There is a wonderful old US film called Reefer Madness made in 1938, which showed the delirious dangers of smoking Marijuana. It begins with this warning and description of the drug’s dangers.
It’s first effect is sudden violent, uncontrollable laughter; then come dangerous hallucinations – space expands – time slows down, almost stands still….fixed ideas come next, conjuring extravagances, followed by emotional disturbances, the total inability to direct thoughts, the loss of all power to resist physical emotions… leading finally to acts of shocking violence…ending often in incurable insanity.”
What the nation was never told was that while Marijuana was indeed addling the brains of spotty youths, their betters were the ones addicted to a far, far more destructive drug. Today it is that drug, the drug of the establishment and ruling class – debt – which is the drug endangering our collective sanity.
Come with me into the bendy world of debt dependence. Our destination, Japan.
Japan has been using debt for 20 years. They have so far accumulated a truly stunning 10 Trillion dollars worth. All in an effort to hide bad bank debts and to hold back the deflation that debt created.
When the Japanese began their addiction they were a nation of famously earnest savers, with a national savings rate of 18%. More than enough, they thought, to fund their debt problem. And so they smoked – sorry bought the lot. Which has meant nearly all of Japan’s national debt was smoked, sorry again – was held domestically. Japanese banks and ordinary savers bought the debt, allowing the government to pay a rate of around only 0.5% interest. They laughed violently and uncontrollably at their debt.
Put this way it sounds like a workable plan – almost. But look closer and you will find it is not.
I said the Japanese “were” famously earnest savers because they no longer are. The present rate of saving in Japan is now only 2%. And Japan’s public pension fund has started this year to SELL Japanese debt for the first time. These are flashing red panic buttons.
Let’s run through this again in a little more detail.
Japan had a vast property and bank debt bubble which burst twenty years ago. They decided to NOT clear those debts but to bail them out. Bad idea. To do so they needed to borrow money. Luckily their own people had huge savings. The government eagerly tapped this cash. Cash which people had earned, paid tax on and banked – in now insolvent banks.
The government issued debt in 10 year bonds. (In lots of bonds actually but we’ll chose the ten year.) Which are Government IOU’s. They borrowed the money, gave it to those they wanted to ‘save’ and promised to repay, those from whom they had borrowed it, over a period of ten years.
As the ten years rolled by, the government was, for some reason no one could quite fathom, still ‘saving’ the nation from those same debts. Time seemed to have slowed down. And worse the debts seemed to have grown. Ten years of new debts seemed to have accumulated due to a decade of deflation, due itself to…those outstanding debts and how they had strangled growth …AND more … there was now also the interest on the whole pile. People began to wonder if reality was going squiffy.
To save the nation from these now impacted and slightly hallucinatory debts, the government took a big-bowl hit, held it in as long as they could and then said, in a collectively squeaky voice, “we’ve decided to issue more debt”. It was an idea which it seemed to them just MUST be right. It was lodged firmly and “was good’. MORE debt seemed like it might do the job. Maybe, they thought, the problem is they hadn’t had ENOUGH debt the last time. They needed to do it BIG. GRAND. And so they piled it up. And the people bought/smoked it all and the government promised to pay them back with interest. Every year this conviction seemed better and more sure fire than the last time. And the logical illogical loop wound itself another time tighter around Japan’s receding future.
Today 59% of ALL Japan’s tax revenue goes to paying this debt. Which is NOT a good situation. But the amount itself is not the bendy, mad part.
This is. Lets do it again, faster this time.
Japanese banks and property bubble bursts. Banks have death-level debts. The government says the banks must be saved. The government doesn’t have enough money to do it. So it borrows. Luckily it can borrow from its own thrifty people. Who have saved trillions and put their savings in the banks. Which despite all that money are struggling for breath.
The government borrows from the people. It promises to pay them back out of the money it will get from future taxes. Whose future taxes? Well the people’s future taxes. Never mind. Moving on.
