers as advisers on bolstering the country’s competitiveness.

 

Kyle Bass says the end is near for Japan and, therefore, avoid equities there.  Meanwhile, Tom Russo, Pabrai, and Guy Spier appear to be putting money into Japan.

 

So a question for board members: Which side do you fall on?

 

And, btw, I don't want to read any answers saying too hard or I ignore macro or why not invest in the US instead or whatever.  Those may be fine views to have, but I'm more interested in seeing what people actually think about the Japanese policy.

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I've also been thinking about this a lot.  I'm looking forward to seeing how things play out for Japan, the US, and Europe over the next 10 years, as we are undergoing a massive economic experiment.  This is one of the reasons I wanted Obama to win--to see if these policies were "right" or at least how they turn out, versus a dramatic shift right in the middle, which would have killed our portion of the experiment.

 

I have trouble not agreeing with Kyle Bass, as it seems logical, but there does seem to be a different rules set for governments that can print/monetize debt.

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I have trouble not agreeing with Kyle Bass, as it seems logical, but there does seem to be a different rules set for governments that can print/monetize debt.

 

I personally disagree with Bass.  Not because it isn't possible, but because it isn't likely.  You can itemize the reasons that interest rates spike on sovereign debt and Japan is not standing in the headlights of any of them:

 

1) They can't control their money supply (i.e. Greece vs. ECB, "gold standard" situations) and debt servicing becomes unsustainable and forms a positive-feedback loop.

2) They peg their currency (target price instead of quantity - Russia 1998) - really just another form of #1 - and the exchange pressures become unsustainable and form a positive-feedback loop.

3) They hold foreign-denominated debt (Argentina 2002) and the domestic currency they print to pay it depreciates faster than they can pay off the foreign debt in a positive-feedback loop.

4) The real productive capacity of the economy collapses (Weimar Germany, Zimbabwe).  Triggered by extreme societal stresses and a psychological rejection of the currency by the people.

5) The central bank SETS high interest rates in order to stamp out high inflation/high inflation expectations (Volcker, early 80's U.S.).  The most viable of these options but certainly not imminent, IMO.

 

By far, I think the most important point is that Japan is sovereign in the Yen and do not have institutional restrictions (gold standard, currency peg, etc...) that prevent them from setting interest rates wherever they want them.  Whether they have future inflation is a matter of whether the economy pushes against its productive capacity, and, to a lesser extent, cost of energy, food, and other "inputs".  Bass makes it sound like the BoJ can just, whoops!, one day lose the ability to set interest rates wherever they want them.  All they have to manage to is aggregate demand unless Japan one day finds itself in one of the situations above.

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I have trouble not agreeing with Kyle Bass, as it seems logical, but there does seem to be a different rules set for governments that can print/monetize debt.

 

I personally disagree with Bass.  Not because it isn't possible, but because it isn't likely.  You can itemize the reasons that interest rates spike on sovereign debt and Japan is not standing in the headlights of any of them:

 

1) They can't control their money supply (i.e. Greece vs. ECB, "gold standard" situations) and debt servicing becomes unsustainable and forms a positive-feedback loop.

2) They peg their currency (target price instead of quantity - Russia 1998) - really just another form of #1 - and the exchange pressures become unsustainable and form a positive-feedback loop.

3) They hold foreign-denominated debt (Argentina 2002) and the domestic currency they print to pay it depreciates faster than they can pay off the foreign debt in a positive-feedback loop.

4) The real productive capacity of the economy collapses (Weimar Germany, Zimbabwe).  Triggered by extreme societal stresses and a psychological rejection of the currency by the people.

5) The central bank SETS high interest rates in order to stamp out high inflation/high inflation expectations (Volcker, early 80's U.S.).  The most viable of these options but certainly not imminent, IMO.

 

By far, I think the most important point is that Japan is sovereign in the Yen and do not have institutional restrictions (gold standard, currency peg, etc...) that prevent them from setting interest rates wherever they want them.  Whether they have future inflation is a matter of whether the economy pushes against its productive capacity, and, to a lesser extent, cost of energy, food, and other "inputs".  Bass makes it sound like the BoJ can just, whoops!, one day lose the ability to set interest rates wherever they want them.  All they have to manage to is aggregate demand unless Japan one day finds itself in one of the situations above.

 

I think #4 is the one that Bass is illustrating in his presentation.  Demographics suggest that Japan's social trusts are not only bankrupt, but the underfunding will continue as the population ages, immigration is limited and the number of younger Japanese carrying the burden continues to fall.  At some point the Japanese population will realize that the yen will only take them so far in purchasing power.

