(Oct 18, 2014)

My friend Ishida San recently enlightened me as to a widely held Japanese belief. He whole heartedly approved of my theory that the Japanese and the English are somehow cultural cousins; as island nations, they are both fanatical about tea, being polite, gardening, social hierarchy and prone to invading other nations. But my last comparison; ‘seeing things through to the bitter end’ he stated, I had misinterpreted.

Ishida San (not his real name) is a senior banker for one of the three Japanese ‘Megabanks’ (Mitsubishi UFJ, Sumitomo and Mizuho.) Immaculately dressed at all times, exceedingly polite, staggeringly well-read, he mysteriously still takes English lessons as he believes his ‘turn of phrase is often incongruous with the topic in hand.’ Over dinner, we were discussing of course, Abe’s re-election and the BOJ’s commitment to print 80 Trillion Yen a year.

I had put forward my theory that the Japanese have a tendency to see things through to the final degree. Perfection of an insular samurai based culture was continued until Japan had finally fallen so far behind in terms of technology that she was forced by Commodore Perry to modernize. Then, under the Meiji Restoration, Nippon managed to embrace modernization and technology so emphatically that within a generation they transformed from a feudal culture to a fully industrialized, technologically advanced powerhouse. Then they took an interest in empire building and only conceded defeat when not one, but two atomic bombs made her reconsider the flawed logic of fighting all of the great powers at the same. (The last WWII soldier, Onoda – surrendered in 1974.) She dusted herself off, rebuilt her economy and then decided to go on a credit fueled real estate and stock market boom so large that in 1989, the Nikkei was worth more than the US stock market and real estate in Tokyo sold for as much as $139,000 per sqf – more than 350 times as much as in Manhattan. Such a valuation suggested that the land under the Imperial Palace in Tokyo was notionally worth more than all the real estate in California. On each occasion, the populace had continued to believe something until it clashed with reality so hard that they were forced to stop. All perfectly true, Ishida San conceded.

And now something astonishing is happening in the Japanese currency and bond markets. Previous to the New Currency Act of 1871, Japan’s monetary system was based upon hansatsu, paper notes created by feudal lards. In its place the Yen was introduced with a value of 1 Mexican Silver Dollar – the standard unit of account in Asia at the time. During the Meiji restoration period the Japanese Government Bond was created. In 1897, Japan moved onto the Gold Standard and foreign capital poured into the rapidly industrializing economy. After the whole world decoupled from the Gold standard in 1971, a credit bubble started to form in Japan which finally popped in 1989. Japan’s private sector has since been in deflation, the only known true cure for a credit bubble. The public sector has however, been on a spending binge and borrowed a staggering 1 Quadrillion Yen and amassing a debt to GDP ratio of approximately 240%.

Literally no other country has ever managed to get anywhere near as far in racking up debts without being punished in the bond markets. On every other occasion, bond holders have correctly realized that such a debt load will not be repaid and have ditched the bonds – sending the yield price upwards. The debt becomes more unmanageable at higher interest rates and the process accelerates in a self-reinforcing cycle. (Actually this is not true – Japan’s cultural cousins the UK managed to return from a 250% debt to GDP ratio after the Napoleonic War but needed to create the industrial revolution and conquer half the globe to do so.)

Japan’s extraordinary situation has only been made possible by her domestic market’s all-consuming fear of deflation resulting in the continued purchasing of the JGB in vast quantities for over 25 years. Since Shinzo Abe was elected to power in 2012 he and the Bank of Japan Chairman Haruhiko Kuroda have been rapidly accelerating the money printing at an alarming rate. Abe stated that his December 2014 re-election gave him a clear mandate to continue with ‘Abenomics’ – his total commitment of gaining inflation by trashing the Yen. He has been successful in one part of his goals – the Yen has declined from 80 to 1 USD in 2012 to 120 today – wiping out a third of its value during his 4 year reign.

But Abenomics has not created as much inflation as they had hoped for. The BOJ now wants to print 80 Trillion Yen per annum which given the size of the Japanese economy is the equivalent to USD $3 Trillion per year. This is more than even the Japanese government wants to borrow and the yield on the JGB has, as I write, dropped to a staggering 0.36% yield on the 10 year note. Even at this rate, payment of interest rates accounts for 25% of tax revenue. An interest rate of just 1.5% would therefore be unpayable. The notion that the risk on a government bond that has an aging, declining population and that is beyond bankrupt by any measure is so low – is almost unthinkable to anyone but the Japanese.

Ishida San stated that my theory about the Japanese seeing things through to the end was flawed. Rather, he stated, for the Japanese, thinking a negative thought could in fact cause that thought to turn into reality. It is therefore, every member of the community’s duty to not think these thoughts. This was the reason that such extremes have been achieved in Japanese cultural history rather than a result of a goal.

“And anyway, what has this got to do with the JGB?” he asked, “it is risk free and has been going up in value since I can remember and that is why we banks hold it as our main asset.”

I outlined as gently as I could that “should Abe and Kuroda achieve their goal of scaring the Japanese enough as to the value of the Yen that they may one day agree that inflation really is a concern, and at that point they will start to sell their JGBs. This would have the reverse effect on the government bonds.”

Ishida San looked into the middle distance, stared, frowned, blinked, shook his head, smiled and stated serenely – ‘impossible’.

Only time will tell how long until this philosophy, now not only found in Japan, will finally meet with economic reality.