THE JAPANESE, THE GREEKS AND THE BONDHOLDERS

It certainly is amazing what the Bank of Japan has been doing.

The Central bank’s use of the State Pension Fund as an intermediary helps to abate suspicions of direct intervention. In practice however, their actions have amounted to buying Japanese and international stocks in large quantities with freshly printed yen.

If I were the head of the central bank, I would also do the same, which is getting something for nothing, and isn’t that the world’s best business transaction? What is happening is that the Bank of Japan is printing yen, and primarily purchasing Japanese treasuries with it, since in the meantime the huge Japanese pension fund has decided it is going to lower the percentage of treasuries in its holding (In plain language, the pension fund will give the treasuries to the central bank, in exchange for freshly printed yen.) while increasing the percentage of stocks (purchased with all that yen). So yes, what really is happening is all that newly printed yen is being turned into stocks. Clearly, this is the main reason why the Japanese stock market is soaring, but another consequence is also of interest. Despite how cheap the yen has become (On the basis of various real effective exchange rate indices, it has been decades since it was last so undervalued.), it is under further devaluation pressure, for the newly printed yen is being exchanged by the pension fund (and I assume all the insurance companies and various other private and semi-state portfolio holders) for foreign currency that is then used to buy foreign assets. On a macroeconomic level this is the right decision for the Japanese to make. If they do it right, assuming they can maintain this level of buying for the next five to six years, then for all practical purposes their national debt will disappear (since all the debt will be in the possession of the central bank, which can eliminate it with the stroke of a pen), and in its place will be a lot of valuable foreign assets, which Japan’s aging society can live off. It truly is genius. However, from today’s perspective, it is rather the yen’s situation that is interesting. No one is very enthusiastic to short it – nor am I, since it is so cheap – but from the looks of things, it is under tremendous selling pressure, and could weaken further, perhaps even dramatically…

The other devious people are the Greeks. The descendants of resourceful Odysseus have Europe by the balls, while at the same time the Europeans actually think they have the upper hand. As Yanis Varoufakis stalls for more time, everyone thinks it is the Greeks who are in trouble. That is actually not the case. For while money continues to flow out of the Greek banking system, the ECB (European Central Bank) continues to raise the size of the credit line extended to the Bank of Greek, which is called the ELA (Emergency Liquidity Assistance*). Also while the politicians absolutely and unequivocally declare that under no circumstances will they loan another cent to the Greeks until the Greeks start doing something, the ECB, albeit indirectly, is nonetheless increasing the loans (in addition billions) to them. And if the Greeks leave the euro zone, the entire ELA then transforms into a European debt, which of course no wants to happen. In other words, as the size of the ELA grows, the difficulty involved in reining it in also increases because Europe’s exposure will be too large. It already is, but since it appears that the ECB does not dare let Greece collapse, the ELA is allowed to grow incrementally. And of course the Greeks are familiar with the old adage: If you owe the bank $100 that is your problem. But if you owe the bank $100 million, then that is the bank’s problem. So the debt is now so large, and continues to grow day by day, that the Greeks will not be allowed to go under in the end. I assume the great negotiator Varoufakis knows this as well. From the beginning it was clear (I had written about it) that a major Odyssey was about to begin, with the European bureaucrats easily getting lost among the Greek isles. Despite the tactical maneuvering by the Greeks, they, too, have acted foolishly, for they have managed to kill any nascent economic recovery by prolonging the uncertainty, and are now heading back into recession. So in the end this may be one of those duels wherein one side stabs the other in the heart, while the other simultaneously shoots the stabber in the gut. Everyone loses…

Treasuries continue to maintain the interest of all the world’s capital markets. What is most interesting is that despite the soft (perhaps recessionary) data, bond yields are not going lower, but rather higher, not just in the United States, but also in England and Europe. It would appear that future economic growth and a climbing out of these deflationary times are being priced in, which essentially is good news, but could cause a few more difficult instances for stocks and emerging foreign currencies down the road.

 

*For anyone interested, here is the link to the 2-page guide to the procedures related to ELA extensions.