Japan – The Canary in the Coal Mine

Reasonable people from all walks of life can see that the current economic scenario from a macro point of view – basically borrowing and printing to consume – is unsustainable.  However, just because something is unsustainable does not mean its going to crash tomorrow.  So that begs the question, how long can the developed world consume more than it produces, essentially racking up the credit card for future generations to be responsible for the tab? Honestly, it surprises me it has hung on as long as it has – but let’s take a look and see what indicators will warn us that the fiat demise is finally at hand. 

Anything posted in a discussion of this type is likely to be an oversimplification of a terribly complex issue, however I will post a basic premise and back it up with some imperical evidence.

A simplified backdrop of the world’s economic situation looks like this.  The developed world is swimming in an ocean of fiat debt – the depth of which the world has never seen during peacetime.  With sovereign debt over $50 Trillion and total debt more like $200 Trillion the numbers are truly staggering and central banks continue expand their balance sheets. It will soon turn to a Madoffesque macabre if things aren’t changed drastically and quickly. Basically we are 70 years into a debt cycle that is doomed to fail – the only question is when.

I like to use Japan as the proverbial canary in the coal mine.  Betting against the Japanese because of their ludicrous debt situation (sovereign debt close to 250% of GDP) has been dubbed “the widowmaker.” For years, the fundamentals have been out of whack, and not only have the Japanese gotten away with enormous debt, but the have done it with the LOWEST PRICE DEBT IN THE WORLD.  That’s right, the Japanese only pay .72% on their TEN YEAR debt!  Shortsellers have been slaughtered – hence the term “widowmaker!”

The reasons the debt has been so cheap and the yen has been strong are all coming to an end – so shortsellers will soon get their revenge.  Japan has recently turned from an export to an import economy. The catalysts of this have been the import of hydrocarbons for energy as their nuclear plants have been shut down and trade turmoil with the Chinese over worthless islands.

Their citizenry is aging and retiring at an alarming rate – not only will they not be buying government bonds as savings, they will be selling them for living expenses. The Japanese have not allowed for immigration. So the Madoff strategy of new victims entering the game is not being utilized and the average Japanese woman now has about 1.3 children – this is how ponzi schemes end.

Their new prime minister is setting a 2% inflation target rate.  That will scare off bond buyers who have been depending on deflation considering the low interest.

Japan is spending about 25% of their government revenues on debt service right now.  Imagine what happens when interest rates on their debt begin to rise!  Compare this to Italy. The Italians went from  what seemed to be an economic pillar of stability to a veritable dumpster fire IN JUST 100 BASIS POINTS WHEN THEIR TEN YEAR RATE WENT FROM 5% TO 6%.  What happens in Japan when rates come off the floor ?  They have more than twice as much debt to GDP as the Italians and to add more insult to injury their debt is of shorter duration – meaning it is coming due and they will have to refi !!  More and more of their government revenues will be required for debt service payments and the situation will accelerate. Their prime minister has no idea what he is doing pushing for 2% inflation.  That would ignite the debt bomb.

How does this roll out and when?  I don’t know, but the currency will go first.  Meaning, the Japanese yen will weaken significantly from where it is now and then the bonds will sell off sending interest rates higher. Eventually this will end in some sort of debt restructuring – that is inevitable.  How does the debt restructuring of the third largest economy in the world effect the globe?  No one knows, but one thing is for sure – a lot of people will lose a lot of money. When you check the European situation – they are not far behind Japan and the then the US will be on deck. Many parts of the globe will be in trouble, but the Japanese numbers and situation are by far the worst.

So right now, use the Japanese situation as your indicator – if the currency accelerates down and bond yields start to go up REEL IN AS MUCH PORTFOLIO RISK AS YOU CAN!  It will be much more important to get the return OF your money than worry about the return ON your money…


Greyson Geiler  


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