Any experts on Japan?

[PJM]

The BOJ has already exhausted interest rate weapon as rates are almost zero and 3% increase in rates would mean that all tax revenues are used just to service the debt.

 

The bonds being mostly held by Japanese, then most of the interest paid goes back to their tax base.

 

So while it's true that all (current level of) tax revenues would be used just to service the debt, the private sector would see a massive surge in govt bond interest income cash flow.

 

The government could tax this increase of interest income, and put it back into the programs it currently spends money on.  So the private sector would in theory see no change in cash flow.  Bond holders would get the same as they get today, as would the beneficiaries of government programs.

 

So it would in effect be defaulting on interest payments to it's domestic bond holders, but foreign bond holders wouldn't get hurt (there are so few of them). 

 

And it's private bondholders would just keep on seeing the same level of bond income that they see today.  Net of tax.

 

I'm not convinced this wouldn't lead to some sort of dumping of bonds by the Japanese.  It's just that it appears if you are increasing payments to your own people, that seems to open a door to raising taxes.

 

Just brainstorming.

 

In short, if you pay too much interest to your own people, take it back!  Otherwise, it would be somewhat like an economy without taxation if all the money taken in taxes were given right back again.

 

Taxes in Japan are already high, for both individuals (40% for income above $180K) and corporates (around 38%). On top of that there is service tax (which will be increased to 8% in April) and a special surcharge of around 3% for rebuilding program post 2011-earthquake.

 

Interest income is already taxed at around 22%, so increasing it would naturally put off investors investing into bonds. Govt can only tax and take back a certain portion of the interest income, so the deficit will keep growing if the government is using all of its tax revenues to service the interest.

 

Rising interest rates will have a massive impact on the book values of banks(e.g. below) and pension funds (which is already running a deficit due to ageing population and life expectancy rate of 80+). So the choice for pension funds is to sell the existing bonds at a big loss to pick up new bonds at higher yields or hold the existing bonds until maturity with a negative real yield creating bigger hole in the deficit.

 

The country's second-largest bank, Mizuho Financial Group Inc., 8411.TO +0.95%  said in May 2013 that a one-percentage-point rise in the yield of the 10-year bond would result in paper losses of ¥100 billion-¥200 billion ($1.1 billion-$2.1 billion) on its loan portfolio

[Orange]

What's always bugged me about Bass is how he's rooting for default and unrest in Japan.  I never liked people who were cheering for bad things to happen.  It's like wishing a terrible car crash or horrific death on someone.  Yes people make mistakes, companies make mistakes, and countries make mistakes.  I'd rather hope for a solution rather than wishing ill on anyone..

 

This is the same thing that's said about every short seller. When I short a company I believe to be fraudulent I don't think to myself, 'I can't wait until all of the workers get fired and lose their source of income.' What I hope for is the market to recognize the facts of reality. Every day that it doesn't is a day that capital is misallocated.

 

I imagine the same is true of Mr. Bass. Do you really think he's sitting there thinking, 'I hope that millions of people lose their jobs and are starving in the street'? Unless he's psychotic, I doubt it. When the market does not reflect economic reality, that is categorically bad. Assuming the Japanese economy is on the brink of collapse (I don't have an opinion), think of all of the capital invested every day on the assumption that it is not going to collapse. Keeping a charade going isn't good for anyone if you're thinking beyond the immediate moment.

 

I think you have a healthy point of view.  My experience is that most who short don't have that same view.  I have used Salesforce.com, I've seen it change businesses.  The stock is overvalued, when I talk to short sellers about it they are hoping doom and gloom and that the company crashes and burns.  They can't separate the stock valuation from the actual company.  In theory the stock could go to zero and the company continue to hum along like nothing happened. 

 

Bass clearly benefits from the Japan gloom and doom trade.  If Japan fails his mortgage is paid off with cheap Yen, his fund makes a mint and he can go on TV again and say he was right and attract even more assets.

 

I don't short anything, I don't think there's anything wrong with shorting, but I'd rather be optimistically biased.  I'd rather things turnaround and do well than fail.  In the end I want everyone to do well.

 

 

Would it be better if Bass identified what he believes to be problems with Japan's economy, and then did nothing and said nothing because it would be too negative and mean? After Michael Burry uncovered the problems with subprime housing, should he have told nobody since people might lose their homes if he is right?

 

That's an incredibly naive viewpoint. Without short sellers, cynics, and pessimists, market highs and lows would be even more pronounced. Society benefits when there is less boom and bust. Especially in times of bubbles, a dash of pessimism is a very good, moral thing for markets.

