Taper Tantrum

Bernanke's talk of tapering down the rate of quantitative easing seems to have triggered a tantrum in the bond market.   But the more people get out of bonds, the more the remaining people are losing and deciding to get out.  This could be a chain reaction or positive feedback loop.  If foreign governments/central-banks also sell, as seems to be the case, there could be a lot of selling.   If the US dollar also starts going down, as the central bank make more and more new money to buy more and more bonds, we might get the hyperinflation feedback loop.   So this taper tantrum might just end in hyperinflation. 

I really expect Japan to go first as the central bank there is monetizing very fast to hold interest rates very low.   But the US is not very stable at the moment either. 

Bond Bubbles Popping?

For years now central banks around the world have been making new money and buying bonds to drive up the price of bonds and down interest rates.   In the short term central banks can make interest rates go down, but in the long run all the new money they make while doing this will cause interest rates to go up.   I think we might be going from short run to long run.

Another way to look at it is that central banks have spent trillions driving up the prices for bonds.  This has made bond bubbles all over the world.  At some point these bond bubbles will pop.  We may be seeing the start of that pop now.

Interest rates in many countries have been going up fast the last couple months and bond prices are falling.

Yen Long Term

In 1980 it was 306 Yen to the Dollar.   In 2000 it was just 99.  If you held Yen for these 20 years you made a factor of 3 relative to the dollar just on the change in currency value.  This meant that you could earn low interest on Yen and still be willing to hold Yen.  However, if now the value of the Yen starts dropping fast people will not be so willing to hold Yen at low interest rates.

Foreign Holdings of US Treasuries Reported Down

The foreign holdings of US Treasuries seems to be down $70 billion in the latest reporting period.  This is only 1.2% but foreign holdings usually seems to go up every month.   There is a chance this is just some artifact of a change in the way they report the numbers as the previous reporting periods all have a footnote next to their date.   But it might be the start of an important new trend where foreigners don't want to hold US Treasuries or dollars.   If that is the case there is a risk that this starts the bond panic that results in the main hyperinflation feedback loop.

Interest Rates Up Implies Stocks Down

The earnings and dividend yields on stocks sort of compete with the interest yield on bonds for investors.   The inverse of the P/E ratio, or E/P ratio, can be compared to the interest rate on bonds.  The idea is often called the Fed Model and makes sense as a starting point for stock valuations.  This is really why when the Fed forces interest rates down they can expect the stock market to go up.   But this implies that if interest rates double you should expect the stock market to go to half what it was.  I expect that algorithmic trading must take this into account.    At the moment the interest rates are up far more than stocks have gone down so far.  I think there is a good chance that interest rates keep going up.  The more bond values drop the less people want to hold them.  The more sellers there are, the more the value drops.   I think there is a high risk that the stock market goes down much more.

Here is E/P compared to interest rate on 10 year government bonds:

Here is E/P compared to interest rate on corporate bonds:

The graph below gives some idea of what is going on in corporate interest rates currently.  Just eyeballing, it looks like about 5% to about 7%, or about a 40% increase.  It could easily go up much much more.

 As corporate bond yields go up it really makes sense for stocks to go down.  Another way to think about this is that when companies can borrow money really cheaply an easy way to boost earning per share, and possible get executive bonuses, is to just borrow money and buy back some shares.  But when interest rates go up they won't do this so much.  So a major thing propping up the stock market will go away.

Yen Daily Volatility vs 5 Year Earnings

In the past week the yen has gone up about 4%, then down about 4%, then up about 4%. This is very high volatility.  Japanese bonds are paying 0.33% per year for 5 years, for a grand total, with compounding, of 1.66% after 5 years.  There were several days when the value of the Yen changed by that much in 1 day this past week.   When the daily volatility is about as much as the 5 year earnings, people should be rushing for the exits.   As people realize this and get out the central bank will make many more Yen to buy up existing bonds and new ones from the government.  The value of the Yen will drop faster.  More will exit bonds.   The central bank will print even faster. 

I have had hyperinflation as a hobby for several years now.  But it has been sort of theoretical and abstract.  It is amazing to watch things unfold in Japan as a real world example of how it works.  It is like we have a ringside seat at a slow motion train wreck.  Very strange and fascinating at the same time.  We live in interesting times.