So the government borrows. Later it taxes. The more it borrows, the more of its taxes it has to pay to the people it is getting the taxes from, in order to pay them back for the money it borrowed from them a while ago, in an effort to save the banks those people had put their money in. At this point some people had violent seizures and emotional disturbances.
But it was too late to stop. The money the government was getting in from its citizens had to be diverted from investing in the future of the country so that it could, instead, be used to pay off the debts from the past. Tax money from today, diverted from the future, to pay off the past. OK! Onwards.
Or to confuse you an additional way, the government borrowed the money people had earned in the past, to pay off debts incurred today, with the comforting promise to pay it back with taxes levied on money those people hadn’t earned yet, but would in the future as long as they still had both their sanity and a job. An increasing number of people, however, started to feel unable to direct their thoughts coherently any more. Some even resorted to acts of shocking violence.
Certainly it started to seem to outsiders that the government was inflicting shocking violence on a once vibrant and proud country and its long suffering but by now very, very confused people.
In the end, people just hung on to the fact that, in these uncertain times, their savings were, at least, in safe government bonds. And they had been paid some interest. Of course that interest had come from their own taxes, which had to be higher in order to pay back to them that debt and its interest.
Sadly, by diverting so much tax away from investment in new industries, the economy grew less. In fact it contracted. As it contracted industry cut back. People lost their jobs or found their salaries being cut (in real terms). That sad state of affairs meant people became a little cautious and spent less. Which hurt the economy.
The government felt it had to borrow more to off-set this additional deflationary spiral. Luckily it could still borrow at low rates from its people. Except…. as we come up to where we started, the terminally fuddled present, the people are all out of savings and the government can’t borrow from them.
Which puts the government in a dangerous place. The government owes its own people 10 trillion dollars. The government doesn’t actually HAVE that money of course. They borrowed it and spent it. Much of it went to the banks. Who don’t have it either.
In fact what the banks have been doing with a great deal of the money is lending it out to foreign speculators in what is called the Yen Carry Trade. Which means it was invested elsewhere in other countries, not in Japan.
This leaves the government needing to borrow a lot more, and right now, in order just to pay the interest on everything they have borrowed in the last twenty years. But the people they usually borrow from are broke.
But of course, if they can’t borrow from someone, then they won’t be able to pay back the people they owe – their own people. Which would mean all those savings, put in all those safe government bonds would …default. Which would be insanity would it not? Insanity and complete utter implosion, impoverishment and collapse.
Luckily, this cautionary public information message will ensure such madness never takes hold here.
Excellent commentary Golem. It makes me addled just reading it, so I can't imagine how you wrote it and kept the sentences flowing.
Have you considered writing a comical stage play? The confusing parts could be handled by a 2-part Greek chorus, so as to not confuse the audience too much. Maybe a pantomime format would be more appropriate.
Rick Moranis simplified the madness around him by saying "Smoke 'em if you've got 'em!"
Too true!
Maybe the government of Japan could print money and lend it to the people, so that they can continue to lend it back to the government and pay the interest with their taxes. Sounds like it could keep the reefer alight for a while longer.
Cheers dudes!
Excellent article, the story Japan's rise and (possible) fall is simply extraordinary.
However, I was under the impression that the Yen carry trade artificially suppressed the value of the Yen, and the Yen's recent rises in value relative to the USD have been the result of the unwinding of the carry trades.
Or am I wrong? I'm not exactly a world's expert on Foreign Exchange markets.
Onwards and upwards.
Unclear,
I'm not an expert in FX trading nor Carry trades either. So I could be wrong. Hope not. I hate peddling misinformation.
Frog2! – if you're out there! Frog2 can sort this out. Come in Frog2!
Anyway, here is my quite possibly erroneous understanding. At least you'll be able to understand how I came to my wrong understanding and correct it perhaps.
The logic I was following was that the more people want to buy the yen, the greater the demand and the higher its value. Thus when you want to intervene to devalue a currency you sell, thus flooding the market and make supply exceed demand.
The popularity of the Yen carry trade meant there was always a voracious demand, no matter how much Japan printed. That demand kept the Yen's value high.
Freely available, but because it was snapped up, higher in vlaue than the Japanaese wanted it to be.