 

[randomep]

 

 

Would it be better if Bass identified what he believes to be problems with Japan's economy, and then did nothing and said nothing because it would be too negative and mean? After Michael Burry uncovered the problems with subprime housing, should he have told nobody since people might lose their homes if he is right?

 

 

Michael Burry told nobody. He just made his fund investors rich with his subprime trade.

 

Mind you I think short sellers have a utility, but just wanted to correct your statement.

[ERICOPOLY]

The BOJ has already exhausted interest rate weapon as rates are almost zero and 3% increase in rates would mean that all tax revenues are used just to service the debt.

 

The bonds being mostly held by Japanese, then most of the interest paid goes back to their tax base.

 

So while it's true that all (current level of) tax revenues would be used just to service the debt, the private sector would see a massive surge in govt bond interest income cash flow.

 

The government could tax this increase of interest income, and put it back into the programs it currently spends money on.  So the private sector would in theory see no change in cash flow.  Bond holders would get the same as they get today, as would the beneficiaries of government programs.

 

So it would in effect be defaulting on interest payments to it's domestic bond holders, but foreign bond holders wouldn't get hurt (there are so few of them). 

 

And it's private bondholders would just keep on seeing the same level of bond income that they see today.  Net of tax.

 

I'm not convinced this wouldn't lead to some sort of dumping of bonds by the Japanese.  It's just that it appears if you are increasing payments to your own people, that seems to open a door to raising taxes.

 

Just brainstorming.

 

In short, if you pay too much interest to your own people, take it back!  Otherwise, it would be somewhat like an economy without taxation if all the money taken in taxes were given right back again.

 

Taxes in Japan are already high, for both individuals (40% for income above $180K) and corporates (around 38%). On top of that there is service tax (which will be increased to 8% in April) and a special surcharge of around 3% for rebuilding program post 2011-earthquake.

 

Interest income is already taxed at around 22%, so increasing it would naturally put off investors investing into bonds. Govt can only tax and take back a certain portion of the interest income, so the deficit will keep growing if the government is using all of its tax revenues to service the interest.

 

Rising interest rates will have a massive impact on the book values of banks(e.g. below) and pension funds (which is already running a deficit due to ageing population and life expectancy rate of 80+). So the choice for pension funds is to sell the existing bonds at a big loss to pick up new bonds at higher yields or hold the existing bonds until maturity with a negative real yield creating bigger hole in the deficit.

 

The country's second-largest bank, Mizuho Financial Group Inc., 8411.TO +0.95%  said in May 2013 that a one-percentage-point rise in the yield of the 10-year bond would result in paper losses of ¥100 billion-¥200 billion ($1.1 billion-$2.1 billion) on its loan portfolio

 

Alright, where does the money go?  The government starts paying interest income through a firehose onto the private sector.  Private sector income is ballooning.  Does this show up positively somewhere in the economy?  Can the government see rising tax revenues when income is flooding into the private sector (via higher interest).

 

I mean, you suddenly have the situation where all tax receipts go right back to the private sector.  Does that... have any... impact?  It's not like it won't.  People won't have to save as much, for example, if they can reinvest at higher rates.  That means pensions won't need to be funded as heavily (for one example). 

 

There must be some knock-on effects from the government suddenly flooding the private sector with interest income.  Inflation?

 

22% tax rate on interest income???  Seriously?  Interest income is taxed at like 40% top personal federal tax rate in USA, and over 50% top rate in California.  Large banks probably pay more like 30%+.

 

[ERICOPOLY]

But look, if people will invest their money in government bonds at 1% interest rates and 20% tax rate, why would they hold back if interest rates were 3% at 73%. 

 

In both cases, the after-tax income is 0.8%.  It doesn't disrupt their earning and spending power at all.

 

The United States had a top-end tax rate of 70+% for quite a while after WWII.

[PJM]

But look, if people will invest their money in government bonds at 1% interest rates and 20% tax rate, why would they hold back if interest rates were 3% at 73%. 

 

In both cases, the after-tax income is 0.8%.  It doesn't disrupt their earning and spending power at all.

 

The United States had a top-end tax rate of 70+% for quite a while after WWII.

 

I hear you and you raise a very good point. If income flows back to private sector, it should lead to increased wages and more spending, more investment at higher yields and in turn more tax revenues. But the broken piece is that when Japanese people get more money, they just put it under the rugs as savings. The key reason is that the Japanese don't trust the banks or the government. This morning on front page of WSJ, there is an article in which people were asked if they spending the winter bonuses which was higher for the first time in 5 years. The response "I'm not spending because I'm concerned that they may go down". I know many people who think every penny given to banks and govt will be lost in future. When i lived in japan until a few years ago we literally got free money into our bank account by the govt but all that money disappeared from the banks or the economy.

