The world’s finances may be reaching critical stress-points, and as Bill Fleckenstein points out in this excellent article, the recent cracks that have started to appear in the Japanese and US bond markets could be as significant as the first payment defaults that occurred during the subprime mortgage meltdown.
Bill Fleckenstein, president of money management firm Fleckenstein Capital, begins by talking about the huge spike in yields that occurred in the Japanese bond market on 23 May. “I believe that was a very important moment in recent and longer-term financial history. In the near-term, I believe it marked the end of the ‘sweet spot’, a term I have used to describe the environment we’ve been in where people believe that central banks could create an easy-money nirvana at the push of a button.”
He continues, “In a recent column, I mused about which bond market – Japan’s, Britain’s or ours (that of the US) – would crack first. Now we know: Japan’s. The reason I say the sweet spot has ended is because on May 23, the very early stages of a funding crisis hit Japan. This is demonstrated by the fact that Japanese government bonds traded through 1.00%, which is two-and-a-half times their rate when the Bank of Japan’s huge quantitative easing efforts began.”
What’s remarkable about this is not that yields spiked, that shouldn’t have come as a surprise to anyone, but that this didn’t happen sooner in other major debtor nations such as the UK or the US.
For a number of years bond markets (with the exception of those in the PIIGS countries), have defied the laws of economics, something which has essentially given many nations a free pass. There are several reasons for this, not least the absurd Ponzi scheme in which central banks provide bailout funds to struggling banks who then use the money to buy government debt. But, regardless of the reasons, the fact that massive QE programmes in these countries hasn’t yet led to a spike in bond yields has created a false sense of security.
Even before the 23 May spike in JGB (Japanese government bond) yields I was stunned by a Bloomberg article which read, “Kuroda’s doubling of bond purchases last month to achieve 2 percent inflation in two years has failed to cap borrowing costs, with the 10-year yield rising the most since August 2003 in the three sessions through May 14.”
Of course yields rose. The BoJ is buying bonds in order to push new money into the economy such that inflation picks up very substantially. If you were a bond holder wouldn’t you demand higher rates of interest to hold JGBs?
Why the bond market in Japan should be subject to the laws of economics while bond markets elsewhere are not, is not completely clear. It may have to do with the fact that Japan’s public debt-to-GDP ratio (currently around 230%) is so much higher than that of any other developed nation. Another factor could be that the majority of Japan’s JGB are held domestically. Whatever the reason, rising yields are the normal, natural response to higher inflation, and it’s only a matter of time before other nations face a similar threat.
As Fleckenstein points out, “The Federal Reserve is trapped and – as May 23 demonstrated – so is Japan. The choice central bankers are facing is the same one that has confronted them since the money printing inspired by former Fed Chairman Alan Greenspan began. Once trouble starts, they have to decide if they are going to allow their economies to fall into a depression or go down a path that seems painless but leads to inflation. My belief has been that central bankers – as they have already demonstrated – will always choose the path that leads to inflation because they think they can easily stop it. And for a long time (most especially recently), people have believed that the money-printing path was essentially painless. I believe that view peaked on May 23 (even though no real inflection point can ever pinned down to one day, or even one week).”
Moving on to talk about the US bond market, which experienced its own turmoil on 28 May, Fleckenstein places the blame, “at the feet of Fed chief Ben Bernanke and the other Fed heads trying to talk out of both sides of their mouths. It is understandable that Bernanke & Co. would want to prepare the markets for the eventual end to quantitative easing. They have never understood that they are the problem, and they continually think that money printing will solve everything, so every now and then, when the stock market gets frisky and the economic data get better, they contemplate that they will be able to stop someday. I don’t believe that, as when the end comes for QE, it will be because the bond market has forced it to stop.” In other words because the bond vigilantes cause a funding crisis by driving up rates.
Fleckenstein’s central argument is that politicians and central bankers will continue printing money until bond investors take away the punch bowl and that we may just be beginning to see the first signs of this.
The Federal Reserve, the Bank of Japan and many other global central banks continue to believe that sooner or later the combination of record low interest rates, freshly printed money and other market meddling will magically produce a sustainable economic recovery. Of course, to anyone with an understanding of Austrian economics (or just a modicum of common sense), this is clearly nonsense. What’s so galling is that even after five years of asset purchases and funding schemes, hardly anyone stops to ask why this self-sustaining recovery hasn’t yet materialised.
Fleckenstein concludes, “Eventually, even the really slow learners should be able to understand that the central banks are trapped and that their only choice is between depression and easy money.” You’ll get no argument from us.
Read the full article here.