One path to monetary collapse in Japan is now clear

27 Dec 2012 by Jim Fickett.

Even before taking office, Shinzo Abe, the new Prime Minister, made it clear he wanted to end central bank independence (Japan's next prime minister wants to end central bank independence). In his first moments in office, Abe has made clear that stimulus is his first priority, and that record budget deficits and government debt are not a concern.

I am not going to try to predict when the situation will collapse, but I will say that Abe's actions have now made it easy, for the first time, to construct a realistic, near-term disaster scenario:

  • Abe forces the central bank to fund the government deficit, and he widens that deficit as well
  • He succeeds, thereby, in creating inflation (a stated goal)
  • Japanese Government Bonds, which now pay a positive real yield, become like those of the US and many others and, after inflation, pay a negative yield
  • Investors no longer have the attraction of a positive real yield and see, as well, the threat of the world's highest debt and an out-of-control government
  • Foreign investors began to dump the bonds; though they are a small part of the market, it is enough to cause some losses in the bond market
  • Japanese banks, which have thin capital cushions and huge holdings of government bonds, see these losses and began to lighten their holdings (GFSR 4: Tail risk in Japanese Government Bonds)
  • This leads to a vicious circle of further sales and losses
  • The government, which can barely afford interest on its bonds even at current very low yields, faces an insurmountable problem with rising yields and, through the now-tame central bank, is forced to print ever larger amounts of money (Debt service and retirement costs are swallowing Japan's budget)
  • Hyperinflation

I realize hyperinflation is a scare word, and overused. But in this case true hyperinflation is entirely plausible, and even likely.

Again, this is not a prediction. But before Abe, even though it was easy to see the situation was not sustainable, it was hard to see just how it would start to unravel. Now at least one path to the end game is clear. Time to watch Japan very closely.