Unlimited QE and a reminder of discontinued series

Just when you thought it couldn’t get crazier, the Fed has announced that it will buy unlimited sizes of treasuries, mortgage-backed securities and corporate bonds. Recall our comments in 2018 when the Fed discontinued its reporting of assets. We noted that the Fed discontinued M3 money stock in 2006, two years before the GFC. Coincidence?

We were always struck by former Fed Chair Janet Yellen’s comments in 2016:

Monetary and fiscal policy is far better prepared for large positive shocks than negative ones

and 2017:

Don’t expect another financial crisis in our lifetime

The only thing left is to buy equities outright which would require an act of Congress. Such moves once again only highlight just how bad the situation has become. The Bank of Japan can hardly be credited with success over its ETF based equity purchases. It has now lost $30bn in this recent market rout. We should mention that the BoJ is a top 10 shareholder in almost 50% of listed stocks, creating an overhang of epic proportions should it ever announce it wants to reduce holdings. It now owns $300bn and due to be $400bn by year-end.

Return of the State-Owned Enterprise

Image result for state owned enterprises

A new investor to Japan once asked CM how to categorise corporate behaviour in the land of the rising sun. CM replied, “Japan is not capitalism with warts, but socialism with beauty spots.

Latest reports confirm the Bank of Japan (BoJ) has now become a top 10 shareholder in almost 50% of listed stocks. In a sense, we have a trend which threatens to turn Japan’s largest businesses into quasi-state-owned enterprises (SoE) by the back door. The BoJ now owns $250bn of listed Japanese equities. It is the top shareholder in household Japanese brands such as Omron, Nidec and Fanuc. At current investment rates, the BoJ is set to own $400bn worth of the market by 2020-end.

The original reason for this move was to boost the ETF market and hope that Mrs Watanabe would pocket her winnings and splurge them at Mitsukoshi Department Store to increase consumption. Sadly all she has done is stuff it under the futon.

Although the government has been very public about the drive for good corporate governance, a stewardship code that drives to unwind cross-shareholdings, improve liquidity and lift returns, sadly the BoJ essentially reverses free-float and confounds the ability of companies to be attractive investments. What will happen if one day the BoJ announces it needs to pare its balance sheet back or that its holdings become too noticeable? These stocks will crater and Mrs Watanabe will become even more gun shy.

We shouldn’t forget that behind the walls of the BoJ, there is discussion to buy all $10 trillion of outstanding Japanese Government Bonds (JGBs) and convert them into zero-coupon perpetual bonds with a mild administration fee to legitimise the asset. Global markets won’t take nicely to wiping out 2 years worth of GDP with a printing press. Such a reckless experiment has yet to hit the Japanese Diet for discussion because such a move will require legislation to approve it. If it happens, the inflation the BoJ has now given up on will turn into a tsunami.

蜘蛛の糸 The Spider’s Thread – when helicopters can’t save central banks from hell


Almost 100 years ago a children’s tale known as “The Spider’s Thread” (Kumo no ito) described Buddha’s compassion for a criminal named Kandata. It sums up the problems facing the Bank of Japan and how it intends to climb out of fiscal hell.

Buddha is meandering around Paradise one morning, when he stops at a lotus-filled pond. Between the lilies, he can see, through the crystal-clear waters, the depths of Hell. He notices one sinner in particular – Kandata. Kandata was a cold-hearted criminal, but had one good deed to his name: while walking through the forest one day, he decided not to kill a spider he was about to crush with his foot. Moved by this single act of compassion, the Buddha takes the silvery thread of a spider in Paradise and lowers it down into Hell.

Down in Hell, the myriad sinners are struggling in the Pool of Blood. Kandata, looking up by chance at the sky above the pool, sees the spider’s thread descending towards him and grabs hold with all the might of a seasoned criminal. The climb from Hell to Paradise is not a short one, however, and Kandata quickly tires. Dangling from the middle of the rope, he glances downward, and sees how far he has come. Realizing that he may actually escape from Hell, he is overcome by joy and laughs giddily. His elation is short-lived, however, as he realizes that others have started climbing the thread behind him, stretching down into the murky depths below. Fearing that the thread will break from the weight of the others, he shouts that the spider’s thread is his and his alone. It is at this moment that the thread breaks, and he and all the other sinners are cast back down into the Pool of Blood. In the end, Kandata condemned himself by being concerned only with his own salvation and not that of others.