If this is wrong, I'll remove it from the post. It doesn't alter the bulk of it or my over all point.
FROG2 come in please!
OK I think that plays it safe. Sorry about that. Thanks Unclear.
No worries. As you say it makes no difference to the point you were making.
We should all understand how this profoundly life affecting stuff works or at least that it is going on. It should be on the school syllabus. What the hell were we doing, trusting that everything would be all right if left to the experts?
Anyway, after a little light reading: investors borrow the Yen from the Japanese banks, then sell the Yen and buy Dollars (or Whatever).
So have the BoJ been effectively printing Euros and USD?
This leads to the value of Yen being suppressed relative to other currencies. They then invest the USD/Euros at a higher rate of interest Elsewhere.
This goes on until Elsewhere reduces their interest rates too, or the cost of buying back the Yen in order to repay the Japanese banks starts to rise. In fact, reducing interest Elsewhere will cause the relative value of Yen to rise.
This is why they talk about 'violent unwinding' of the carry trade; because once the Elsewhere began to even think about reducing interest rates, everyone with a debt in Yen needs to get that debt converted back into Yen and paid off lickety split, which of course drives up the price of Yen suddenly and unstoppably.
Is there now a carry trade in USD or GBP? If so, where are they investing it?
As ever, Unclear.
But no! But wait. How many angels did you say were dancing on the head of that pin?
Thanks Unclear.
Interesting discussion, but I still think that the explosion in debt is a symtom rather than a cause of the crisis.
Debt is just the only way that the middle classes in the 'developed' world can keep their standard of living during these times of globalisation. Debt is just easier than any other solution, at least in the short term – which is all politicians care about.
Well I started out with plenty, but then I saw an opportunity to exchange them for a package of AAA rated Cherubs, Seraphs and Sprites, with enough left over for a yacht in Antibes. How was I to know that the celestial being market was about to collapse? Managed to mislay the pin too as it happens.
Still if anyone fancies a sail this weekend…
As ever, Unclear.
Rob,
I agree with you taht debt is how teh middle class have maintained thei standard of living. Does that make it a cause or a symptom? Political desire/economic method – two snakes eating each other's tail.
Main thing is we see both of them for what they are and how they lock in to each other.
Unclear,
Seraphim futures are way too volatile.
Stick with the lower orders.
Golem – yes doesn't make a lot of difference in the end.
Another long article by Mr Hudson, BTW,
how-brazil-can-defend-against-financialization
Fits somewhat into the debt and globalisation debate. Must admit, only had time to read the first few paragraphs…
Cheers Rob.
But but, what I don't understand is when the central banks intervene and flood the market with their own money in order to bring the price down, everyone knows who is behind it. If it were anonymous people off-loading a currency you might think that it was a good thing to get out of so the price would drop. But if the central bank does it so what? We all know they want the currency to be valued less, they might wish for this but why should it just happen?
Confused…
IanG,
Actually you have put your finger on the problem. Everybody does know when its a CB. The reason it still works is because of time scales.
If you are an FX trader holding currency at one value and a central bank comes in selling hard. They WILL move the market down simply because they will sell so much, so quickly. So unless you can afford to just sit it out until the value bounces back, then you will be forced to cover and get out. That is you sell to avoid a larger loss.
But that is just the short term. Eventually all CB's have to give up because even they run out of cash. But 'eventually' can be as long as two years. It was in the case of the Yen. Most raders could not wait that long.
You can't fight a CB in the short term. Not as a trader. But longer term the market as a whole will win.
The carry trade works like this in my experience.
A well heeled American working in Japan borrows shed loads of yen at .5% interest and buys a flat in London (unseen and off plan with first year rent guaranteed)and invests a smaller amount of cash (20% say) into an investment fund which is supposed to grow and repay the Yen Loan in 25 years time (assuming the fund grows at 7%pa. Typically the yen loan and investment vehicle are through the same bank.
Thanks Tom,
Made me laugh.
Yes, the guy has lost big money on all 3 sides from a single "investment".