And speaking of carry trade. There seems no other fantastic example than the Nikkei 225-Japanese Yen.
The Nikkei Yen trade is a Bet on the Direction of Stimulus
Since Abenomics, the Nikkei’s (Nikk) movements have practically been a mirror image of the Japanese Yen (XJY) where each time the yen troughs, the Nikkei peaks (green ellipses). It is a stunning picture which shows that Japan’s stocks have become a proxy for a punt on the yen and vice versa, and where stock market investors have been trading shoes with currency traders.
And you think stocks are about fundamentals? The Nikkei Yen correlation has basically been a bet on the direction of stimulus from Abenomics.
Early during the year, the Bank of Japan (BoJ) reportedly bought beyond its quota thus the central bank expected to slow their monthly purchases[1]. The result has been devastating, the Nikkei plunged while the yen rallied.
This week has been “bad news is good news” for the Nikkei.
Two bad news: one the GDP numbers had been reported below mainstream expectations, and two, Japanese consumers showed reluctance to spend. The frontloading effect in the face of the coming increase in sales taxes from 5-8% this April has failed to inspire a surge in consumer spending. Hence the mainstream urged for more stimulus, the good news, the BoJ relented.
The BoJ without adding to the QE programs, announced an expansion in two key lending programmes. Upon the announcement last Tuesday the Yen fell, the Nikkei skyrocketed 3.3%[2]!
The Nikkei ended the week 3.86% up which means the Tuesday’s gains has been more than preserved, as rumors of more stimulus[3] seem to have whetted on the appetite for stock market bulls.
In the face of very strong evidence I don’t why the mainstream stubbornly insist that the Nikkei actions has been about fundamentals when it has been a bet on the direction of stimulus.
What’s Really Wrong with Japan?
This graph serves as a startling evidence of the kernel of the problems facing the Japanese economy. The graph represents prices of corporate goods by stage of demand and use[4]. In other words, this should reflect on the price levels of various stages of production. I don’t know to what degree of representativeness this applies to Japanese corporations.
But the message above is that price of raw materials and intermediate goods have been rising faster than final goods.
In short, corporations appear to be very hesitant to raise prices perhaps in fear of demand slowdown. Thereby this means a squeeze in corporate profits. Abenomics has only worsened such existing conditions.
What’s has been the repercussions?
One, Japanese corporations have been hesitant to expand. Growth in machinery orders remain sluggish as December data reported a sharp drop following an increase in November[5].
Two, Japanese firms seem unwilling to raise wages, as base pay slip to “levels around those during the global recession of 2009”[6]. While unemployment rates have reportedly improved[7], statistics hardly identifies which industry has been hiring. My suspicion is that most of the hiring will come from sectors benefiting the boom, financials and real estate[8].
Like the Philippines Japan’s Prime Minister Shinzo Abe wants to stoke another property bubble from QE and zero bound rates helped by the easing of construction, building and land zoning regulations[9]
And a lower yen has hardly been beneficial to Japan’s stagnating exports which has also been hampered by high energy costs.
Third Japanese companies continue to invest abroad[10].
And the lower than expected performance by Japanese enterprises has been reflected on the consumption patterns by households in the face of Abenomics.
This report gives us a clue how Japanese consumers have seen a reduction in disposable income[11] from Abenomics
Price increases are prompting Japanese shoppers to buy less mayonnaise, showing the fragility of any economic rebound unless wages keep up with living costs
The article like most mainstream articles sees a simple solution: higher wages.
But higher wages can only happen if there are more investors. To have more investors mean that profit opportunities should abound. And that is what has been missing.
Governments can temporarily provide jobs, but such jobs have to come from taxpayer money. This means again shifting capital from productive ventures to unproductive bureaucratic tenures. At the end of the day everything boils down to productive risk taking from private investors.
Since every politician and economic expert seem to have a magical elixir in influencing Japan’s policies, they end up creating more problems than less.
Japan’s problems can’t be solved by opening or closing the monetary gap or by government providing jobs or by more government spending, the issue is to create profit opportunities for investors to invest. And that’s something the Japanese government has been doing in the opposite direction. Given the aging population, liberalizing immigration could be a good start.
Also Japan’s stock market bubble has hardly been providing consumers resources to spend, the subsidy from Abenomics only supports a small number of Japanese stock punters. Japanese households only own 8.5% of assets in stocks. Rising stocks has only been supportive of financial institutions and non financial private institutions whose shares have been listed in the markets[12].
