2011-02-16

Third Great Depression, Japan is sunk

我们离“全球第三次大萧条”还有多么近
The first was in the 1930s, the second just past, and the third is not far off. For Americans, this may actually sound more like a repeat of the first Great Depression. The first part of the Great Depression ended in 1932-33 with a massive dose of inflation following the nationalization of gold and the devaluation of the dollar. However, this inflation was nipped in the bud in 1937, and along with an insane amount of government intervention that put Hoover's tinkering to shame, causes the depression withing the Depression.

A similar scenario is unfolding today. The U.S. central bank floods the world with liquidity, setting off inflation and booms in developing markets. Central banks are already starting to counter the loose policy of 2008-2010, but this time they are pushing against their own policies plus the Federal Reserve and to some extent, the ECB, which is bailing out several countries. As Liu Junluo says in this latest blog, central banks are a flawed system. I would take it a step further and say that if central banks are making policy, they are making policy mistakes. Based on current conditions, the mistakes will be very large this time, at least as large as in 2006-2008.

Monetary policy takes time. Andy Xie is looking for 2012 crisis, maybe he is also early. In the near term, watch Japan. That is the most dangerous country right now due to a deterioration in the savings rate. Goldman Sachs predicts that the savings rate of Japan will turn negative this year. That's important because it means that foreigners will become the marginal buyers of Japanese government bonds. Now, if you are a foreigner, you're first going to look to the U.S. and Europe, where rates are higher and debt levels are lower. Adding to the mix, the emerging markets are hiking rates and tightening monetary policy, reducing the pool of funds available for Japanese government bonds (JGBs). All of which signals higher interest rates.
Higher interest rates are bad news for Japan.
Up until now, Japan’s government has been able to “cover the minimum payment” by borrowing from reserves in its Government Pension Investment Fund and selling its debt to Japan’s life insurance companies. But as seniors, which now number nearly one in four, start drawing down those assets, those avenues will be closed to further purchases of bonds issued by the state. In fact, they will soon become net sellers of their existing holdings in order to support the new pensioners, and then, “who will buy?”

Japan’s government revenues of $1.6 trillion annually fall short of its expenses of $2 trillion, creating an annual deficit of $400 billion. Kyle Bass, who runs Hayman Advisors, estimates that debt service eats up $244 billion every year. He calculates that if investors demand just an additional two percentage points in interest, that would double that debt service. Bass concludes that “the Japanese have created the circumstances for the greatest financial failure in world history.”
Japanese interest rates could easily rise 2%, it would bring their yields to roughly the level of U.S. bonds right now.

Credit markets in the U.S. actually seem to be picking up steam at the moment, which means this all may be a year or two, or more, away. I'm watching Japan for the possible spoiler though.

我们离“全球第三次大萧条”还有多么近

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