SO THE VERSION of events being touted by Japan bulls is that
last week's one-day 7.3% plunge in the Nikkei represented simply
a pullback for a market that had put in its most supercharged
performance over six months since 1953. This presents a major
buying opportunity for those who believe "Abenomics" and the
newly pugilistic Bank of Japan will drag Japan out of its two
lost decades - or so the story goes.
But was Thursday's stock market collapse about equities or
really all about bonds? I suspect the latter, as the equity
meltdown unfolded after a capitulation in Japanese government
bonds that saw yields spike to their highest in a year. Bank of
Japan governor Kuroda spoke on Friday about calming bond
markets, but ever since he announced the mammoth quantitative
easing programme in April the JGB market has turned into a
quivering mass of uncertainty bordering on terror.
It might just be that now the easy money has been made by
punting on Japanese equities, a slower grind higher is on the
cards after last week's "correction".
But I'm not convinced it was simply a correction. Rather, it
might have been something closer to a realisation that for all
the brouhaha of Abenomics, the "three arrows" and the shed-loads
of money printing, the Japanese financial authorities are losing
HEDGE FUND MANAGER Kyle Bass, whose Hayman Capital fund has
returned 25% a year since 2006 and who correctly bet against US
mortgage-backed securities, reckons a full-blown Japanese
financial crisis is around the corner. And that's because the
old status quo of household saving, current account surpluses
and low fiscal deficits has been chucked out of the window.
There are more spenders than savers in Japan, and the country is
close to facing a current account deficit as well as running a
budget deficit of more than 10% of GDP.
Meanwhile, Japan's public debt to GDP is approaching 230%,
the highest percentage of any nation in the world, with the debt
largely funded domestically.
A Tokyo-based Japan funding head for a European bank told me
last week that bank investors in JGBs had been "shell-shocked"
by the recent capital losses they had sustained on their JGB
portfolios, and were panicking about how to protect themselves
against further losses.
That wasn't the Kuroda script at all - monthly purchases of
JGBs were supposed to pull yields down. But then there's the
Alice in Wonderland absurdity of announcing a 2% inflation
target as an explicit policy goal and not expecting that nominal
yields will have to rise in anticipation of higher real yields
in the future, assuming the target is achieved. The market
bought that argument over the alternative that JGB purchases by
the BoJ would put a ceiling on yields.
YOU HAVE TO wonder whether last Thursday was a turning point
for global financial markets. Collapsing Japanese equities had a
knock-on effect on Asian, European and US equities, while JGB
yields spiked to their highest in a year and 10-year Treasuries
pushed through 2%. Blame was placed on the vaguest of hints from
Bernanke that QE3 was about to be tapered off as well as weak
manufacturing data from China.
But might it not have represented a moment of clarity among
market players that something is really not quite right in the
global economy? Are investors finally noticing that central
banks have been forced to resort to desperate measures that
represent the failure of ordinary monetary policy, and that
fiscal policy in the US, Japan and Europe is no more about
fine-tuning but how to confront mountains of debt that threaten
to bring the whole house tumbling down?
THE GREAT US economist JK Galbraith observed that "anything
unsustainable cannot be sustained" and it seems that nowhere is
that more apposite than when it comes to the Japanese government
bond market. It might well have been that the JGB market could
have kept chugging along at record-low yields as long as Japan's
leaders were willing to accept low growth and deflation as the
Indeed, the former BoJ governor Masaaki Shirakawa regarded
Japan's deflation as structural, and based on the country's
woeful demographic of an ageing and declining population.
Now, Prime Minister Shinzo Abe's grand ambitions threaten to
turn the spotlight on the unsustainable nature of the JGB
market, which Bass has likened to a Ponzi scheme.
The bankers in Tokyo tell me there is a widespread mindset
of panic among institutional holders of JGBs and that can't be a
good thing. Panic tends inevitably to lead to crisis, and
goodness knows, after the eurozone crisis - which I refuse to
believe has had a line drawn under it - global financial markets
could hardly deal with another crisis without contagion on a
In order to stem panic-selling in JGBs, the BoJ will have to
undertake a buying programme of a far greater size than
initially envisaged and one that simply might not be viable
given Japan's precarious fiscal position.
I suspect the JGB market is about to take centre stage among
the variables that dictate the actions of global financial
market players, and that its role will be unequivocally that of
the villain. Mr Abe might soon come to wish that he had kept
Japan chugging along. His grand vision, for all its laudable
intentions, seems likely to soon be revealed as fundamentally