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8/6/2019 The Tail Chaser - The Land of the Setting Sun [June2011]
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The Land of the Setting Sun
June 2011
The Intrigued Trader
http://thetailchaser.blogspot.com
8/6/2019 The Tail Chaser - The Land of the Setting Sun [June2011]
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2
The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
Executive Summary
Macroeconomic factors, structural fiscal issues and worsening demographics seem to be fundamentally
unsustainable
1980s equity and property bubbles: the can was kicked down the road and targeted the governments
balance sheet
Rapid economic development in East Asia, debt bubbles in the US and Western Europe along side a
finite supply of domestic forbearance has allowed Japan to avoid economic collapse and subsist near zero
economic growth for the last 16 years
A high level of sovereign debt at low rates were sustained successfully because Japan funded
approximately 95% of debt issuance domestically through a comparatively high savings rates while
keeping short-term rates close to 0%
Government policy indicates that the near term debt issuance wont subside
Antecipated demographic issues are starting to impact growth and impact the fiscal outlook and will
soon compel Japan to fund part of its debt internationally
The severity and notion that it cant happen creates opportunity for a very asymmetrical trade,
especially considering the on-going sovereign debt issues around the world that could possibly serve as
na important catalyst both in terms of confidence and lower growth ahead
8/6/2019 The Tail Chaser - The Land of the Setting Sun [June2011]
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
The Land of the Setting Sun
8/6/2019 The Tail Chaser - The Land of the Setting Sun [June2011]
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
The Golden Times Turned Gray
JPY appreciated 300%
against the USD from 1970to before the crash in late
1989
Nikkei annual returns :
1970-1980: +10.5%
1980-1990: +19.5%
1990-2000: -6.9%
1990-2011: -6.4%
Nominal GDP (annual):
1980-1990: +6.2%
1990-2000: +1.1%
2000-2011: -0.5%
~1990-2011: +0.3%
Ginza district real estate
market bubble:
1 m2 = USD 93k
Land of the Imperial Palace
was worth more than the
entire state of California200,000
250,000
300,000
350,000
400,000
450,000
500,000
550,000
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
1980
1982
1985
1987
1990
1992
1995
2006
2008
Nikkei and Nominal GDP
Nikkei 225 Index (rhs)
Nominal GDP (rhs, billion yen)
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
The Golden Times Turned Gray Gross Debt Explodes
8/6/2019 The Tail Chaser - The Land of the Setting Sun [June2011]
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
The Golden Times Turned Gray Government Takes Over Debt
8/6/2019 The Tail Chaser - The Land of the Setting Sun [June2011]
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
The Golden Times Turned Gray - Deleveraging
As corporations deleverage and reduce spending after the pop the Government takes over
and, while reducing interest rates, increases its debt burden
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
The Golden Times Turned Gray
Apparently the Government had no success as nominal GDP growth remained mediocre
8/6/2019 The Tail Chaser - The Land of the Setting Sun [June2011]
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
The Golden Times Turned Gray
If it didnt act Japan would have been worse off...
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
Fiscal Situation Divergence in Revenues x Expenditures
Expenditures increased while revenues are decreasing: the gap has been widening
Debt issuance is almost 2x revenues
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
Can Funding Get Any Cheaper?
It all started in 1991: from
6% to
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
Fiscal Situation Interest + Social Security = Japans Taxes
The Japanese now uses all its tax revenues to pay for its elders and its past fiscal performance (IE+SS)
IE+SS 1995 to 2005: +3.6% per year
IE+SS 2005 to 2011: +4.4% per year
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
Fiscal Situation Spending in Education, Defense, Infra?
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
Fiscal Situation Working to pay interest expense?
Almost half of the japanese tax revenues goes to covering its debt service...
And that is while its average interest rate is very low
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
The Castle of Cards Maturity
This Time Is Different: Eight Centuries of Financial Folly authors Reinhart and Rogoff say
that one of the early warning signals of a government funding crisis is a narrowing of the debtmaturity
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
The Castle of Cards Central Government Debt Profile
A lot of debt to be rolled into the coming quarters
Will this debt-roll be into longer tenors with such low current yields?
What would happen to interest expense if debt was rolled at 2-3% yields instead of 0.10% or
1.20% (current 10yr yields)?
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
The Castle of Cards Holders
The largest holders of JGBs have started selling...
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
Where is Japan globally speaking?
The primary balance outlook doesnt get any better for a long, long time...
While household savings into foreign-denominated investments increase.