Update on June 20th, 4 am:
     The Yen is down over 3% in the last 24 hours.   The 5 year bonds are paying 0.35% per year.  With 5 years of compounding this comes to a grand total of 1.76%.   The currency dropped about twice this in one day.  Only an idiot would hold JGBs.   Japan will soon have a shortage of idiots.

Big Mac Hyperinflations

I thought it would be interesting to look at The Economists Big Mac Index and see how many times we saw more than 26% price increase in the local currency.   From 1987 to 2012 this happens more than 100 times.

One Year Hyperinfltion
USA: 1.6(1987), 2.39(1988) 49.38% up
Yugoslavia: 2300(1988), 7000(1989) 204.35% up
Yugoslavia: 16(1990), 32(1991) 100.00% up
Russia: 3.75(1990), 10(1991) 166.67% up
Singapore: 2.8(1991), 4.75(1992) 69.64% up
Russia: 10(1991), 58(1992) 480.00% up
Brazil: 3800(1992), 77000(1993) 1926.32% up
China: 6.3(1992), 8.5(1993) 34.92% up
Russia: 58(1992), 780(1993) 1244.83% up
Russia: 780(1993), 2900(1994) 271.79% up
Russia: 2900(1994), 8100(1995) 179.31% up
Mexico: 8.1(1994), 10.9(1995) 34.57% up
Mexico: 10.9(1995), 14.9(1996) 36.70% up
Chile: 950(1996), 1200(1997) 26.32% up
Hungary: 214(1996), 271(1997) 26.64% up
Indonesia: 9900(1998), 14500(1999) 46.46% up
Turkey: 649152.9(2000), 1577827.5(2001) 143.06% up
Turkey: 1577827.5(2001), 4000000(2002) 153.51% up
Colombia: 4200.02(2001), 5700(2002) 35.71% up
Brazil: 3.6(2002), 4.55(2003) 26.39% up
Argentina: 2.5(2002), 4.1(2003) 64.00% up
Venezuela: 2500(2002), 3700(2003) 48.00% up
South Africa: 9.7(2002), 13.95(2003) 43.81% up

Uruguay: 42.3(2006), 55.0(2007) 30.02% up
Czech Republic: 52.1(2007), 66.1(2008) 26.87% up
Costa Rica: 1.130(2007), 1800(2008) 159192.04% up
Slovakia: 57.98(2007), 77.00(2008) 32.80% up
Argentina: 8.25(2007), 11.00(2008) 33.33% up
Egypt: 9.09(2007), 13.0(2008) 43.01% up
Colombia: 6.900(2007), 7000(2008) 101349.28% up
Iceland: 469.00(2008), 640(2009) 36.46% up
Chile: 1.550(2008), 1750(2009) 112803.23% up
Ukraine: 11.00(2008), 14(2009) 27.27% up
Indonesia: 18.700(2008), 20900(2009) 111664.71% up
Pakistan: 140.00(2008), 190(2009) 35.71% up
South Korea: 3.200(2008), 3400(2009) 106150.00% up
Uruguay: 61(2009), 79.0(2010) 29.51% up
Argentina: 14.0(2010), 20.0(2011) 42.86% up
Pakistan: 205(2011), 260(2012) 26.83% up

Two Years of Hyperinflation
Russia: 3.75(1990), 10(1991) 166.67% up, 58(1992) 480.00% up
Russia: 10(1991), 58(1992) 480.00% up, 780(1993) 1244.83% up
Russia: 58(1992), 780(1993) 1244.83% up, 2900(1994) 271.79% up
Russia: 780(1993), 2900(1994) 271.79% up, 8100(1995) 179.31% up
Mexico: 8.1(1994), 10.9(1995) 34.57% up, 14.9(1996) 36.70% up
Turkey: 649152.9(2000), 1577827.5(2001) 143.06% up, 4000000(2002) 153.51% up

The Mother of All Painted-In Corners

I highly recommend the paper, The Mother of All Painted-In Corners by John Mauldin.   It talks about how Japan has gotten themselves into a situation where there is no good way out.

 
Let me give my own highlevel overview of Japan's predicament.   Japan spends about twice what they get in taxes and has debt approaching 250% of GNP.   If they let interest rates go up just 2% then interest on the debt would use up nearly all their tax  money.  If that happened then nobody would loan the government money and they would have to print for all their expenses and get hyperinflation.   However, if they hold interest rates down then people will keep getting out of bonds till they have printed for all the bonds and they will get hyperinflation.   Either way, they get hyperinflation.

