While the fabrics of the world financial system is too complicated for anyone to understand it is sometimes possible to track several bold moves that are likely to lead into equally bold consequences.
First of all is the continuous disruption of the world food economics. After I’ve tried to explain the sharp increase of food prices by simple supply and demand the collective finger was pointed toward my nose forcing me to accept that the apparent disruption of the world financial equilibrium is also likely to be the cause.
This is very similar to the gold run that we observed in the past few years. When the trust into dollar future was fading the first reaction of market participants was to hoard something precious to them, like gold. But in the past few weeks the world market discovered that there is something much more precious than gold, like food. If you saw the multitude of movies about wars you probably know that (at least in the movies) during the war a fine gold watch will buy you few cans of spam or a bag of flour. Not that gold is so cheap, but the food is so precious. When millions of people are losing any trust to their local currency (pegged to falling dollar) they resort to hoarding rice, which is relatively easy to store. One bag of rice is equivalent to one gold watch, when the time comes.
Now the second bold move. It’s the apparent shortfall of US tax collections comparing to soaring needs of this administration spending habits. The outstanding treasury debt is quickly approaching $10 trillion, and this is one of biggest Ponzi schemes in the world. This is the story we all know.
And the third bold move is the panic at Japanese bond market this night. Inflation finally reached Japan and the bonds started to fall so fast that the trading was suspended (those guys still don’t understand free markets). The elimination of ZIRP in Japan will lead into many redistributions in the word financial system. For example, I think the eventual introduction of the unified Asian currency may prompt China to sharply increase the purchase of Yens and reduce the purchase of dollars, and now is a good time to start doing so, because the interest rates in Japan will start moving closer to the rest of Asia.
Now the result of all this. Check the chart of the 10Y bond yield:
It clearly broke the trendline by a meaningful margin. The sharpness of the upward move will tell us the magnitude of the disaster. I think this is the most important event on US markets we need to watch now
April 25, 2008 at 1:32 pm
theroxylandr wrote:
” The elimination of ZIRP in Japan will lead into many redistributions in the word financial system. For example, I think the eventual introduction of the unified Asian currency may prompt China to sharply increase the purchase of Yens and reduce the purchase of dollars, and now is a good time to start doing so, because the interest rates in Japan will start moving closer to the rest of Asia.”
A loss of ZIRP likely spells disaster for Japan. I have serious doubts that the gov’t of Japan can remain solvent with normal interest rates. A Japan gov’t financial crisis would probably spill over to the US, since Japan holds a big chunk of US debt. We could see a cascade affect, where the interest rates on all gov’t debt (worldwide) soar dramatically if investors get a whiff of a Japanese Gov’t Debt Crisis .
April 25, 2008 at 3:32 pm
Correct on the 10yr
Where did Ben hide all the toxic paper to “save” the financials……..
Treasury paper is beginning to smell…..
Sadly….this final resting place…taxpayers and .Gov’s ability to tax and extract to pay debt is the ultimate trump card.
April 25, 2008 at 4:58 pm
TechGuy, this is a very deep topic about interest rates. I think sooner or later I will be able to present some clear evidence to support my point of view, which is:
- The government and central bank of any country have only partial control over interest rates. They have some (but not total) control on the short end and almost no control at the long end.
Japan CB can do whatever it wants. Interest rates are going up.
I think the Kondratieff Winter for Japan is over, welcome to Spring!
April 25, 2008 at 6:10 pm
Suggesting we go long on JPY?
I had a long JPY position since JPY was 120 or so. Just closed it. (Should have closed it at 99.)
What would you suggest buying in Japan?
April 26, 2008 at 12:10 am
Last night on the phone i was telling my girlfriend how i thought different things over the years had built wealth and how in the developed nations of the world there was nothing left to develope wealth over accept energy or food. Amazing how central banks are like diapers, they are designed to hold do do, but if they hang around too long they start to stink.
April 26, 2008 at 3:24 am
TechGuy, Bravo!
A very smart person in finance once told me that without the Yen Carry trade, Japanese banks would cease to exist! This is similar to what you just said about the ZIRP. Everybody is focusing on China and the OPEC countries but TechGuy just noticed the elephant in the room (Japan). They are the world’s second biggest economy and a monster financier. It’s been said that without the Yen Carry (and endless Japanese GSE and Treasury support), many of the bizarre credit distortions we’ve seen in recent years (RE bubble, etc.) would have basically been impossible.
It still smells like a bond collapse is coming. I can’t put my finger on it but it is lurking right beneath the surface.
April 26, 2008 at 3:32 am
And Bravo Roxy as well for shining much light on this interwoven puzzle!
April 26, 2008 at 4:55 am
I am expecting US long rates to start increasing. There is too much debt in the US for rates to be as low as they are. The negative returns (interest rate-inflation rate) will eventually deter China and Japan from buying so many bonds, especially if funding needs are present for food and energy.
April 26, 2008 at 5:33 am
Obviously it seems interest rates are more important than rice.
And I’d like to see some numbers on a supposed or hypothetical Japanese government finance/debt crisis.
April 26, 2008 at 2:17 pm
>>> Suggesting we go long on JPY?
Only the extra-short bonds, no more than 3 weeks, because all Yen bonds with maturity over 1Y will be in free fall.
And buying the currency itself is only for super-professionals.
