Monday, January 4, 2010

2010: Japan To Lead World in Sovereign Bond Crisis

Ambrose Evans Pritchard has published a stunning article on the state of the world'd economy and financial crisis. Titled, "Global bear rally will deflate as Japan leads world in sovereign bond crisis", Mr. Pritchard says that M3 money supply has been contracting in the US and Europe in recent months and this will slowly puncture economic recovery in 2010. He says that there is a lag of one year or so for this to show up.

He says Bernanke will be caught off guard and that by mid to late 2010, we will have lanced the biggest boils of the global system. Only then, amid fear and investor revulsion, will we touch bottom.

Only then it will be the "buying opportunity of our lives".

He states that the 2009 bear rally will end this year and it will become clear that we are in the grip of a 21st Century Depression, much like Japan's Lost Decade. Entertaining read to say the least!

He goes on:

"The surplus regions (China, Japan, Germania, Gulf ) have not increased demand enough to compensate for belt-tightening in the deficit bloc (Anglo-sphere, Club Med, East Europe), and fiscal adrenalin is already fading in Europe. The vast East-West imbalances that caused the credit crisis are no better a year later, and perhaps worse. Household debt as a share of GDP sits near record levels in two-fifths of the world economy. Our long purge has barely begun. That is the elephant in the global tent.

Yields on AAA German, French, US, and Canadian bonds will slither back down for a while in a fresh deflation scare. Exit strategies will go back into the deep freeze. Far from ending QE, the Fed will step up bond purchases. Bernanke will get religion again and ram down 10-year Treasury yields, quietly targeting 2.5pc. The funds will try to play the liquidity game yet again, piling into crude, gold, and Russian equities, but this time returns will be meagre. They will learn to respect secular deflation.

Weak sovereigns will buckle. The shocker will be Japan, our Weimar-in-waiting. This is the year when Tokyo finds it can no longer borrow at 1pc from a captive bond market, and when it must foot the bill for all those fiscal packages that seemed such a good idea at the time. Every auction of JGBs will be a news event as the public debt punches above 225pc of GDP. Finance Minister Hirohisa Fujii will become as familiar as a rock star.

Once the dam breaks, debt service costs will tear the budget to pieces. The Bank of Japan will pull the emergency lever on QE. The country will flip from deflation to incipient hyperinflation. The yen will fall out of bed, outdoing China's yuan in the beggar-thy-neighbour race to the bottom. By then China too will be in a quandary. Wild credit growth can mask the weakness of its mercantilist export model for a while, but only at the price of an asset bubble. Beijing must hit the brakes this year, or store up serious trouble. It will make as big a hash of this as Western central banks did in 2007-2008.

The European Central Bank will stick to its Wagnerian course, standing aloof as ugly loan books set off wave two of Europe's banking woes. The Bundesbank will veto proper QE until it is too late, deeming it an implicit German bail-out for Club Med.

More hedge funds will join the EMU divergence play, betting that the North-South split has gone beyond the point of no return for a currency union. This will enrage the Eurogroup. Brussels will dust down its paper exploring the legal basis for capital controls. Italy's Giulio Tremonti will suggest using EU terror legislation against "speculators".

Wage cuts will prove a self-defeating policy for Club Med, trapping them in textbook debt-deflation. The victims will start to notice this. Articles will appear in the Greek, Spanish, and Portuguese press airing doubts about EMU. Eurosceptic professors will be ungagged. Heresy will spread into mainstream parties.

Greece's Prime Minister Papandréou will balk at EMU immolation . The Hellenic Socialists will call Europe's bluff, extracting loans that gain time but solve nothing. Berlin will climb down and pay, but only once: thereafter, Zum Teufel.

In the end, the Euro's fate will be decided by strikes, street protest, and car bombs as the primacy of politics returns. I doubt that 2010 will see the denouement, but the mood music will be bad enough to knock the euro off its stilts.

The dollar rally will gather pace. America's economy – though sick – will shine within the even sicker OECD club. The British will need the shock of a gilts crisis to shatter their complacency. In time, the Dunkirk spirit will rise again. Mervyn King's pre-emptive QE and timely devaluation will bear fruit this year, sparing us the worst".

However, please keep in mind that In late 2008, The Telegraph also published his predictions for 2009:

"We will stop talking about banks. Interest rates will flirt with zero across the world. This will not be enough to prevent debt deflation leading to a light global depression. Job losses will reach one million a month in the US. The damage will be slower in Europe, but last longer. The great surprise will be the ferocity of the downturn in China. By the middle of the year, the geopolitical landscape will look very different: those without a deep-rooted democracy and rule of law will lose legitimacy. In the eurozone, the markets will look closely at Spain, Italy, Greece, Austria, and Ireland. By late 2009, the emergency fiscal stimulus will feed through. Those first into recession will be first out, led by the US. Wall Street will anticipate a US rebound. Equities, oil and gold will rally. Bonds will be slaughtered".

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