Bernanke was in Japan warning advisors to PM Abe that Japan risked slipping back into deflation (err it is already in deflation). He noted that helicopter money — in which the government  issues non-marketable perpetual bonds that are linked to O/N rates plus a premium with no maturity date and the Bank of Japan (BoJ) directly buys them — could work as the strongest tool to overcome deflation.  The government would hold the right to redeem the perpetual bonds at their face value. It would only logically choose to redeem if inflation came back in the mix.

In essence the BoJ has bought 40% of outstanding JGBs ($4 trillion) and the balance is held mostly by domestic financial institutions. If they end up swallowing all the $10 trillion of outstanding JGBs the idea is that they are packaged as a swap into perpetuals. The Diet would have to ratify this transaction and the complexity of it would likely bamboozle most Japanese politicians. I’m not quite sure if that makes it an easier or harder sell. The BoJ’s balance sheet is as big as the US Fed

None-the-less, if you park a majority of the $10 trillion dollars (Y1,000 trillion) or 2x GDP then it doesn’t overcome the need for the government to raise Y40-50 trillion (or raise a Switzerland) annually to cover the shortfall in the budget deficit given the dwindling tax base. This gap is ongoing.

While $10 trillion dollars can be put inside a velvet bag and packaged in a way that disguises the contents then it come down to how willing financial institutions will step up to buy new JGB issuance. The risk is that if the BoJ is the only willing buyer them the psychological impacts on the lack of confidence of buying JGBs any collapse in the currency will potentially create inflation that will be far harder to control. Japan imports 60% of its food and most of its raw materials and energy. To all of a sudden be faced with dollar denominated contracts to mitigate risk for suppliers Japan’s inflation could soar way beyond desirable levels. Would a yen fall to Y300 or Y400/$ from almost parity today? Then we are staring down the barrel of double digit rate inflation.

Let’s consider the collapse of the Argentinian Peso in early 2000s. It exploded from 1/US$ to 4/US$ and today trades closer to 14.5/$. At the time inflation surged to 25% and has remained between 5% and 20% since. 

As soon as markets have seen the MoF & BoJ in cahoots on monetising the debt, the risk is that they can always do it again. No-one ever suspected they would do it in the first place but once it is done it can be done again and Japan is 10x the size of Argentina so the knock on effects are far greater. 

Imagine even 10% rates of inflation in Japan. Banks that have loan books that are 30 years fixed at 3% and below with 90%+ of financing coming from deposits. If the currency was collapsing, Mrs Watanabe would be flocking to safe havens – gold, US$ etc. If there was a run on the banks, deposit rates would have to go high enough to offset the flight. At the same time, the net margins would be crucially negative causing the likelihood of nationalisation with yet more printed money…exacerbating the problem.

Which takes us back to Kandata. The financial gods may lower a spider’s thread but if central banks become too greedy in implementing helicopter strategies, it will snap as they climb from the infernal hell they’ve traded themselves into. Then it really will be a pool of blood.

I also think listening to Bernanke is not necessarily wise as he merely continued in the footsteps of Greenspan to lead us into the GFC. Should we credit those who got us into this mess with pretending they’ve got us out of it? To me, the failing experimentation in financial markets is disproving a lot of theories of monetary policy (especially NIRP) and the declining confidence in central banks expressed by rising poverty is being shown in the shake up of incumbent political classes. It feels that the big RESET button will have to be pushed.

Japan’s moral hazard plan would be harakiri

I’ve said it before and I’ll say it again. Central banks are in such dire straits. ECB President Draghi admitted that he is merely doing what every other central bank is doing. Group think. Perhaps more telling is  Alan Greenspan has started to put himself into the public again saying we are in trouble. You know we are in really big trouble because he’s always ‘behind the curve’. My bigger concern is how the Central Banks cannot play moral hazard like the private sector has. If central banks decide to magically make debt disappear through a debt jubilee the financial devastation would be 100x worse than 1929.

