STAFF NEWS & ANALYSIS
Long-Term Doom, Short-Term Profits
By Staff News & Analysis - May 24, 2013

The Bank of Japan must crush all resistance, and will do so … Kudos to Kyle Bass at Hayman Advisers for warning that the Bank of Japan would lose control of its ¥70 trillion bond buying blitz. The spike in the 10-year yield to 1pc on Thursday was certainly shocking to behold. His point is that the BoJ faces a "rational investor paradox". The authorities are trying to drive up the inflation to 2pc and therefore to devalue Japanese government bonds (JGBs), so why on earth would you want to own them? − UK Telegraph

Dominant Social Theme: It is impossible to control the market

Free-Market Analysis: In the short term, it is possible to control markets, even big ones. This is surely an investment lesson we need to internalize.

Yesterday we saw the Japanese market crack after a large upward move caused by the application of Abenomics. But we would be surprised if the Japanese descent continued indefinitely. As we have seen plenty of times, in the short-term markets are controllable, especially equity markets.

In the US, Federal Reserve money printing has doubled market averages. In Europe, the ECB wants to do the same. And in Japan, markets have already moved up hard before moving down.

What goes on during these great stimulations is that markets become captives of monetary debasement. And any news that counters that debasement policy can create a shock and a plunge. But if central banks move quickly enough, they can staunch the bleeding and build the markets back up as they have over the past half decade, certainly in the US.

The cost is a viable system. As markets gyrate and the investing public increasingly stays away, the only money flowing into the market is professional money, making the total equity thin indeed.

For central bankers engaged in debasement and thus "stimulation," the trick is to generate such oversize returns over time that people are irresistibly attracted to equity markets. It is an entirely cynical exercise, but if we are correct, it will continue for a while longer and those who are careful about their participation and disciplined about their exposure may benefit considerably.

Here's more from the article:

I stick with my view that the BoJ has the means to crush all resistance, and should do so. This may require financial repression. Rutaro Kono and Makoto Watanabe from BNP Paribas have an excellent note out this morning arguing that Kuroda will have to copy the "pegging operations" of the Fed in the 1940s. In effect, the Fed became part of the Treasury's debt management team as the budget defict hit 25pc of GDP in WW2. It capped one-year notes at 0.875pc and 30-year bonds at 2.5pc.

The markets knew that all necessary means would be used to hold the line (as the Swiss did in 2011 to hold the franc at 1.20 to the euro). It certainly worked. It allowed the US to whittle away its wartime debt through inflation and negative real rates. The creditors paid the price. It was an "inflation tax", or covert debt restructuring. That is what lies in store for Japan, and it will be horrible for pensioners, savers, and those expecting an annuity. Whether the authorities can pull it off it without capital controls is an interesting question. My guess is that controls will be part of the mix in the end, and much else besides.

Tough. Leaders don't run countries for the benefit of markets. But all this is clearly "doable", and if the alternative is a spiral into mayhem and debt default, you can hardly blame Mr Abe for wanting to try. There was always a "Hail Mary" element to this massive reflation experiment, a last-ditch effort to avert a debt compound spiral. The critics are right to say it may fail. But are they suggesting that the previous status quo was tenable? … As for the countless readers demanding an apology from me for backing QE, Abenomics, and all the sins of monetarism: I defy you all.

Unlike the author of this article, we are not fans of the sort of monetary manipulation taking place. Yes, it IS untenable in the long term and immensely destructive, especially for pensioners and those planning for retirement. Anybody, in fact, depending on stable and rational interest rates.

Price inflation is an inevitable outcome of central banking strategies that we are seeing. And once price inflation takes hold, rates go up and markets crash. This article is thus wrong when asserting that the BOJ can crush resistance. What it can do is reinvigorate paper assets on the backs of the elderly and the working poor.

People are not necessarily stupid, even in aggregate. How long will they tolerate this sort of system? One hundred years ago its destructive effects were not so evident. Today they are surely obvious.

We think the system is indeed doomed but in the meantime, those with strong stomachs and disciplined investment systems can anticipate much of what is going on in both the metals markets and fiat investment markets. There is money to be made, both long and short, if one is savvy enough to appreciate the realities of what is occurring.

After Thoughts

The long-term outlook is a gloomy one … that anticipates destabilization of the system. The short-term outlook is considerably more promising, we would suggest, provided you know what you are doing.

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