 

The other issue Bass commented on, related to #4, was if the central bank changes focus to an inflationary environment, why would Japanese institutions continue to hold sovereign debt when they would return 100-150 basis points below real inflation?  I don't think it's a slam dunk like Bass suggests, but it is possible that Japanese institutions start to shift capital out of Japanese sovereign debt, and that's when the yield curve begins to shift because the government still needs to fund their expenditures.  At best, this increase in the rate that Japan would have to pay would begin to show up in swaps, and you would start to see the world focus on Japan's finances.  Cheers!

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I think #4 is the one that Bass is illustrating in his presentation.  Demographics suggest that Japan's social trusts are not only bankrupt, but the underfunding will continue as the population ages, immigration is limited and the number of younger Japanese carrying the burden continues to fall.  At some point the Japanese population will realize that the yen will only take them so far in purchasing power.

 

The other issue Bass commented on, related to #4, was if the central bank changes focus to an inflationary environment, why would Japanese institutions continue to hold sovereign debt when they would return 100-150 basis points below real inflation?  I don't think it's a slam dunk like Bass suggests, but it is possible that Japanese institutions start to shift capital out of Japanese sovereign debt, and that's when the yield curve begins to shift because the government still needs to fund their expenditures.  At best, this increase in the rate that Japan would have to pay would begin to show up in swaps, and you would start to see the world focus on Japan's finances.  Cheers!

 

I agree that a "softer" version of #4 is the best interpretation for what HE thinks will happen - a decrease in productive capacity will trigger interest rates to increase, but in my mind that makes the theory [GDP decrease] -> ??? -> [spiking Interest Rates!]

 

I would simply point out that regardless of what holders of sovereign debt choose to do, the Bank of Japan can always set interest rates, as they have the ability to buy every Yen-denominated bond in existence and replace them with reserves, which simply act like checking accounts for banks.

 

I would characterize the risks as institutional, by which I really just mean that the yield curve or the deficit would be mismanaged in such a way that facilitated higher interest rates.  Plenty of ways that can happen but Bass sure seems to be suggesting something a little more drastic than an adjustment.

 

One thing is for sure, someone is going to be wrong!  Sounds like Bass isn't paying much for the bet, though, so perhaps it's "heads I win, tails I don't lose much".

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I think #4 is the one that Bass is illustrating in his presentation.  Demographics suggest that Japan's social trusts are not only bankrupt, but the underfunding will continue as the population ages, immigration is limited and the number of younger Japanese carrying the burden continues to fall.  At some point the Japanese population will realize that the yen will only take them so far in purchasing power.

 

The other issue Bass commented on, related to #4, was if the central bank changes focus to an inflationary environment, why would Japanese institutions continue to hold sovereign debt when they would return 100-150 basis points below real inflation?  I don't think it's a slam dunk like Bass suggests, but it is possible that Japanese institutions start to shift capital out of Japanese sovereign debt, and that's when the yield curve begins to shift because the government still needs to fund their expenditures.  At best, this increase in the rate that Japan would have to pay would begin to show up in swaps, and you would start to see the world focus on Japan's finances.  Cheers!

 

I agree that a "softer" version of #4 is the best interpretation for what HE thinks will happen - a decrease in productive capacity will trigger interest rates to increase, but in my mind that makes the theory [GDP decrease] -> ??? -> [spiking Interest Rates!]

 

I would simply point out that regardless of what holders of sovereign debt choose to do, the Bank of Japan can always set interest rates, as they have the ability to buy every Yen-denominated bond in existence and replace them with reserves, which simply act like checking accounts for banks.

 

I would characterize the risks as institutional, by which I really just mean that the yield curve or the deficit would be mismanaged in such a way that facilitated higher interest rates.  Plenty of ways that can happen but Bass sure seems to be suggesting something a little more drastic than an adjustment.

 

One thing is for sure, someone is going to be wrong!  Sounds like Bass isn't paying much for the bet, though, so perhaps it's "heads I win, tails I don't lose much".

 

I agree with you JRH.  Don't know how he is playing it.  The swaps are good for 5 or 10 years out?  That time arbitrage is the difficult question.  Cheers!

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Looks like this is the discussion I tried to start on another thread. Tipping points are clearly potentialy VERY profitable themes to identify. I believe the Japan debt to GDP dilema is one of those tipping points. I can remember debating the sub prime issue and the real estate bubble in the US back in 2007 with some shareholders of of Country wide. I think a similar situation is developing with sovereign debt and currencies. I am of the school that postulates that we do not emerge from the  financial crises until the write offs occur. The write-offs will now likely be at a national level because the risk and liability was transfered from private to public capital. Japan has become the world champion at marathon can kicking I suspect that the race is soon to come to an end as suggested by Mr Bass.

    Hedgies piling on a trend, bond vigilanties and the Japanese house wife ( who have become masters of currency speculation) will be the forces that start the snow ball rolling down hill I believe that will end with bad things happening. It is very likely that the damages will not just be limited to Japan.

    I have not got a clue how to play this and I would watch the spreads on japanese govt bonds and a developing interest in gold by the japenese house wife as tells that the gig is close to up.

