Japan Heat Wave Will Accelerate Power Shortage

Last week, temperatures in Saitama Prefecture hit a new historical high for this time of year at 39.8 centigrade, and TEPCO (9501) was announcing that power demand was now 91% of capacity. Economists and analysts had been concerned about demand bumping up against TEPCO, Chubu and Kansai Electric’s new reduced electric power supply in July~August of this year, but the recent heatwave could mean the test comes much earlier.

With 35 of Japan’s 54 nuclear power stations now offline after the Fukushima Daiichi nuclear plant disaster, Japan is facing higher electricity costs and an absolute shortage of electricity supply that threatens to both strangle the quake interrupted recovery in production, but also skim additional disposable income from the pockets of Japan’s consumers.

Assuming that the remaining 19 nuclear plants go offline for scheduled maintaince as foreseen, Japan’s import bill for the increased crude oil and LNG needed to fire alternative oil- and LNG-fired plants could reach JPY3.5 trillion in 2012, which represents some 52% of Japan’s JPY6.77 trillion trade balance in 2010. The result would be electric power prices between 18% and 36% higher than they now are. Japan’s electric power costs were already higher than most developed nations before the disaster. For example, averagae cost per kilowatt hour in Japan in 2009 was JPY15.8, or two times higher than in the U.S. and 5.8X higher than rival South Korea’s average cost of electricity.

These higher electricity costs will exacerbate the tax hikes the Japanese government will inevitably introduce to pay for Tohoku reconstruction funding of JPY10~JPY15 trillion. Raising the consumption tax by 2~3 percentage points to (7%~9%) over the next 2~3 years could ostensibly generate the tax revenues to pay for the needed expenditures, and the government could introduce additional measures, such as a flat income/corporate tax and additional corporate taxes.

The bottom line is that this will be a drag on corporate profits as well as personal disposable income.

If that were not enough, the end of QE2 this month is expected to exert upward pressure on JPY rates, and exert further pressure on recovering corporate profits. As far as Japan’s import bill is concerned however, the higher yen and currently falling global crude oil price would help to limit the rise in Japan’s import bill.

Tokyo Takes provides free commentary on global investments from a Japan perspective. To contact the author, please email darrel@japaninvestor.com

China Shifts to Longer Maturities in JGBs

U.S. investors and economists have noticed that China has been reducing its holdings in U.S. treasuries, by around JPY30 billion since October of last year in five months of declines in holdings. Despite this, China is still the largest foreign holder of U.S. treasuries, at USD1.1449 trillion as of the end of March 2011, and with the US treasury market being the largest and most liquid fixed income market, China has no choice but to remain a big holder.

Thus China is not exactly dumping its USD treasury holdings. Rather, with USD3.447 trillion of forex reserves as of the end of March 2011, China is obviously trying to diversify its forex reserves to reduce over concentration in one foreign currency. According to estimates, USD-denominated reserves are over 2/3rd’s China’s total forex holdings, while Euro-denominated holdings are around 20% and British Pound as well as Japan Yen-denominated holdings are only several percent.

According to Japan’s MOF, China was a net buyer of medium-term JGBs by some JPY1.33 trillion in April, or about six times the net purchase of JPY234.5 billion in March, which was a new historical high. China has consistently been a net buyer of medium-term JGBs since last October. On the other hand, while China had been a big net buyer of short-term JGBs previously, they were net sellers of short-term JGBs (with maturities of less than one year) by JPY1.4687 trillion in April, meaning that they are shifting to longer JGB maturities for better yields, and that their net position in JGBs actually declined slightly in April by about JPY139 billion.

Tokyo Takes provides free commentary on global investments from a Japan perspective. To contact the author, please email darrel@japaninvestor.com

Bank of Japan: In Bed With the Rating Agencies?

The Bank of Japan’s governor Masaaki Shirakawa took the opportunity of the Fitch Rating downgrade of Japan’s sovereign debt to push back at the politicians who have been pressuring the bank to directly underwrite JGBs (monetize debt). Mr. Shirakawa again called on the government to tackle its “very serious” fiscal state. Highlighting the risks of losing market confidence, BOJ Gov. Masaaki Shirakawa again dismissed talk of directly purchasing JGBs to help pay for disaster reconstruction, saying the government risks sparking “a negative mutual interaction” involving the nation’s fiscal state, the financial system and the real economy that would undermine economic activities.

The BOJ sitting on the sidelines wagging its finger at the politicians but not willing to “do whatever it takes” and opposition politicians being more interested in forcing a no-confidence vote on PM Kan than quickly drafting an integrated plan for reconstruction (and financing) is not exactly conducive to instilling confidence in Japan’s consumers and domestic/foreign investors, especially as it is still clear that TEPCO still does not have its arms around the Fukushima Daiichi nuclear plant disaster.

BOJ: Japan’s Fiscal State Very Serious

Tokyo Takes provides free commentary on global investments from a Japan perspective. To contact the author, please email darrel@japaninvestor.com

Moody’s Cuts Japan Sovereign Debt Outlook. So What?

