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Circular lending
theories have spread from Europe to Asia.
Please consider Japan Talking to China About
Buying Yuan Government Bonds
Japan
is discussing with China possible purchases of Chinese government bonds,
Finance Minister Jun Azumi said, a sign the nation
is diversifying foreign- exchange holdings by tapping into the world’s
second-largest economy.
“I think it’s mutually beneficial” for the two countries to
be investing in one another’s debt, Azumi
said at a press conference in Tokyo today. “We’re not abandoning
the dollar or euro, but we’re adding the yuan
to deepen our relationship.”
Japan Scared to Death
As I was reading the article it was immediately apparent what the problem is.
The last paragraph explains nicely.
China,
which is also Japan’s largest trading partner, sold the second-biggest
net amount of Japanese debt on record as the yen headed for a postwar high
against the dollar and benchmark yields approached their lowest levels in a
year. It cut Japanese debt by 853 billion yen ($11 billion) in October,
Japan’s Ministry of Finance said on Dec. 8. China sold a net 2.02
trillion yen of Japanese debt in August 2010, a record based on data going
back to January 2005.
Japan Records Trade
Deficit in October
The above chart from Trading Economics.
Japan's Exports Collapse
Bloomberg reports Japan’s Exports Fall
More Than Estimated as Yen Gains
Japan’s
exports fell for the first time in three months, indicating that the
yen’s appreciation and financial turmoil in Europe are slowing the
nation’s recovery from the March disaster.
Shipments dropped 3.7 percent in October from a year earlier, the Ministry of
Finance said today in Tokyo, worse than all 29 estimates of economists
surveyed by Bloomberg News.
Exports to China, Japan’s biggest market, slid 7.7 percent, the largest
drop since May, today’s report showed. Weakening overseas demand has
led companies including Toshiba Corp. and Nippon Yusen K.K. to call on the
government to follow up on last month’s yen intervention with steps to
prevent the currency from appreciating further.
Function of Math
As I have talked about numerous times before, foreign debt buying is a
function of math: Countries that run current account surpluses accumulate
foreign currency and bonds.
As trade deficits or surpluses change so will accumulation of foreign
reserves.
Thus the discussion between Japan and China is complete silliness, although
it clearly highlights Japan's concern as to servicing its enormous national
debt.
If China has a trade surplus with Japan, then over the long haul China
is likely to buy Japanese bonds, just as Japan and China buy US treasuries
today.
However, everyone cannot be a net exporter to everyone else. Please see Another Preposterous Proposal
to "Fix the Unfixable"; Political, Economic, and Mathematical
Realities for the latest proposal from Europe on how to save
the euro by increasing exports.
It is mathematically impossible for every country to have a trade surplus,
not matter how hard they all attempt to export themselves to nirvana.
Moreover, and more importantly, yields on Japanese bonds are unlikely to
remain low if Japan's vaunted export machine takes a sustained hit and
Japanese corporations and banks slow their buying of Japanese bonds as a
direct consequence.
All hell will break loose when Japanese bond yields rise high enough that
Japan struggles to service its debt.
How Can Japan Service its Debt?
I have written about Japan's debt problem on numerous occasions, most
recently on August 9, 2011, in Worst Demand on Record for
Japanese 40-Year Bonds; Can Japan Service its Debt? How?
Inquiring
minds may be wondering "With a Debt-to-GDP ratio exceeding 200%, how is
Japan going to service its national debt?"
I have been wondering that for years. Adding fuel to the debate, please
consider Worst 40-Year Bond Sale Shows
Cash King as Investors Flinch
The worst demand on record for 40- year Japanese bonds sold yesterday
signals growing concern about Japan’s ability to service the
world’s biggest debt pile and the risk of holding long-term securities
while markets are volatile.
The 400 billion yen ($5.2 billion) sale drew bids valued at 2.03 times the
amount on offer, the weakest since the Ministry of Finance began selling the
securities in 2007.
Japan’s Ministry of Finance said that every 1 percentage- point
increase in 10-year yields above 2 percent would add 1 trillion yen in
debt-servicing costs to a projection of 22.9 trillion yen for the fiscal year
starting April 2012. The nation’s total debt may reach 219 percent of
gross domestic product next year, according to the Organization for Economic
Cooperation and Development.
Double-Edged Sword
Please note that was not a failed auction. Indeed it
was oversubscribed. However, nearly all of that demand is internal.
Internal demand is a double-edged sword. Right now it is still sufficient.
However, when (not if), Japan ever needs foreign buyers for its bond market,
rates will not be 2.3% on 40-year bonds.
On account of miserable and worsening demographics, bond redemptions have
started. However, those redemptions are a still a trickle. That trickle will
at some point turn into a torrent.
Balance of Trade a Key Issue
People have been talking about this for years, although I have not seen
discussion of the trade angle before.
Here is the key: If Japan does not maintain a trade surplus covering both
interest on its national debt and bond redemptions, all hell will break
loose. This gives rise to the question as to how long Japan's vaunted export
machine can remain intact. I do not have the answer to that question, but
China and the rest of Asia are nibbling away bits and pieces now. The tsunami
sure did not help.
Trade issues and demographics explain Japan's paranoia regarding a
strengthening Yen. It is also another one of those global imbalances that
"does not matter, until it does, and it will" kind of
things.
It is mathematically impossible for every country to maintain a trade surplus
and increase exports, yet every country wants to do just that.
Rising interest rates
would crucify Japan, and that is why Japan is courting China, hoping China
will buy Japanese debt.
Europe did the same, for the same reason. Such pleas are useless. If Japanese
exports and corporate profits sink, and Japan needs external financing to
service its massive pile of debt, interest rates on Japanese bonds will head
North, likely in a major way.
Japan is in deep trouble if its export machine breaks down. That time may be
at hand.
Addendum:
In regards to my statement "foreign debt buying is a function of
math: Countries that run current account surpluses accumulate foreign
currency and bonds" Aaron Krowne at
ML-Implode responds ...
You
should also mention that this is only true so much as net trade deficits are
not settled with gold (which would be the smart way to handle this, and the
one based on thousands of years of history up until a few decades ago).
Aaron is correct and
I have discussed this previously on several occasions.
Please see Hugo Salinas Price and
Michael Pettis on the Trade Imbalance Dilemma; Gold's Honest Discipline
Revisited for the solution to the trade imbalance dilemma.
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