   

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The currency play is what I'm looking at.

 

And I would like someone to give me one reason why the yen would appreciate vs USD assuming japan will print more momey in the future than they have in the past 5 years.

Looks like the odds of shorting the yen are quite attractive.

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Japan has become the world champion at marathon can kicking I suspect that the race is soon to come to an end as suggested by Mr Bass.

 

What if they kick it farther a 100 years down the road and in the meatime society changes enough to accept immigration? The fact there's so much wrong with this country also means it's easier (in theory) to fix.  Let hoards of willing, hard working immigrants in, let them raise productivity and carry the burden of the pensions.  (this seems to be Plan F in Japan, current Plan A is Robot Overlords, at least according to various anime movies.)

 

I also think there's a bit of a difference between this and 2007, in what led to 2007 many of those in power did not realize what's actually going on, while in Japan these days they are consciously kicking the can.

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Japan has become the world champion at marathon can kicking I suspect that the race is soon to come to an end as suggested by Mr Bass.

 

What if they kick it farther a 100 years down the road and in the meatime society changes enough to accept immigration? The fact there's so much wrong with this country also means it's easier (in theory) to fix.  Let hoards of willing, hard working immigrants in, let them raise productivity and carry the burden of the pensions.  (this seems to be Plan F in Japan, current Plan A is Robot Overlords, at least according to various anime movies.)

 

I also think there's a bit of a difference between this and 2007, in what led to 2007 many of those in power did not realize what's actually going on, while in Japan these days they are consciously kicking the can.

 

I've wondered about this too.

 

Bass plays up the xenophobic and homogeneous nature of Japan.  Others say that Japanese business is not entrepreneurial enough.

 

But could it be possible that times will change while this inflationary policy does whatever it's supposed to do?  Culture could change.  Energy costs could come down.  New generations of business people who are more entrepreneurial might take the reins.  Immigration and globalism, again, could be adopted by the younger folks.

 

I would agree with the poster who said that the way to play this, so to speak, is with the Yen devaluation.  In that respect, I think it makes sense to try to find Japanese companies with sound balance sheets that export unique or very high quality products that you pretty much can't get from other places.  Haven't really done any digging, though.

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Japan has become the world champion at marathon can kicking I suspect that the race is soon to come to an end as suggested by Mr Bass.

 

What if they kick it farther a 100 years down the road and in the meatime society changes enough to accept immigration? The fact there's so much wrong with this country also means it's easier (in theory) to fix.  Let hoards of willing, hard working immigrants in, let them raise productivity and carry the burden of the pensions.  (this seems to be Plan F in Japan, current Plan A is Robot Overlords, at least according to various anime movies.)

 

I also think there's a bit of a difference between this and 2007, in what led to 2007 many of those in power did not realize what's actually going on, while in Japan these days they are consciously kicking the can.

It takes a crises to change a culture. Japanese citizens have been very docile for a very long time. They are not going to change until such time as change is forced upon them. One only has to look at what happened with Olympic camera to see how difficult it is to make a meaningful change in Japan.
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It takes a crises to change a culture. Japanese citizens have been very docile for a very long time. They are not going to change until such time as change is forced upon them. One only has to look at what happened with Olympic camera to see how difficult it is to make a meaningful change in Japan.

 

I couldn't find anything searching for Olympic Camera. Do you mean Olympus Camera?  They seem to still be around.  What happened to them?

 

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I've been going through a list of japanese stocks lately, and have already bought a few.  The number of companies selling under ncav is pretty interesting.  I get a little scared when people start talking about the yen declining, but there's got to be some price that is too cheap, unless you believe Japan should just go out of business altogether.

 

Now I have a question.  I am just a guy who troubleshoots electronic problems and reads Ben Graham in his spare time, so forgive me for my poor understanding.  But say I am looking at a Japanese stock, and it has cotton, steel, wood or whatever worth 200 yen, and liabilities of 100 yen, and it is selling for 50 yen.  Why should the prospect of the yen declining scare me off?  If anything I'd think that if you've got x yen worth of real assets, and 1/2x yen worth of liabilities payable in yen, then devaluation would make you more valuable.

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Olympus Scandal was documented really well on this board!

 

http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/ocpnf-pk-olympus-corp/

 

Thanks for the link.  I don't follow Olympus (or any other Japanese company), so I never read that thread before today. Interesting.  Japan is a culture I have a very hard time understanding.  Not only the business culture, but all of it.  Probably for this reason alone, I've never been very interested in Japanese stocks.

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Matjone,

 

If the assets are some type of hard commodity then you are absolutely correct, you stand to benefit from a yen depreciation.  However, if the assets are cash/bonds/japanese real estate, anything valued in yen that doesn't have a market outside the country, you could get hit.

 

If you come across any real bargains that meet the first criteria, please share them with the group.

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