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
Where is Japans fiscal situation globally - Stock
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
Where is Japans fiscal situation globally - Flow
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
Where is Japan fiscal situation globally - Relative Flow
Japan is going against the austerity tide along side few other countries while still having a huge fiscal deficit
Japan cannot afford fiscal austerity right now as its growth is still anemic
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
Where is Japan globally - Demographics
The Japanese population, according to the National Institute of Population and Social Security Research,
peaked in 2004 at roughly 128 million people and is now in a long-term secular decline
Japanese population aged 65 or older is estimated to be 22.8%: 1.8x that of the U.S., 3x that of the world
OECD estimates this number will grow higher over time
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
Where is Japan globally Composition of Savings
How much more JGBs can japanese individuals purchase at these absolute yields, at these relative yields
and with that level of holdings?
Has this level of JGB holding peaked?
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
How About Growth Prospects? Savings
High Household Savings is a characteristic of the past
And among other developed nations it doesnt look good either
It cannot be used to boost growth much further
The question now has changed to Will it finance the governments low-growth strategies at these yields?
Source:GS
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
How About Growth Prospects? Savings
Savings edged up in 2009 and some people predict it will increase, but...
2009s growth was due to the sharp decrease in consumer sentiment: lower spending
Fiscal boosts (eco-points + car) boosted consumption even though income growth was muted
Unfavorable demographics still at play: high dependency-ratio and negative population growth
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
How About Growth Prospects? Savings
Savings edged up in 2009 and some people predict it will increase, but...
2009s growth was due to the sharp decrease in consumer sentiment: lower spending
Fiscal boosts (eco-points + car) boosted consumption even though income growth was muted
Unfavorable demographics still at play: high dependency-ratio and negative population growth
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
How About Growth Prospects? Corporate Investments
Can Japan boost investments by reducing its tax rates when its fiscal situation doesnt look too rosy...
And while competitor countries have much lower corporate rates and cheaper labor?
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
How About Growth Prospects? Personal Consumption
Can Japan boost revenues by increasing its tax rates when its domestic consumption growth situation
doesnt look too rosy?
1989: Prime Minister Noboru Takeshita introduced consumption taxes at 3% 1997: Prime Minister Ryutaro Hashimoto increased this tax rate to the now current 5%
Both were ousted after the country was impacted by ongoing recession in the 2 following years
The current Prime Minister is trying to pass legislation to increase consumption tax rate to 10%
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
How About Growth Prospects? Consumption Taxes
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
How About Growth Prospects? Tax Burden / Fiscal Changes
Even with a relative low taxation the country couldnt grow...
But will growth pick-up? It hasnt in the past 20 years...
Will this (unlikely) fiscal program even help improve the countrys finances?
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
How About Fiscal Prospects? Primary Balance and Funding
The primary balance outlook doesnt get any better for a long, long time...
While household savings into foreign-denominated investments increase...
While domestic growth is low and real returns at home are close to negative.
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
How About Growth Prospects? Currency Strength (from early 2011)
The Japanese Yen has been very strong against all the major trading partners and large economies in the
past years
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
How About Growth Prospects? Terms of Trade
Poor in natural resources and with global technology catching up...
And with a strong currency...
the Terms of Trade have deteriorated considerably in the past 15 years
Since its best moment in the mid 90s the japanese ToT has deteriorated a lot and it is now close to the
bottom of the range of the last 25 years
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
How About Growth Prospects? Exports
Exports, which have a considerable effect throughout the japanese economy, have yet recover
Theyve just reached 2006 levels
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
How About Growth Prospects? Trade Balance
With the yens strength, the rise in raw material prices and a minor catch-up in competitors technology
will the Trade Balance recover?
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The Land of the Setting [email protected]
http://thetailchaser.blogspot.com
How About External Financing? Current Account
The global recovery hasnt yet translated into a powerful bounce in the japanese current account
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The Land of the Setting Sun
http://thetailchaser.blogspot.com
How About External Financing? Capital and Financial Account
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The Land of the Setting Sun
http://thetailchaser.blogspot.com
Activity Nomura PMI
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The Land of the Setting Sun
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Activity All Industry
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The Land of the Setting Sun
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Activity All Industry
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The Land of the Setting Sun
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Activity Industrial Production
YoY Growth didnt look too bad... Until the earthquake
l d l [ i d N b 4 20083 16 PM] [ d A il 13 20097 27PM] M \G l\P i E i \@P f li \I i i l\UBS P l PCP P i E i 13 b 09
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The Land of the Setting Sun
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Activity Industrial Production
l d l [ i t d N b 4 20083 16 PM] [ d A il 13 20097 27PM] M \G l\P i t E it \@P tf li \I tit i l\UBS P t l PCP P i t E it 13 b 09 t
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The Land of the Setting Sun
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Activity Machine Tool Orders
YoY Growth looks good here too...