I hold the Merk hard currency mutual fund for a while. They give me decent 15%+ return all the time.
April 26, 2008 at 2:23 pm
I totally agree with TechGuy and Darth Toll that Japan is extremely important to whatever will happen next.
I think more than China, because China is trapped with it’s current situation and I think its influence over the world economy will trend lower, maybe even much lower.
April 26, 2008 at 2:38 pm
Roxy:
Thanks for pointers.
I was long JPY – passively (not active currency trading). Just sold JPY and repurchased US$.
Extra-short term bonds make a lot of sense (and also why not purchase 1+ year bonds).
Yes – Merk Currency Fund makes sense. I think Axel Merk recently started Asian Currency Fund too.
Fully in agreement with China.
April 27, 2008 at 1:19 pm
garyalan wrote:
“I am expecting US long rates to start increasing. There is too much debt in the US for rates to be as low as they are. The negative returns (interest rate-inflation rate) will eventually deter China and Japan from buying so many bonds, especially if funding needs are present for food and energy.”
My gut feeling is that the Fed and the US Treasury dept. will buy US debt to keep the rates artificially low. The US has too much debt to let the interest rates rise much. If the interest rates were to rise to were they need to be, we would go head first into a depression, which would lead to insolvency and probably lead to the break up the United States. If the US economy fell into a depression, foriegn investor would dump the dollar. The main reason why FCB’s hold US dollars is to sell stuff into the US market. If the US is in a depression, Americans aren’t going to be buying foriegn goods and services. There is no longer a reason to continue to hold US debt.
When (not if) the FCB sell the Dollar, the US gov’t is officially insolvent. I think US states would eventually start printing their own currencies so they can trade goods and services. I don’t believe foriegners would except US dollars once the selloff has occured. Perhaps the US might be able to import goods using its stockpile of gold or other assets, that that wouldn’t last very long.
FWIW: I expect the interest rates on US treasury debt to remain low (at least for the next 9 to 12 months). I think we will also see the amount of debt held by the GSEs and the Fed to soar as the gov’t takes toxic debt off the hands of banks and other lenders to keep them solvent. I think we’ll see more financial business go under like Bear Sterns did. We’ll probably see at least one big financial (the size of bear) to go under this year (probably either Lehman or Merril). If investors get a whiff of more financial failures, it will also suppress US treasury rates as investors choose to be bitten by inflation with treasuries, rather then get served “AS Dinner” from Financial failures, in which case they lose everything. The Stock holders of bear will end up with about $10 per share, but the next financial that goes under will probably get nothing. FYI: Today, the US Gov’t is considered the first and last lender (the only lender) for many types of loans. Few banks are interested in adding risk to thier own books. Virtually every loan either ends up on the GSEs or through some other gov’t agency.
The US economy is approaching the end of the game:
1. Unsustainable Gov’t spending which provides about 20% of US GDP. The unemployment rate would probably jump by 4% if the US federal budget was officially balanced.
2. Unsustainable Trade Deficits running north of $700 Billion per year. A large piece of this trade deficit is from enery imports, which are absolutely essential for the US economy to function.
3. Global energy depletion! The US has no mitigation program to move away for Oil and Gas. The US transportation system is about 95% dependant on refined Oil fuels to move people and goods around the country. Few areas have sufficient mass transit for the workforces or freight rail service to deliver essential goods. CIBC predicts US Fuel prices will soar to $7 gallon by 2012. The US consumes 21 Mbpd of Oil and domestic production is about 5.1 Mbpd. If the price of Oil does rise to $225 per barrel, the US economy would spend over a Trillion USD per year just for energy imports.
4. Aging population and massive unfunded entitlement programs. The US entitlement programs go in the red sometime between 2012 and 2016 (GAO). [Probably 2012 since we are entering a long tracted recession that will force many older workers into early retirement as well as decrease the FICA revenue]
5. Declining Education system. Today’s workforce needs to be more educated than ever, yet the public schools have dumbed down the program to make education easier. University around the country have repeatedly complained that public schools are sending them students unprepared for a college education. US student (excluding foriegners) is at an all time low enrollment for science and engineering degrees. Kids are more focused on playing video games, watching TV, and have little to no interest on there future careers. These future workers are going to be unqualified and not physically fit to assume the demanding jobs they need to fill.
April 28, 2008 at 7:58 pm
“My gut feeling is that the Fed and the US Treasury dept. will buy US debt to keep the rates artificially low.”
Well now you are talking about hyperinflation and that is truly the electric third-rail option. You really think .gov will go there, knowing that the end result is chaos, complete revolution and/or regime change followed by collapse anyway? And all to keep rates low?
In order to really execute a hyperinflation strategy, JSP would need big raises and often. So far this has not been in the cards and in a recession I doubt .gov could ignite a true hyperinflation.
This is almost a circular argument. If the FCB’s catch wind of hard-core monetization, they will likely dump treasuries adding to the supply. Then in order to keep rates low, .gov would have to buy even MORE treasuries leading to another round of FCB dumping in a vicious cycle of dollar death. All of that printing minus any real JSP wage increases would lead to the worst crack-up-boom and riot hording that you could possibly imagine, undoubtedly leading to total chaos, revolution, anarchy, etc.
Why not let the bond market collapse and try to save the buck with higher rates? Then they get to keep a hold of their power instead of relinquishing it in a revolution.