When Herding Cats Fails: A Visual Tale Of Two QEs

Following last week’s Japanese market fireworks, one thing has finally become clear: any ongoing collapse in the Yen, and corresponding surge in the Nikkei225 – supposedly beneficial “side-effects” of Abenomics impacting the Japanese economy – will send Japanese bond yields surging as more panic and sell their fixed income exposure, leading to further instability and volatility in the bond market, which in turn becomes a selling catalyst and so on in an escalating selling feedback loop. Because, as we have been warning, Abenomics “works” only as long as it only impacts stocks beneficially, i.e., sends them higher, but much more importantly as long as nobody sells their bonds. This is the reason for the surge in damage control out of Japan, desperate to “keep Mrs Watanabe’s faith” in the wealth effect mechanism known as the stock market following last week’s epic market crash best summarized in this piece by Bloomberg: “Kuroda Backs Japan Bulls After Stock Plunge Jolts Confidence.”

So with Abe and Kuroda supposedly unwilling to take a break until long-term inflation expectations are anchored at 2%, this means the 10 Year JGB, most recently trading south of 1%, has much, much more downside. And as we explained before, the ongoing plunge in JGB prices means massive Tier 1 capital impairment for various Japanese banks which are the biggest holders of JGBs. It also means that as Kyle Bass has long been warning, the amount of Japanese tax revenues needed to fund interest will explode to nearly half of all. Although when the central bank directly monetizes the deficit, all sound math and logic becomes moot.

All that, and many other reasons why QE of the type implements in the US are impossible, have been explained extensively in the past on these pages.

However, the best argument why the type of Quantitative Easing imposed by Ben Bernanke, and the associated “necessary and sufficient” condition to exit this greatest of all monetary experiments, or eventually allow Ben and Kuroda to taper QE, i.e., the “great rotation” from government bonds into stocks (because otherwise both the Fed and the BOJ will be stuck monetizing and monetizing and monetizing until one day, soon, they own all government bonds), will never work in Japan is a simple one. And quite visual.

The chart below is a comparative study of the US and Japanese government bond markets: it assumes tota US government and Japanese debt of $16.7 trillion and $11.5 trillion, respectively, are indexed 1:1.

What is shown, and is far more important, is the relative size of the associated stock market, nearly $20 trillion for the US, but just a tiny $3.3 trillion in Japan.

And here lies the rub. Because while for the US the relative party of the bond and equity markets (delta of under 20%), the largest in the world, allows Bernanke to experiment with major moves in and out of the bond and stock market without major impacts to either class, in Japan the ratio of the bond to the stock market is a whopping $11.5 to $3.3 or a tiny 0.29x

Now, we won’t get into the details of what happens when one tries to funnel liquid (because it literally is “flow”) from a massive container into a tiny one, and the volatility that results on the margin as more and more contents from massive bucket A are transferred into tiny bucket B, but we don’t think it is necessary. It is sufficiently intuitive.

The bottom line is that what may have worked for Bernanke up until now, will absolutely not work for Abe and Kuroda, who literally try to herd massive cats into a tiny trap, and where the bond and stock markets are literally worlds apart.

Of course, if Abenomics entire purpose is to destabilize global markets on the margin, create unprecedented stock and bond volatility, and ultimately crush faith in the Yen first, and then all other fiat, then he most certainly is on the right path.


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