1/24. Is Japan in a debt trap and is that trap now snapping shut? A long thread. We start with the Ministry of Finance's "Japanese Public Finance Fact Sheet' (a must read for everyone).
2/24. From this, one of the most scary charts in the economic world. Japan has run chronic budget deficits for years, with the result that its accumulated debt level has soared.
3/24. Total government debt-to-GDP has risen from 59% in 1990 (when Japan's bubble popped) to 220% today. How could this be sustainable?
4/24. Because as interest rates came down, debt-service payments fell. But if you keep adding debt, and interest rates can't fall any more, your debt-service burden at some stage rises. From the chart below, Japan appears to have hit that point.
5/24. Japan's total debt keeps rising because one third of expenditure is financed by bond issuance.
6/24. Surprisingly, Japan actually has quite a "small government" compared with other advanced economies. Further, expenditures are totally dominated by social security:
7/24. But if you have such a huge gap between revenues and expenditures (as is the case in Japan), then you will run large government's primary deficits as a % of GDP despite the small state:
8/24. And every time Japan hits an economic head wind, it enacts a fiscal stimulus package financed by bonds. This past week, here we go again:
9/24. If you study economic growth accounting, identities below are seared into your brain. Japan has generally kept 'r' (nominal interest rate) < 'g' (nominal growth rate) in most yrs due to BOJ's QE, but the debt-to-GDP ratio still rose on back of large primary deficits.
10/24. If 'r' should ever get above 'g', game over for Japan: it's debt-GDP ratio will explode out of control on rocketing debt-service payments. How could that happen? Either 'r' rises or 'g' falls. Unfortunately, Japan's horrendous demographic outlook means that 'g' will fall.
11/24. Near term, however, Japan's Achilles' heel is "r". Japan currently exists in an interest rate regime of financial repression; that is, "r" is set by the Bank of Japan. Zero at the overnight policy rate and 0.25% for the 10-year bond.
12/24. Note that longer-term bonds have a lot higher interest rate, as the BoJ does not (yet) target them:
13/24. At the end of March 2022, the BOJ owned 43% of outstanding government bonds.
14/24. Why are financial institutions so happy to accept such low yields? Because inflation has been non-existent in Japan since the 1980s:
15/24. How could equilibrium be upset? First, inflation could pick up & exceed the 10-yield govt bond yield of 0.25% & LT bond yields of 0.8%. It is doing just that, with the Sep number at 3.0% y/y (excluding fresh food 1.8%) from around zero last year.
16/24. The authorities, however, could respond to inflation fears in 2 ways: could direct insurance cos and pension funds to buy bonds anyway (Japan has history of directed finance). Or, the BOJ just buys every bond that comes up for sale.
17/24. Even if insurance cos & pension funds can't sell, there is a limit to how many extra bonds they can buy for asset-liability matching reasons. So the BOJ is the ultimate buyer. Is this sustainable? Let's follow the money.
18/24. When the BOJ buys a bond from the government, the government gets a matching deposit with its account at the BOJ. It can then go out into the market place and buy goods and services from corporates for its social security & other needs.
19/24. These firms deposit a portion of proceeds from selling their goods & services in their bank accounts or pay their workers, who deposit a portion in their accounts. These accounts pay zero, but who cares when inflation is zero? They are safe and highly liquid deposits.
20/24. Let's jump to Japan's Statistical Yearbook to see how quickly corporate & household bank deposits have built up.
21/24. From the "Financial Assets & Liabilities" page of the "Flow of Funds", corporate bank deposits have gone from Y202 trillion in FY 09 to Y293 trillion in FY 19 (latest year), +45%, & households from Y798 trillion to Y1,000 trillion between FY09 & FY19,+25%.
22/24. Over same period, Japanese nominal GDP has gone from Y529 trillion to Y558 trillion, + 5.5%. So build-up of bank deposits on corporate/household balance sheets has significantly exceeded nominal GDP growth, but UNTIL NOW we have had no inflation & no flight out of the yen.