The Japanese have been toying with a plan to wipe out the US$10 trillion of public debt by converting the JGBs they’ll buy with printed money into zero coupon perpetual bonds.The value of a zero coupon perpetual is mathematically zero. So in a heart beat the Japanese government debt gets written down to zero. The Bank of Japan has a $10 trillion asset which is now worth nothing. 200% of GDP gone in an instant. Mauldin also made this assertion that monetising all debt at once by all countries would be unthinkable but the only way you could do it.

Let’s entertain the premise if Japan did this. What would happen? Global markets run on confidence. Nothing more. Nothing less. Without confidence markets will fret. People forget that the Japanese government STILL needs to fund Y40-50 trillion every year to plug the hole in the deficit. Tax take is less than Y56 trillion. Expenditures, thanks to an ageing society are rising above Y100tn. That gap won’t close easily. Sure the BoJ could print that gap every year but honestly, how could Japan’s yen be worth anything if they printed $400-500bn per annum? That’s right Japan would press start on the printing presses and produce the GDP of Thailand or Austria or Sweden or Belgium or Taiwan. Does this pass any sniff test?

Japan imports 60% of its food. It imports most of its energy sources like coal or LNG. It imports iron ore and coking coal to make steel. They must pay these foreigners in their currency. What supplier would want to accept a currency where the central bank just prints it. No country would accept yen pricing. Yes, hyper inflation would be the result. 

The debt service costs of the Japanese banks would become extreme. The low interest fixed mortgages which drives bank income are funded by predominantly depositors. However to avoid the Japanese banks witnessing capital flight they would need to raise deposit rates to dizzying levels and even then as Mrs Watanabe realises the Japanese yen is becoming like the Zimbabwean dollar she’ll convert into another currency exacerbating the downward pressure. Japanese banks would quickly become insolvent. Then corporations would start collapsing causing widespread unemployment.

The Global Financial Crisis (GFC) of 2008 taught us about moral hazard. People just walked away from their interest only mortgages and left the taxpayer to clean up the mess. Moral hazard is not good under any circumstances but if central banks and governments start playing moral hazard by ‘walking away from debt’ then effectively you permanently ruin trust and financial markets are destroyed. Think about. If people think that the end game will always result in a bail out then moral hazard becomes the default. It is permanent helicopter money. There is absolutely zero incentive to act prudently. Everyone should have a $50mn home, a Rolls-Royce and not have to work for it. Simple economics means that this solution is completely untenable. In a sense paper money would be worthless, we would have full unemployment and society would cease to function.

Now before we start reeling off the resumes of the incredibly intelligent people who can mathematically prove theories like this, note that was exactly the same type of argument hurled at me back in 2001 when I heavily criticised Greenspan predicting he would lead the world off a cliff in 5 years. I was right and they were wrong. Central banks have no idea. Their policies are group think. They don’t live in markets. They don’t breath markets 24-7. The only thing Greenspan was right on was to say “The gut feel of the 55-year old trader is more important than the mathematical elegance of the 25-year old genius.” Ask any of your experienced financial sector friends and get them to give you their gut feeling in private (publically they’e always bullish) and their answer to an almost 100% degree will be funereal.

If Japan makes the move to make $10 trillion dollars disappear (i.e. the GDP of China, home to 1.2 billion people) it will be the biggest mass suicide the world has ever seen in financial markets. You can take that to the BANK.

Bank of Japan’s “assets” as big as US Fed – huh?

FRED japan

The Bank of Japan (BoJ) now has the equivalent of Y420 trillion yen (US$4tn) of ‘assets (!?)’ on its balance sheet. Asset is a broadly used term. When I looked at the US Fed’s balance sheet it is approximately $4.4tn (below). The BoJ is now 58% of purchases of equity ETFs in its home market and near as makes no difference 100% of new bond auctions. It is simple debt monetisation. So if we look at the immediate post GFC reaction the Fed doubled its balance sheet and has doubled it again (i.e 4x). The Japanese have also quadrupled since Abenomics and the Europeans have tripled. All courtesy of the printing press.

FRED FEDThe ECB has started to hoover up ‘assets’ recently too now totalling 3.1tn euros (US$3.5tn)


Despite all this massive capital injection into the markets, economic growth continues to falter and inflation is such an elusive goal that the next thing we should await is a rejigging of the CPI baskets to fool us into thinking everything is OK!