And it has been ironic that even with deep capital markets, Japanese households own about a record “ more than $6,000” in cash per person compared to the US at $2,029 where much of such cash has been “ socked away at home in dressing cabinets and shoe boxes” Cash accounts for 38% of retail transactions[13]. This is a sign of distrust on the banking system.
Japan’s Ticking Black Swan: the JGB
All these remain sideshow to Japan’s real problem: the Japanese government bonds (JGB).
10 year JGB yields have been declining since the early spike in May 2013, rose at the end of 2013 as the Nikkei boom climaxed, but collapsed again this year, when the public expectations for more stimulus waned. Like stocks and the yen all seem to have focused on whether the BoJ will increase or decrease her easing programs.
The BoJ has essentially become the only major buyer of Japanese debt as banks, foreigners and households have shown a decline in JGBs ownership from June 2013 to September 2013. Aside from the BoJ only life and nonlife insurance posted a minor .1% gain.
The odd thing is that the Japanese government in their latest budget projection has been expecting a jump in revenues. They expect tax revenues to grow by 16% in 2014 and also expect a reduction of bond issuance by 3.6% to fund government budget. Japan’s government budget has been expected to grow by 3.5%[14].
Meanwhile expected tax revenues accounts for 52% of the Japan’s government budget while JGB issuance constitutes 43%. The budget for debt service which has been expected to grow by 4.6% represents 46.5% of tax revenues. So about half of tax revenues will end up just servicing debt and that is if the optimistic target will be met.
Yet the Japanese government maintains a cognitive dissonance—holding two ideas—as part of their finance management. First they are optimistic that they can raise the targeted budget so they even expect a reduction in bond issuance.
Yet in December, they raised a bogeyman to secure more stimulus. They argued that the slated national sales-tax hike in April may jeopardize growth, thus appealed and got approval for a fiscal stimulus worth 18.6 trillion yen ($182 billion). Most of the loans have been said will emanate from existing spending by local governments and loans from government backed lenders[15].
Two months after, the government seems deeper in straits as the economy has hardly performed as expected and thereby markets expect an increase in BoJ support
Japan’s dilemma is that if Abenomics successfully ignites “inflation” then this should bolster JGB yields and put burden on her trillion yen debt load. The Japanese government has a debt to gdp ratio of 244%[16]. And higher yields will likely force the BoJ to bring down yields by increasingly frantic money printing that may not only lead to a debt crisis but to a currency crisis.
On the other hand if Japan’s thrust to inflate a bubble fails, then a bust would mean greater dependence on debt to finance her budget. With debt servicing accounting for 46% of tax revenues a severe shrinkage in tax revenues may force the government into a debt crisis.
Japan’s current tenuous “kick the can” measures operates midway between these two extreme conditions.
As noted at the start of the year[17], Japan is a closet Black Swan in the making.
[1] Japan Times BOJ near limit for bond buys but boost may be needed, January 20, 2014
[2] See Japan’s NIkkei Rockets 3.3% as Bank of Japan Promises More Kool Aid February 18, 2014
[3] Reuters.com Bank of Japan likely to expand asset buying by summer February 21, 2014
[4] Bank of Japan Monthly Report on the Corporate Goods Price Index, February 13, 2014
[5] Wall Street Journal Japan Machinery Data Show Companies Still Cautious on Outlook February 11, 2014
[6] Wall Street Journal Real Times Economic Blog Real Japanese Wages Slip, Posing Challenge to ‘Abenomics’ February 5, 2014
[7] IBC Times UK Japan's Unemployment Rate Drops to Six-Year Low Amid Rising Inflation January 31, 2014
[8] FoxNews.com Japan economy grows slower-than-expected 1 percent in Oct-Dec despite housing boom February 16, 2014
[9] Bloomberg.com Abe Eyes Land-Price Reflation to Spur Construction Boom January 20, 2014
[10] Bloomberg.com Japan Companies to Keep Up Foreign M&A Even After Yen Drop January 17, 2014
[11] Japan Times Arrival of ‘bad inflation’ trend bodes ill for Japan’s rebound January 16, 2014
[12] Bank of Japan Basic Figures of the Flow of Funds -- Third Quarter of 2013 December 25, 2013
[13] Wall Street Journal Japanese Keep Holding Cash January 9, 2014
[14] Ministry of Finance Japan's Fiscal Condition December 2013
[15] Reuters.com Japan approves $182 billion economic package, doubts remain December 5, 2013
[16] Bloomberg.com Abe Doomsday Risk Prompts Moody’s Warning on JGBs: Japan Credit January 31, 2014
[17] See Phisix: Will a Black Swan Event Occur in 2014? January 13, 2014
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