23/24. This was a reasonably stable equilibrium since firms and households had no incentive to spend these deposits as long as there was a) no inflation and/or b) a stable yen. Both of these conditions have been breached, so the incentive now exists to get out of these deposits.
24/24. The BOJ then has 2 choices: raise interest rates, which puts government into a debt-service trap, with an accelerating debt-GDP ratio, or bring back capital controls to defend the yen once its FX reserves run dry. What will it do?
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1/18. This is a thread on how we could see a 75% drop in the S&P. Absurd, ridiculous, hyperbole? Please humour me. We will start with China.
2/18. Following a series of 3 tweets highlighting Chinese industrial strength, I want to stress that I am not a cheerleader for China (unlike say Jason Smith @ShangguanJiewen). China's growing manufacturing & tech dominance just appears to be an objective fact for me.
3/18. And the geopolitical and market ramifications of this sea change are immense. China makes up the third shock wave currently engulfing the US stock market and the least understood. But let's get the better know negative hits out of the way first.
1/8. Symbols of Chinese dominance of the Big Three: autonomous vehicles, drones and robotics. And China is on its way to having 10X the productive capacity in all three domains compared with the US.
2/8. And such commercial capacity has the ability to be turned into military capacity. This is basically what the US did in WW2 with Japan. It flicked a switch: then auto makers produced tanks and commercial ship yards produced aircraft carriers.
3/8. For any serious observer of China tech, Twitter comments suggesting China can’t innovate & its technology is the result only of theft from US are now laughable.
1/5. Hmmm. Be careful what you wish for. Slash and burn spending cuts will tip the economy into recession. And under recessions deficits expand, not contract. Elon never studied Econ 101.
2/5. Ballooning structural deficits are due to a multitude of factors, most important of which are negative demographic (principally an ageing population & falling trend in workforce participation, plus an LT decline in the corporate tax take.
3/5. Trump, Elon and Vance will throw MAGA the red meat of scrapped DEI programs, etc. But attacking “woke mind virus” expenditures won’t make a dent in the deficit. In the grand scheme of things they are rounding errors.
1/5. If #Deepseek is the Sputnik Moment, the realisation that other countries apart from US can do tech too, it’s been a long time coming. X accounts like @GlennLuk, @wmhuo168 but above all @hsu_steve have been flagging this for ages.
2/5. For @hsu_steve, it’s China’s Science, Technology, Engineering & Mathematical academic prowess that has changed everything. Forget the PLA, this is China’s new STEM army.
3/5. A tsunami of STEM graduates & post graduates are pouring into the China workplace at a time when Chinese universities are exploding up the academic league tables. Follow his tweets for the numbers.
1/24. Rocket Lab $RKLB is a symbol to me of the craziness of this market. Now it's a good company with a very engaging Kiwi founder Peter Beck. But the valuation is so insane as to require psychedelic drugs to justify.
2/24. Looking at Twitter feed, I don't think any one of its rabid supporters has looked at 10Q.
Company's revenue run rate is about $400 million, but stock valued at $12 billion.
3/24. Currently, we are trading at 30X sales (true a bit less than Palantir, but Palantir is cash flow positive). Of course, Rocket Lab is losing money and there is no hope in hell that it will make any kind of profit before 2028 at the earliest.
1/16. Jeremy Grantham. Surely the greatest historian of bubbles wrote this article ("Waiting for the Last Dance") in Jan 2021 amidst the pandemic's monetary & fiscal stimulus euphoria. Nasdaq was at 1400, Apple at $128 and the meme stocks "to the moon".
2/16. Wow, what a bubble! Wouldn't see that again? But we have: 4 yrs on, Nasdaq at 2,000+, Apple at $228 & meme stocks? Well, aren't they all meme now? Rocket Lab at 20X sales (earnings? 'forgetaboutit'), Palintir at 45X, Apple at 10X. Back in the day, these were P/E ratios.
3/16. OK, let's adjust that Jan 2021 Nasdaq number for inflation (around 20%) and real GDP growth (about 10%). That gives us Nasdaq at 1,900. So we are now way past Grantham's "Last Dance" and appear to be heading higher.