Following S&P, Moody’s has put Japan’s sovereign debt rating (Aa2) outlook to “negative” from stable. The downgrade was ostensibly due to concern that the current economic and fiscal policies of Japan’s DPJ-led government “may not prove strong enough” to achieve the government’s debt reduction plan and counter the inexorable rise in Japan’s debt. At the same time, Moody’s said that a debt crisis in Japan was unlikely in the “near or medium term”.

Memo to Moody’s. We hate to steal your thunder, but no one believed the current DPJ government economic and fiscal policies would help stem the rise in Japan’s debt. Indeed, most in Japan believed that the DPJ’s “progressive” policies will actually make it worse.

Memo to Investors. How credible are the very same people that kept giving CDOs triple-A rating even as the US housing house of cards was collapsing?

Of course, every one who has looked closely at Japan’s ballooning government debt situation knows that this will end badly—eventually. Our trigger is when Japan’s structural balance of payments surpluses turn negative–after which its only a matter of (relatively short) time when Japan runs out of money. However, that day is not tomorrow, next year or perhaps even a few years from now.

Tokyo Takes provides free commentary on global investments from a Japan perspective. To contact the author, please email darrel@japaninvestor.com

Japan’s Banks Continue to Gorge on JGBs, US Treasuries

John Dizard of the FT is the latest to throw his hat in the ring for the big Japan short, i.e., shorting JGBs. He of all people is well aware that a lot of good money from smart people has been lost over the past decade betting Japan will run out of money. Like his hedge fund contacts, however, he is probably several years too early.
Since its not his money, its probably not a big problem for him, but could be for someone who takes his advice literally.

His article was carried on the Nikkei Net site along with the news that money center and regional Japanese banks had purchased record sums of JGBs amid weak demand for corporate as well as individual loans. The money center banks gorged on JPY8.7 trillion of JGBs in 2010, while the regions bought JPY7 trillion, according to the JSDA, both representing new records.

Banks saw their deposits grow about JPY4.2 trillion yen last year while lending dropped by JPY9 trillion yen, meaning Japan’s banks literally have money running out of their ears with no place to profitably invest it. The Japanese government, banks and other financial institutions were also gorging on US treasuries, where Japanese holdings hit a record in December and again rival China as the top foreign holder–despite the fact that the “street” consensus is that US treasuries are worse than dead money, i.e., there is a real risk of losses as US rates turn the big corner.

Japanese investors are not too concerned about the capital losses, they are going after yield income to a) recycle Japan’s excess savings from persistent balance of payments surpluses and b) growing asset-liability imbalances in Japanese pension funds, i.e., these funds are now mature and have begun paying out more than they bring in, meaning they have increasingly less tolerance for “risk assets” like stocks.

Tokyo Takes provides free commentary on global investments from a Japan perspective. To contact the author, please email darrel@japaninvestor.com

Japan’s Debt: One for the Record Books

Japan’s debt in the government sector — both central and local levels — rose to 217% of nominal gross domestic product in 2009, the largest figure since comparable data became available in 1875, according to the IMF. The IMF’s latest forecasts suggest the balance will reach 232% of GDP in 2012–only a year from now. During WWII, Japan’s went heavily into debt to wage a global war, but the ration peaked at 204% in 1944. The lesson of the 1940s however was that postwar inflation slashed the real value of JGBs, reducing the debt balance to only 56% of GDP just two years later, in 1946.

Japan doesn’t have the developed world record yet, The U.K.’s debt hit 269% of GDP in 1946, which was the worst so far for any developed nation except Germany’s Weimer Republic. The lesson again from the U.K. was that the U.K. was was forced to accept financial support from the IMF in the 1970s after its foreign currency reserves dried up as it was plagued by inflation and a weak currency. At the current pace, however, Japan’s debt-to-GDP ratio will exceed the U.K.’s and reach 277% by 2016.

The end game for Japan is two scenarios; a) default, or b) excess inflation like in the 1940s, as Japan is now beyond the point where it could ever hope to pay down this debt with economic growth or austerity. We believe the point of no return will be reached when Japan starts to record a current balance of payments deficit and begins eating into its hoard of over USD 1 trillion of foreign exchange reserves.

However, since Japan’s balance of payments surplus is now largely provided by income from overseas investments (like US treasuries) and dividend repatriation from overseas subsidiaries, a balance of trade deficit won’t immediately mean a current balance of payments deficit. Further, even a significant rise in JGB yields would take several years to work its way into significantly higher interest rates paid on new debt and existing debt rollovers.

This means that Japan could still tolerate its growing mountain of debt for the next 5~10 years before the end game is upon us–i.e., you will probably still lose money shorting JGBs.

Tokyo Takes provides free commentary on global investments from a Japan perspective. To contact the author, please email darrel@japaninvestor.com

BOJ: What Threat from the Strong Yen?