To avoid hyperinflation they could cut the government budget in half and default on all the debt; however, that is just not going to happen.   On any given day or week it seems like printing money is the easier answer.   So they will keep on printing money, week after week.  This will go on till it is too late to avoid hyperinflation, if it is not already too late.

Bank of Japan Printing at Hyperinflation Rates

In the 10 days from Apr 10th to Apr 20th the Bank of Japan increased the base money supply by 7.3%. From May 20 to May 31 they increased the money supply by 4.1%.   Apr 10 to May 20 they increased it by about 9%.  Last Thursday they increased the money supply by 1% in one day.

The BOJ data is released every 10 days.  With compounding a steady  0.65% every 10 days comes to over 26% per year.  With no change in velocity of money or GNP this would result in prices going up 26% per year and count as hyperinflation.   So any 10 day period below with over 0.65% can be viewed as printing money at hyperinflation rates.  Normally the velocity of money would start going up, and the real GNP would start going down, so even less than 0.65% increase in the money supply every 10 days should be enough to get hyperinflation.  They are aiming to double the money supply in 2 years which is about 1% every 10 days.  If the trend starts to go well above this then they are probably losing control and people are getting out of bonds.

It seems the BOJ is working hard to keep interest rates down.   If they have decided to peg interest rates then they have given up on limiting the amount of money creation.

I think this money creation will soon be out of control with the  panic/avalanche/death-spiral/hyperinflation as people get out of Japanese bonds and the central bank makes money faster and faster.  The more new money the central bank makes, the less people will want to hold bonds.  But the less people want to hold bonds, the more the central bank will have to make money and buy bond so that the government has enough money to keep spending twice what they get in taxes.   So I expect the money creation to speed up, not slow down.  At some point prices will start going up.

I highly recommend this video on Japan by OtterWood and also a talk by Kyle Bass on Japan.

Updating below with new releases.

Date        thousand yen          percent change in 10 day period
Mar 31   164,312,302,598
Apr 10    162,832,490,238   -1%
Apr 20    174,711,567,512   7.3%
Apr 30    174,691,381,195    0%
May 10   173,033,334,459   -1%
May 20   177,091,303,645    2.3%
May 31   184,286,172,619    4.1%
June 10   184,283,135,009    0%
June 20   185,895,479,817    0.9%
June 30   187,068,441,810    0.6%
July 10    189,355,201,934    1.2%
July 20    191,731,282,912    1.3%
July 31    196,758,169,295    2.6%
Aug 10    199,135,657,856    1.2%
Aug 20    198,973,150,602   -0.1% 
Aug 31    205,691,877,619    3.4% 
Sep 10    207,289,120,593    0.8%
Sep 20    208,722,749,341    0.7%
Sep 30    208,189,436,612   -0.3%
Oct 10    211,828,333,555     1.7% 
Oct 20    212,494,170,740     0.3%
Oct 31    215,514,238,129     1.4% 
Nov 10   217,667,308,260     1%
Nov 20   220,364,015,346     1.2%
Nov 30   224,088,843,446     1.7%
Dec 10   224,678,737,264     0.3%
Dec 20   223,456,178,374    -0.5%
Dec 31   224,189,765,264     0.3%
Jan 10    228,969,324,231     2.1%
Jan 20    224,986,639,860    -1.7%
Jan 31    232,178,071,091     3.2%
Feb 10   235,222,967,993      1.3%

From March 31 to Oct 20 this is up 37.7%.    This is 20 periods.  With compounding this is equal to about 1.6% per 10 day period.  This is more than twice what is needed to get hyperinflation with a constant velocity of money.  Again, I expect the velocity of money to start going up.  So it is much more than what is needed to make it to hyperinflation. 

The reports are found here and the release schedule is here.

The missing Bond Vigilantes are now Currency Vigilantes

The central banks are so aggressive on buying bonds that they are effectively controlling the price of the bonds.   Because of this investors are not shorting bonds but instead shorting the currency.   As the central banks print like crazy to control interest rates on bonds they devalue the currency.   So while there are not many Bond Vigilantes, there are Currency Vigilantes.