 

As for private sector and pensions, I think that they ain't investing in JGBs because they think its great investment but they are forced by the govt, just like recently Abe has been pushing pension funds to invest more in equities to inflate asset prices. Even if yields went up, would you be investing in debt that you think is unlikely to be repaid or some other assets, especially if the yield returns are going to be paid back as taxes?

 

Japanese corporates should be able to take advantage of the cheap/free money (BOJ just announced increase in lending to banks at zero rates) for more capex, expand overseas and pick up good assets, but Japanese corporates are very poorly managed. They don't have confidence in domestic economy and always land up paying inflated prices for overseas acquisition. Even post-acquisition they are unable to integrate it properly and reap its benefit.

 

It is unfortunate that its the same country that built fantastic companies only few decades ago. People like Matsushita and Morita would have been very sad to see the plight of Japanese corporates today.

[Happy]

How would I actually go about benefiting from this (or at least protecting myself) in case this happens?

Can I just short Japanese 5-year government bonds? I have never shorted anything in my life, but this situation really seems unsustainable to me and both the downside and annual carrying cost seem extremely low if the bonds hardly yield anything.

If Japan were to monetize its debt to keep rates down, the currency should depreciate. So one probably would also buy options on the currency or short the currency as well.

 

Any advice on how to actually do this would be appreciated. I read some time ago that Interactive Brokers is a good option for shorting.

 

[rogermunibond]

I think PJM points the main problem.  It's not so much the Japanese household sector that is saving (I think the latest 2012-2013 numbers show the household sector is reducing savings as the aging population has increased and the working population has decreased), but that the Japanese corporate sector has an extreme overabundance of saving.  In this case the cash just sits on the balance sheet.

 

Structural issues and governance problems in the corporate sector are the reason the transmission mechanism is broken.  They aren't investing and they aren't sending it to shareholders.

[Kiltacular]

I think PJM points the main problem.  It's not so much the Japanese household sector that is saving (I think the latest 2012-2013 numbers show the household sector is reducing savings as the aging population has increased and the working population has decreased), but that the Japanese corporate sector has an extreme overabundance of saving.  In this case the cash just sits on the balance sheet.

 

Structural issues and governance problems in the corporate sector are the reason the transmission mechanism is broken.  They aren't investing and they aren't sending it to shareholders.

 

Roger,

 

It is difficult to disagree with idea that Japan has some problems and perhaps even very serious problems.  Going back to the original question on this thread about Bass betting on a default within two years -- do you believe that will happen?

 

It seems to me that if a country like Japan (or U.K.) were to default, there would be disastrous worldwide repercussions.

[rogermunibond]

Default within two years, no.  I think they have too many options with selling off assets, privatizing Japan Post and other assets, taxation changes, legislating corporate reform, or even god forbid for them, immigration policy reform.  As a last resort, Abe could always resort to nationalism.  The guy uses Yasukuni deliberately as a way to distract his critics and to make his right wingers link economic reform to national strength.

[Kiltacular]

Default within two years, no.  I think they have too many options with selling off assets, privatizing Japan Post and other assets, taxation changes, legislating corporate reform, or even god forbid for them, immigration policy reform.  As a last resort, Abe could always resort to nationalism.  The guy uses Yasukuni deliberately as a way to distract his critics and to make his right wingers link economic reform to national strength.

 

Thanks for your thoughts and the link to the interesting blog earlier in this thread.

[PJM]

I think PJM points the main problem.  It's not so much the Japanese household sector that is saving (I think the latest 2012-2013 numbers show the household sector is reducing savings as the aging population has increased and the working population has decreased), but that the Japanese corporate sector has an extreme overabundance of saving.  In this case the cash just sits on the balance sheet.

 

Structural issues and governance problems in the corporate sector are the reason the transmission mechanism is broken.  They aren't investing and they aren't sending it to shareholders.

 

One way to force these companies to become more active is by imposing undistributed profit tax (just like US did in 1936). This will force the companies to distribute the retained cash/earnings and put money into the hands of the investors giving them more purchasing power (and more tax revenues for the govt). It will be win-win situation for the govt in terms of getting more tax revenue and reducing its budget deficit. Since the companies wont have any retained earnings for future investment, it will be forced to raise capital/credit, expanding the debt market and creating velocity for the newly printed money. Alternatively the companies may actively start doing capex instead of distributing earnings, which will again inflate the economy.