DEBT TRAPS ARE BEING SPRUNG EVERYWHERE / MACLEOD FINANCE

Debt traps are being sprung everywhere

The threat to government finances from rising bond yields is becoming apparent to investors. They are crashing the entire dollar-based currency system starting with the yen.

ALASDAIR MACLEOD

 

The political pressure on central banks has always been to suppress interest rates. 

Inevitably, this has led to a compounding explosion of government debt and a proliferation of zombie corporations. 

Thanks to the US ensuring that Hormuz remains bottled up and now the Bab el-Mandab strait as well, G7 nations face a severe slump in business activity crashing their government finances.

Furthermore, the Keynesian playbook is for governments to expand credit in addition, to prevent economic slumps and recessions. 

Coupled with domestic political priorities G7 central banks will be forced to intensify suppression of interest rates and bond yields. It is leading all these nations into deeper debt traps.

So, what is a debt trap? 

At the sovereign level, here is a definition:

“A debt trap describes a country borrowing more than it can service. 

The debt becomes self-perpetuating because servicing costs outstrip the borrower’s capacity to pay it down.”

In fact, G7 countries are already there, most obviously Japan whose government debt to GDP is about 240%. 

This is illustrated by the consequences for borrowing costs, which have started rising from the most suppressed base possible at less than 0%:

 

Japan is particularly exposed to the Hormuz crisis, with 93% of her oil and 11% of her LNG coming from the Middle East. 

Obviously, this dependency is driving her private sector into a slump in demand, which will reduce estimates of current and future GDP considerably. In other words, with the divisor in the debt/GDP ratio declining, the quotient ratches up even further.

Consequently, borrowers have every reason to steer clear of Japanese government bonds, so that their yields will continue to rise, making the position considerably worse for the debtor. 

This is why interest on payday loans go to thousands per cent for desperate borrowers, and Japan is in the same trap. And the higher bond yields go, the worse the debtor’s position.

Creditors simply steer clear of situations like this, which is why the yen is collapsing, even valued against its fiat currency peers:

 

Very recently, Japan’s finance ministry requested households and pension funds including the huge Government Pension Investment Fund to increase their investment in Japanese financial assets. 

When a finance minister makes such a request, pension and other investment funds such as insurance companies cannot ignore it and must at least appear supportive of the national financial interest. 

They will stop investing in foreign assets.

This request from the finance minister reveals that her ministry is worried to the point of panic. 

And they are right to be, for the reasons outlined above. 

In a nutshell, Japan is more exposed to this crisis than any other G7, all of which have other energy suppliers. 

For its debtors Japan is a basket case whose credibility is collapsing. 

Bond yields should soar with no discernible limit, and the yen which reflects Japan’s creditworthiness will collapse even further.

Japan is an obvious trigger in this global crisis. 

Interconnectedness of global finances makes Japan’s rapidly escalating problems a serious danger to other G7 nations and the credibility of their own currencies. 

The yen carry trade and direct investment from Japan’s institutions have perpetuated the myth of government finances being secure for decades. 

The US, for example now faces dumping of US treasuries by China and non-investment at the least if not outright selling from its largest foreign investor, which is Japan.

There are many examples in the history of financial crises, where an event off everyone’s radar leads to a wider catastrophe. 

In 1932, the collapse of Austria’s Creditanstalt bank led to a domino effect throughout Europe. 

In the same way, Japan’s debt problems are set to spread to the US and other G7 nations, driving up their bond yields and currencies down.

This is France’s 10-year bond yield, which was bought by Japanese institutions in recent years and presumably are now selling:

Unbeknown to nearly everyone, G7 currencies are already losing purchasing power at an accelerating rate, as their values priced in gold clearly shows: