Japan is the Next Shoe to Drop

The fiscal cliff has been getting most of the media attention these days.  And when not fretting over U.S. political gridlock, investors have turned their attention to Europe.

But the real crisis brewing—and the one that no one seems to notice—is in Japan.  The land of the rising sun is a ticking time bomb, and when it finally blows up it will make all the talk of Eurozone disintegration seem petty by comparison.

Japan is the most heavily-indebted nation in the world with government debts of over 220% of GDP and a gaping budget deficit of nearly 10% of GDP.

To put that in perspective, Greece, Spain and Italy—the European countries most viewed as being at risk of default—have debts equivalent to 160%, 68% and 120% of their respective GDPs.  The United States recently tripped over the 100% mark, but for all of the (completely justified) fretting about out-of-control debt in America, Japan’s debts are more than twice as big.

Once the statistics are released, we will most likely get confirmation that Japan spent a good part of 2012 in recession.  And already, the Japanese government is planning a 1 trillion yen ($12.3 billion) stimulus package to jolt the economy back into growth.

Seriously?  Japan has racked up the biggest debts in modern history trying to stimulate a dead economy, yet it has still been in and out of recession for the better part of the past two decades.  It’s hard to see that extra trillion yen making much of a difference at this point.

I know, I know.  Japan is different.  Unlike America and Europe, most of its debts are held by its own population, so there is little risk of international bond vigilantes punishing the country the same way they’ve punished Europe’s problem children.  Plus, you know the Japanese.  They are conservative and save a high percentage of their income.

If your money manager or financial advisor has told you this, pick up the phone right now and fire him.

I say this in complete seriousness.  Anyone who says something that phenomenally stupid should not be allowed to manage money professionally.  Yet there appear to be plenty of them out there, because the Japanese yen has been pushed sharply higher in recent years by investors who are delusional enough to consider the country a safe haven.

Think I’m being too harsh?

Let’s look at some very simple demographic math.  Those high savings rates we all heard so much about last decade were a product of Japan’s high-income earners in their 40s, 50s and early 60s socking away money for a retirement they knew was quickly approaching.

Well, it came.  Japan is the oldest country in the world with the highest percentage of its population beyond retirement age (roughly a quarter of the population).  And as Japan’s Post-WWII generation drops out of the workforce, they are starting to dip into those savings they spent the last three decades accumulating.  Japan’s savings rate is now just 2% and falling—a far cry from the 44% savings rate it recorded in 1990.  If it has not dipped into negative territory already, rest assured that it will soon. (The OECD estimates that Japan’s savings rate will be 1.9% next year; that may prove to be far too optimisitic.)

Figure 1: Japan Household Savings Rate (2012 and 2013 Forecasted)

















Source: OECD

The legions of Mrs. Watanabes that Japan has depended on to buy its government debt are no longer saving and investing.  They are living off of their past savings and, given how low interest rates are, are probably going to be selling a good chunk of those bonds in the years ahead to make ends meet.

What then?  What do you expect will happen to Japanese government yields when the Japanese have to turn to the international bond markets for the first time?

They could turn to the Bank of Japan, of course.  And in fact, that is exactly what Shinzo Abe, the probable winner of Japan’s December election, is advocating.  Abe has called for “unlimited” bond buying, and not just in the secondary markets.  He wants the Bank to lend money to the government directly.

We have the pieces in place for a hyperinflationary meltdown.  This may sound impossible given that Japan has had on again / off again deflation for the past two decades, but it is hard to see any other outcome.  As Japan’s borrowing costs inevitably rise, it will have to fund more and more of its budget via the central bank.  And from that point, the path to hyperinflation becomes a slippery slope.

Investors will eventually lose their faith in the Japanese yen.  It is a little shocking to me that they haven’t already.  And when they do, the value of the yen will plummet and the prices that Japan pays for imported products and materials will soar…and will necessitate more money printing.

In Endgame, John Mauldin called Japan a “bug in search of a windshield,” and it’s an apt metaphor.  It’s just a question of when it will splat and what the particular windshield will be.

