Abe’s warning

Japanese Prime Minister Shinzo Abe warned his counterparts at the G7 meeting in Japan that the world may be facing another “Lehman’s moment” (alluding to severe stresses in the financial system, indicated in his view by the weakness of commodity prices).

Once again, when we thought it would not be possible, Japanese policymakers surprise us with the paucity of their true understanding. It’s not Commodity Prices that worry us – they are simply the manifestation of an underlying process of rebalancing that the Japanese have correctly identified. It’s the perilous state of the Japanese banks and the ongoing damage being inflicted by Japanese monetary policy that is, to us, of most concern.

Mr Abe said, “We agreed on the perception that we are facing serious risks, that the world economy is facing serious risks”.

In that regard, he’s right, but the most worrying point is that Japanese Banks pose a substantial and worsening threat to Global Financial Stability. Here’s the picture:

Firstly, Yen 80 trillion of annual QE by the Bank of Japan (fully 15% of GDP each year) has left the Bank of Japan (BoJ) owning 27% of the outstanding STOCK of Japanese Government Bonds. They were purchased from banks that held them with a nice running “carry” (the difference between the cash rate they paid on their deposits liabilities used to fund them and the yield on the bonds themselves) that has now disappeared. Japanese banks, as a direct consequence of the Bank of Japan, now have approaching 20% of their entire ASSETS in cash and deposits:

Needless to say, those assets earn nothing.

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Secondly, Japanese licensed banks have 9.6% of their assets in Central Government Bonds – the yield on those bonds is now below the deposit rate paid to new deposits. That’s not good for earnings, when you pay a higher rate out than you get on your investment.

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Thirdly, the general loan rate for new loans is fast converging on the deposit rate paid to new deposits, and the margin on loans to the real economy is evaporating:

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Fourthly, banks are being “squeezed” from one side by the BoJ and “squeezed” on the other side by depositors: the level of cash in circulation in Japan relative to GDP is marching ever higher.

It stands at 18% versus 7% in 1990 and has trended higher continuously in the last 25 years:

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So, to recap:

  • Japanese banks hold extraordinary levels of non-earning cash on their balance sheets (in fact, the interest rate on the Yen 280 trillion of excess reserves held in the current account at the Bank of Japan is negative)
  • Government bonds yield less than the rate paid to depositors
  • New loan rates are barely above the rate paid to new depositors
  • The economy is becoming increasingly “cash based” – cash / GDP is way beyond international comparison
  • Non-Performing Loans, NPLs, as in China, are being concealed and understated

We’d say the likelihood of a “Lehman’s moment”, as Mr Abe notes, can’t be ignored… But we’d go further and urge Mr Abe to pay closer attention to the destruction of the Japanese Banks being propagated by the Bank of Japan’s QE policy. Any further QE, or a move to increasing negative official rates, just exacerbates the problem. Hopefully Mr Abe showed some charts like these and didn’t overplay the decline in commodity prices.

The Bank of Japan’s monetary policy is sowing the seeds for a systemic Japanese banking crisis – the TSE banks index is down 39% y/y for a reason.

Takeaway for China investors: stock market bubble can “only end in tears”

May 26, 2015

MONOGRAM, today warns of the threat of a bubble in the Chinese stock market, following a rise of 140% in the Shanghai Composite Index in the past 12 months (the best performer in the main 35 global stock markets).

Paul Marson, Chief Investment Officer of Monogram, commented:

If this is not a bubble then it’s hard to imagine what one looks like. The average daily stock market turnover has increased 10 fold in the last year (830 billion Yuan v 80 billion).

Monogram 1

The root cause of this is the expansion of bank balance sheets in China. Over the past four quarters, Chinese bank balance sheets have grown by the equivalent of 35% of GDP – remarkably this is less than the 55% expansion at the start of the crisis.

If [and that is a big and qualified IF] GDP is expanding seven percent then that leaves an enormous amount of liquidity that has gone from inflating the property market, which is now deflating, to inflating stock prices.

Monogram 2

“This is a very unhealthy sign for the global economy. It can only end in tears. Bubbles always leave behind more problems than they resolved.”