Tuesday, February 9, 2010


Good editorial in this morning's FT.

I remain in the camp that the "risks" in the US credit markets are that interest rates move lower, not higher. This is very much a minority view - one Merrill Lynch survey of institutional investors had literally 100% agreement that interest rates would be higher by the end of the year.

However, I believe that the massive deleveraging process that the US has only just begun will lead to prices moving lower, not higher. Investors will become more comfortable moving out further on the yield curve, especially with short term interest rates so low, and yields will fall.

This is what happened in Japan. Rates on 10 year JGB's currently stand at 1.3% (!), reflecting the huge deflationary spiral that the country currently finds itself in.

Here's the post:

Japan’s debt woes are overstated

Published: February 8 2010 19:20 | Last updated: February 8 2010 19:20

Is Japan, mired in debt and deflation, the next Greece? Even its financial services minister has suggested that Japan Post, the giant bank his ministry oversees, should diversify out of Japanese government bonds. Instead, he suggested it could buy corporate bonds and – of all things – US Treasuries. Those incendiary comments came just as Standard & Poor’s, alarmed at escalating debt levels and sluggish growth, warned that it might lower Japan’s credit rating.

But talk of a massive JGB bubble – let alone default – is farfetched. Certainly, Japan is not in the rudest of fiscal health. The government has spent to keep its economy going. That, combined with falling tax revenues, has pushed the country’s gross debt towards 200 per cent of gross domestic product. With an ageing population, this alarming figure could get worse. So the 10-year JGB yield, at about 1.3 per cent, looks low. What do the markets think they know?

One should be wary about explaining away such aberrations. Yet by several criteria, Japan is different. First, gross debt levels are misleading. Japan’s debt, after netting off the state’s own holdings, is less than 100 per cent of GDP. Second, the cost of servicing its debt is low, at roughly 1.3 per cent of GDP. That compares with 1.8 per cent in the US, 2.3 per cent in the UK and 5.3 per cent in Italy. Third, Japan has fiscal wiggle room: sales tax is just 5 per cent. Fourth, 95 per cent of Japan’s debt is domestically owned. Fickle foreigners have almost no sway. Indeed, Japan’s problem is still an excess of savings. Banks are awash with deposits that they need to place somewhere. For some time yet, the government will not find it hard to secure buyers for JGBs. Japan’s debt problem will be worked out in the family.

In short, Japan does not need to apply the fiscal brakes just yet. Better to consolidate the recovery through loose fiscal policy a while longer. In one area, though, it is being too complacent. That is in the fight against deflation.

No other central bank has been as relaxed about falling prices as the Bank of Japan. Though deflation has not spiralled downwards, it has had a corrosive effect. In Japan, hoarding cash is clever investing. Just as bad, debt-to-GDP levels have deteriorated along with nominal GDP, the denominator in that ratio. The BoJ should do more. It could increase its purchase of JGBs, monetising part of the debt. Though the fiscal situation is not as bad as it appears, a bit of nominal growth would make it look a whole lot better.