Japan’s central bank has come under a spotlight amid speculation that it could act to slow the surging yen, but people familiar with its thinking say officials there aren’t alarmed as much by the increase and aren’t yet ready to move. However, the political pressure from the government and industry leaders on the central bank to curb the yen has noticeably increased. Five of nine BOJ watchers in a Dow Jones Newswires survey last week forecast that the central bank would loosen policy if the yen rises further, either by increasing the amount of cheap three-month loans or extending their duration to six months. A more aggressive step would be for the BOJ to increase the amount of Japanese government bonds it buys outright from the current pace of 1.8 trillion yen a month.

However, as we have pointed out several times, the BOJ considers the yen’s recent gains relatively mild compared with its sharp moves late last year, and that the threat to the overall economy so farappears limited, as the yen’s rise hasn’t been excessively fast and hasn’t dealt a significant blow to business sentiment. BOJ officials have opposed the idea of more aggressively using their balance sheet because of worries that it could increase market concerns about Japan’s fiscal discipline and that the antideflation drug could prove too effective—causing prices to rise out of control. They evidently didn’t get the memo about Q2 GDP. But the BOJ is also probably being realistic, as the yen’s rise is attributable largely to the U.S. dollar’s drop, driven by the U.S. Federal Reserve’s super-loose monetary policy. Consequently, the impact of overseas policies (US) would likely overpower any effort by Japan to weaken the yen.

WSJ: BOJ Sees No Threat

Tokyo Takes provides free commentary on global investments from a Japan perspective. To contact the author, please email darrel@japaninvestor.com

Japan’s GPIF Becomes a Net Seller of JGBs

The Nikkei is reporting that the GPIF (Government Pension Investment Fund) sold a net JPY443.2 billion of JGBs in fiscal 2009 to March 2010 for the first time in nine years, due to a continued decline in pension reserves with rising benefit payouts that Japan’s Welfare Ministry sees continuing at least until fiscal 2013.

This is a big deal because the GPIF owns nearly 12% of outstanding JGBs. At the end of FY2009, the fund held JPY79.5 trillion of JGBs, excluding discount bills. Fund reserves have been dropping since fiscal 2006 and fell below JPY124 trillion at the end of FY2008, from a peak of JPY150 trillion, and could fall another several trillion in FY2010. While the fund has not released a forecast for JGB sales this fiscal year, but net sales could far exceed FY2009 amounts, say analysts.

From FY2014, the Welfare Ministry sees reserve balances recovering as incremental increases in pension premiums kick in, based on reforms enacted in 2004.

As for total JGB supply-demand, broker/dealers sold about JPY300 trillion yen of JGBs in May alone, while domestic financial institutions (particularly cash-rich regional banks) and the Chinese government have been significant buyers for the first 5 months of 2010. The Chinese government’s net purchases were JPY1.4 trillion, while Japanese institutions repatriated some JPY1.3 trillion in proceeds from sales of Euro bonds as they moved to avoid Euro sovereign risk.

Tokyo Takes provides free commentary on global investments from a Japan perspective. To contact the author, please email darrel@japaninvestor.com

Nobody Wants Japan’s Ultralow Yield JGBs? China Does!

One of the factors supporting the strong yen has been a major shift into JGBs (Japanese government bonds) by China. Until 2009, China was a net seller of JGBs, but Euro weakness instigated by a sovereign debt crisis apparently has China diversifying their huge USD2.441 trillion of foreign exchange reserves.

Some 70% of these reserves are believed to be in USD, but China’s foreign ministry on July 6 signalled a new policy to gradually diversify forex reserves away from the Euro, which had been a major alternative to USD until the crisis. JPY-denominated sovereigns are the alternative.

Between January~April 2010, China apparently purchased a total JPY541 billion of JGBs. In May, China purchased even more, for a cumulative JPY1.2762 trillion of purchases in the first five months of 2010, the vast majority of which is short-term JGBs with maturities of under 1 year. The shorter maturity net purchases are a new historical high. Purchases in May alone were JPY735.2 billion, which is 2.9X the previous annual high in 2005.

However, because the bulk of these purchases are short-term paper with maturities under 1 year, the money could flow back into Euros if the Euro begins to stabilize, as Euroland is China’s largest trading partner at over 20% of exports.

Tokyo Takes provides free commentary on global investments from a Japan perspective. To contact the author, please email darrel@japaninvestor.com

China’s Decision to Allow More Flexibility on the Yuan Stimulates Japanese Stocks

The Nikkei 225 tacked on nearly 243 points (2%-plus) as China’s announcement to allow more flexibility in the Yuan did not cause another spurt in JPY, as some investors/traders had feared, and China’s confidence in allowing the Yuan to move more was taken as a positive statement about their view of the global economy.

Not surprisingly, the trading companies, shippers and steel stocks–all perceived beneficiaries of China demand, led the rally.

Tokyo Takes provides free commentary on global investments from a Japan perspective. To contact the author, please email darrel@japaninvestor.com