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The Land of the Setting Sun
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Activity Machine Tool Orders
If it wasnt for being at 2004s level
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The Land of the Setting Sun
http://thetailchaser.blogspot.com
Activity Machinery Orders
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The Land of the Setting Sun
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Activity Machinery Orders
laydnelu [printed:November4,20083:16 PM] [saved:April 13,20097:27PM] M:\Geral\PrivateEquity\@Portfolio\Institucional\UBS Pactual PCP PrivateEquity 13abr09.ppt
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The Land of the Setting Sun
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Activity Capacity Utilization
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y [p , ] [ p , ] q y @ _ q y_ pp
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Activity Capacity Utilization
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Activity Vehicle Production (4 month average)
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Activity Vehicle Production
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Activity Vehicle Sales
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Activity Housing Starts
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Activity Housing Starts
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Activity Construction Orders
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Activity Tokyo Condo Sales
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Activity Tokyo Condo Sales Prices
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Activity Bankruptcies, above 10mln Yen
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Activity Supermarket Sales
Supermarket Sales finished 2010 seasonally lower than 2006, 2007, 2008, 2009...
Recently is recovered after the earthquake: people stocked up on essentials and prices went up
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Activity Department Store Sales
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Activity Department Store Sales
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Activity OECD Working-age Population through 2012
Working-Age population in Japan has been decreasing by a rate of around 0.50%/year
OECD projects this decrease to be around 1.3%/year in December 2012
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Activity Current Labor Force, x10
The size of the current labor force, by the Ministry of Internal Affairs, is the same as it was in 1992
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Activity Still High Unemployment
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Activity Jobs-to-Applicants Ratio
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Activity Labor Cash Earnings, YoY
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Activity Coincident Indicator
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Activity Leading Indicator
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Activity Consumer Confidence
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Activity Small Business Confidence
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Activity Real Household Spending
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Catalysts Can Japan Sell Financial Assets?
The Bank of Japan is currently running a Quantitative Easing program:
It has committed funds to buy equities, bonds, commercial paper, ETFs and REITS
Size: 35 trillion Yen (3.5tln for government securities, 30tln for fixed-rate fund supply operations)
If the Government were to sell financial assets what impact would it have?
Equities: would the domestic and/or foreign markets get hurt?
Bonds: would interest rates remain low?
The BoJ can buy JGBs up to the amount of banknotes issued
That leaves room for money printing
Will the JPY go unscathed in this case?
BoJ and Bank Notes: http://www.boj.or.jp/en/type/law/bojlaws/bojlaw1.htm#05
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Catalysts If Japan Didnt Blow Up Yet, Why Will It Now?
Europe Sovereign Debt Crisis
Rate hikes in the developed markets: Europe and United Kingdom hitting activity / draining global liquidity
Inflation and current/coming tightening in China, India, Brazil, Chile, Australia and others
Further cuts in sovereign debt ratings driving it below investment grade
Japans Government Pension Investment Fund (GPIF), the largest pension fund in the world with about USD
1.4 trillion is now a net seller of funds as contributions decrease as population ages: it has sold bonds worth
around 720 billion Yen in fiscal 2009 to cover its expenses
GPIFs shortfall is expected to reach 4.74 trillion yen in 2010 (fiscal-year ended March 2011) and another 6trillion yen in fiscal 2011.
Takahiro Mitani, president of the GPIF, has mentioned that it will need to rebalance its portfolio by selling
the assets they are currently overweight: the current weight for domestic bonds is 67.44% vs the current
holdings of 70.04% (Sep2010)
Japan Postal Bank has issued notes that will start diversification of its investments. They currently hold the
largest deposit base of Japan (~ 2 trillion USD) and 80% of its assets in JGBs
http://www.ft.com/cms/s/0/8ba0ad52-8e78-11df-964e-00144feab49a.html
http://www.reuters.com/article/2010/03/10/japan-pension-idUSTOE62905K20100310
http://www.gpif.go.jp/eng/pdf/kanri03_h22_p02e.pdf
http://www.ft.com/cms/s/0/209e34e2-0f62-11df-a450-00144feabdc0.html#axzz1EoLDUloR
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Catalysts If Japan Didnt Blow Up Yet, Why Will It Now?
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Execution Call USD / Put JPY* (This trade hasnt been updated)
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Execution Payer Swaption
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Execution CDS