Attention Bond Vigilantes: Japan May Be Your Next Target

By Jeff Harding, on April 6th, 2012

S&P just put out a warning on Japanese banks holding Japan sovereign bonds (JGBs) because of the risk of Japan having a current account deficit:

Standard & Poor’s Ratings Services does not expect Japan to see a current account deficit in the next two to three years. However, if the  yen rises further against other major currencies and fuel imports continue to increase, we believe that the likelihood of a current  account deficit would also edge higher. If Japan’s current account falls into a deficit, the country could find itself becoming a net  importer of capital. This would push up the share of funds from foreign investors when the government raises funds. A higher proportion of foreign investors in public financing could also cause investors to demand premium interest rates to hedge credit risks on Japanese government bonds (JGBs). This could further push down the price of JGBs, lifting their interest rates. Given that Japanese banks have increased investments in JGBs in recent years, potential rate increases could affect their financial profiles in a more severe manner than before.

What you are seeing is the failure of a Keynesian economics system based on years of fiscal stimulus and deficit spending. They have raided the country’s retirement savings to pay for worthless infrastructure projects. Add to this the fact that Japanese citizens are retiring and not saving anymore. Their fabled high rate of savings was <2% at last look. It was always the premise of their economists and politicians that they would never have to rely on external financing of their fiscal deficits. That is coming to an end. In essence the government has spent the savings of their elderly citizens. 

When? S&P doesn’t answer that question, but it is a fair warning. Today’s Bloomberg headline from Japan is: “Bank of Japan Seen Adding Stimulus on Nominee Rejection.” It is only a matter of time.

Those economic reality chickens are coming home to roost. Bond vigilantes won’t be far behind.