Ex-Soros Adviser Fujimaki Sees JGB Bust From Tax Delay, Fed
Takeshi Fujimaki, a former adviser to billionaire investor George Soros who won a seat in Japan’s upper house of parliament last month, said a delay in increasing the sales tax and reduction of Federal Reserve stimulus could cause the nation’s government bond “bubble” to burst.
Prime Minister Shinzo Abe’s administration plans to release later this year its medium-term fiscal plans and a final decision on a two-step doubling of the consumption levy to 10 percent in 2015. Fed Chairman Ben S. Bernanke said in June the U.S. central bank may start scaling down its third round of quantitative easing of asset purchases this year and end it altogether in mid-2014.
Japan’s public debt, the highest ratio globally, may balloon to 245 percent of gross domestic product this year, according to the International Monetary Fund. Even as the nation struggles to turn its primary balance into a surplus, it enjoys the world’s lowest borrowing costs as record bond buying by the Bank of Japan helps keeps yields anchored.
“The JGB market is in a bubble and the tapering of QE in the U.S. or cancellation of the planned tax hike could become a thin needle to prick it,” Fujimaki, 63, who won on a Japan Restoration Party ticket in the July 21 ballot, said in an interview in Tokyo on July 31. “Japan will not be able to avoid default and hyper-inflation with the tax increase, but that’s no excuse for politicians to not go ahead with it.”
In the fiscal year started in April, the primary balance fiscal deficit will be 23.2 trillion yen ($233 billion), the finance ministry estimated in January. The government is considering an 8 trillion yen target for budget-deficit cuts over the next two years, according to two officials who asked not to be named in line with government policy.
Abe said July 27 that he’ll make an “appropriate decision” on the tax that was due to rise to 8 percent next April. The cabinet office estimated in August last year that a 1 percentage point increase in the levy would create about 2.7 trillion yen in extra revenue.
The yield on Japan’s 10-year bonds rose 1 1/2 basis points, or 0.015 percentage point, to 0.81 percent as of 3:22 p.m. in Tokyo. The benchmark rate touched a record low 0.315 percent on April 5, the day after the BOJ announced unveiled a plan to purchase more than 7 trillion yen of Japanese debt a month, and jumped to a one-year high of 1 percent by May 23.
“Japan’s fiscal health is not ringing alarm bells in the market as the BOJ’s enormous amount of bond buying keeps yields low,” said Fujimaki. “No matter how much the government splurges on fiscal spending, the pain won’t be felt, so the debt continues to balloon to the point of no return.”
The cost to protect JGBs for five years with credit default-swaps was at 63 basis points yesterday, after dropping to a two-month low of 62 on July 18, according to data provider CMA, which is owned by McGraw-Hill Cos. The contracts fall as perceptions of creditworthiness improve.
“Postponing the sales tax would be a huge mistake,” said Fujimaki, who previously served as managing director and treasurer at the Tokyo office of Morgan Guarantee Trust Co., which later merged into JPMorgan Chase & Co. “That would be a clear signal for a government bond selloff, or buying of puts. It could be a trigger for hedge funds which have been waiting for a collapse to start moving.” A put option is an agreement that gives the buyer the right to sell a specific quantity of a particular security by a specific date.
Hedge fund manager J. Kyle Bass, whose Hayman Advisors made $500 million during the U.S. subprime crisis, has predicted a Japanese fiscal collapse since 2010.
“Abe and the BOJ face what I call the ‘rational investor paradox,’” Bass told Bloomberg News in an e-mail in May. “If JGB investors begin to believe that Abenomics will be successful, they will ‘rationally’ sell JGBs to buy foreign bonds or equities,” referring to Abe’s economic policies. That would place upward pressure on Japanese bond yields and government debt-service costs.
As the BOJ is set to absorb half of the government bonds planned for sale this fiscal year, domestic investors are venturing overseas for higher yielding assets. Japanese were net buyers of foreign debt for a fourth straight week, according to figures released yesterday by the Ministry of Finance in Tokyo. They bought 233.2 billion yen in overseas bonds and notes in the seven days ended July 26.
Sumitomo Mitsui Financial Group Inc.’s lending unit almost halved its JGB holdings to 11.5 trillion yen in the three months through June, according to the company’s earnings presentation this week. Mitsubishi UFJ Financial Group Inc. pared its holdings by 17 percent over the quarter to 40.3 trillion yen and Mizuho Financial Group Inc. reduced the amount by 20 percent to 24.6 trillion yen.
“As we can see from the megabanks that are drastically reducing their JGB holdings, there are some company managers with a reasonable mind,” said Fujimaki. “The risk of a default is shifting from the private sector to the public as the BOJ splurges on JGBs. If we continue down this path the credibility of the BOJ will be lost and the yen will plunge.”
Japan’s currency has depreciated 9.5 percent this year against a basket of 10 developed-market currencies tracked by Bloomberg Correlation-Weighted Indexes, the biggest decline in the group after the Australian dollar. It has weakened 13 percent against the greenback, trading at 99.62 per dollar today. The yen surged to a postwar record of 75.35 in October 2011 and averaged 79.84 last year.
The BOJ aims to boost the monetary base, which is cash in circulation plus reserves financial institutions have on deposit at the central bank, to 270 trillion yen by the end of next year to achieve its 2 percent inflation target. Central bank data today showed the outstanding amount rose 38 percent in July from a year earlier to 173.3 trillion yen.
Consumer prices excluding fresh food increased 0.4 percent in June from a year earlier, the biggest annual increase since November 2008, the statistics bureau said on July 26.
“We need a weaker yen to stoke inflation,” said Fujimaki. “The yen’s fundamentals suggest to me it should be around 180 to 200 per dollar. Because it has been around 80, we’ve had 20 years of deflation.”
“It’s impossible to avoid a default at this point, but what’s important is to create a system to avoid the same mistake and that’s where I can contribute as a politician,” Fujimaki said. “I want to be the part of writing the blueprint to the system for the next 100 years where we have an equal amount of spending and revenue.”
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