For now, it’s a waiting game.  When investor sentiment finally turns on Japan, I see it creating an incredible short opportunity in Japanese assets.  If you missed the opportunity in 2008 to short subprime lenders and banks, fear not.  You’ll almost certainly be able to make a bundle shorting the yen, Japanese bonds, and Japanese stocks.

In the meantime, keep an eye on Japanese interest rates.  When you see them starting to rise, you might want to start setting yourself up for the short opportunity of a lifetime.

SUBSCRIBE to Sizemore Insights via e-mail today.

Japan’s Endgame Nears

I read a fact this week that I never expected to read in my lifetime: “The Japanese government is expected to announce Wednesday that the country recorded its first annual trade deficit since 1980″ (see ” End of Era for Japan’s Exports “).

Trade deficit? Japan?

Japan’s economy has been a slow-motion train wreck for the past 20 years. The bursting of the country’s 1980s credit, stock market and real estate bubble would have wreaked more than enough havoc on any economy. But on top of the normal debt deflation that would follow the bursting of a financial bubble, Japan adds the worst demographics of any developed country. Japan is aging rapidly, and its population is shrinking.

Most of the research on the effects of Japan’s demographics have focused on skilled labor shortages and pension funding. These are legitimate concerns, to be sure. But you don’t have to be an Ivy League economist to see that there is a much larger problem. The only business not affected by this downfall is the Japan’s オンラインカジノのおすすめランキング online casino which continues to provide players with the best casino experience.

If you own a business—anything from a world-class automaker like Toyota (NYSE: $TM) to a neighborhood corner café—you have a smaller pool of potential customers every year, and within that smaller pool a larger percentage are elderly consumers who buy less. Some companies grow at the expense of others, but it becomes a zero-sum game. Growth in the aggregate becomes impossible. The math simply doesn’t add up.

Unless, of course, you export. And this is what Japan has been quite adept at doing for the past 20 years. Until now.

In his 2011 book Endgame , New York Times best-selling author John Mauldin calls Japan a “bug in search of a windshield,” and it’s a great metaphor. Like a bug buzzing along a highway, Japan’s economy has bumbled along for the past two decades, not really growing but not imploding either. In the not-too-distant future, Japan may be in for a good “splat.”

Two things have kept Japan’s economy afloat all these years: its healthy trade surpluses and its government’s ability to borrow large sums of money at ridiculously low interest rates to fund enormous budget deficits. The high price of the yen and prolonged weakness in the United States and Europe are doing a fine job of denting exports. And soon, the low interest rates may be under attack.

Anyone reading this article is well aware of Europe’s debt woes. But Japan’s debts make Europe’s look like pocket change. Italy, the most indebted of the major Eurozone countries, started to see its market bond yields reach punitive levels when its debt-to-GDP ratio reached 120 . As a comparison, Japan’s debt-to-GDP ratio is an almost unbelievable 220 percent (IMF).

The only reason that Japan hasn’t had a run on its bonds is that they are all by and large purchased by domestic buyers. As Mauldin explains it in Endgame, “94 percent of all JGBs have been bought by the Japanese.” But demographically, Japan is fast shifting from a nation of middle-aged workers saving for retirement to a nation of elderly retirees liquidating their savings to pay their bills. The savings rate has been in stark decline.

The domestic demand for Japanese bonds cannot last forever, and when it dries up, Japan will find itself at the mercy of international banks and investors. Ask Greece and Italy how that worked out for them.

Japan can look forward to a currency and debt crisis that makes Europe’s look mild by comparison. Yet betting on Japan’s collapse is a little like fraternity hazing for macro hedge fund managers. It’s just a rite of passage that they have to go through. They short Japan’s bonds, lose a fortune, and learn a few painful lessons.

Knowing this, I’m not going to recommend you short the yen or Japanese stocks or bonds — yet. Wait until you see Japanese yields starting to creep up. And when they do, position your portfolio for the potential short of a lifetime.