Arthur Hayes on Japan - Resurgence of Japanese Animal Spirits and a Speculative Future

Hello, this is Munou.

Arthur Hayes, founder of BITMEX and one of the Bitcoin OGs, shared his insights on Japan, so I've summarized them here.

Kite or Board

Fiscal Dominance
For those who want to understand how the Fed and the US Treasury will take the correct path in both mathematics and politics, there is a most important paper published by the Federal Reserve Bank of St. Louis earlier this year. They have a research arm where established economists can publish papers. These papers inform Fed policy. If you are serious about investing, you should read this entire paper. I will only excerpt a few sections.

While this paper focuses on the US, the premise of fiscal dominance is global. Currently, Japan serves as a real-time case study of what happens when fiscal dominance occurs.

The Bank of Japan (BOJ) is far less informative and transparent than the Fed. The BOJ will never admit that they have been dominated, and of course, no economics professor at the University of Tokyo will publish a paper criticizing their monetary policy. I will talk a bit more about what is happening in Japan in the next section, but as always, Japan is playing out the future of the planet in real-time.
In the modern US Dollar fiat reserve currency era, the BOJ was the first central bank to attempt QE. They then moved to Yield Curve Control (YCC). And now, the central bank has effectively lost its independence in an attempt to curb domestic inflation.

About BOJ Governor Kazuo Ueda

To assess whether the BOJ has been dominated, let's do a checklist exercise using the necessary conditions provided by Charles.

Is the Japanese government's debt-to-GDP ratio very high?
Yes, at 226%, it is one of the largest among developing countries.

Can the government afford to pay an average real interest rate of 2% over the long term?
No. Japan's inflation rate in July was 3.3%. If we add the long-term average real return on bonds, which is 2%, that makes 5.3%. If the Japanese Ministry of Finance had to fund all its debt at these levels, interest expenses would be many times tax revenue.

Has there been a failed government debt auction?
Yes. Last week, the 20-year Japanese government bond auction essentially failed. It featured the largest tail* in about 40 years. This means private investors are balking at buying long-term bonds with these massive negative real yields.
*In a bond auction, the seller (government or company) issues bonds, and buyers bid to determine the price. The higher the price, the lower the bond's yield (return). A tail occurs when the final price is higher than market expectations, meaning the yield is lower than market expectations.

Is the central bank prioritizing keeping interest rates low rather than raising them to fight inflation?
Yes. Japan's inflation rate is at a 40-year high. Nevertheless, the BOJ continues to make the absurd prediction that all forecasts will return to below 2% "in the future" and therefore must continue easing. That makes no sense, as they have had inflation above 2% for over a year. They have not defined how long inflation above 2% must persist for them to declare success and stop printing money to buy bonds and suppress JGB yields.

Ultra-low interest rates are encouraging a resurgence of Japanese "animal spirits." Some examples include a strong stock market (the Nikkei 225 is approaching its 1989 bubble peak) and rapidly rising apartment prices in cities like Tokyo. I hear from friends that Japanese workers are quitting their jobs to pay for living expenses and becoming contract workers, who receive fewer benefits but an immediate minimum 30% pay raise.

As prices for all real and financial assets rise, the incentive to keep money in banks for low yields is decreasing. The BOJ must act as soon as possible because it has the largest possible deposit base to implement an inflation tax. One of the discussions at Jackson Hole is for the BOJ to first mandate high bank reserve requirements and then force those reserves to buy government bonds. This would allow the Fed and the US Treasury to first observe the effects of the policies of their American vassal state and adjust as necessary.

Now, let's make some fucking money
Dr. Calomiris's paper provided a very solid "solution" to the Fed and US Treasury's problems. I would bet heavily that this is the most likely way for the government to find fools to buy long-term US Treasuries at affordable rates.
For now, cash is king, and nothing else widely available outperforms it in terms of financial returns outside of big tech and crypto. I am human, so I must eat, and unfortunately, in most cases, holding tech stocks or crypto does not generate income.
Tech stocks don't pay dividends, and there are no risk-free Bitcoin bonds. Holding my cash allows me to pay for living expenses without selling or borrowing against my crypto, so a yield of nearly 6% is fantastic. Therefore, I am changing my current portfolio barbell (holding cash at both ends) to MMFs and crypto.

I don't know when the US Treasury market will break and force the Fed to act. And from political demands, the assumption that the Fed will need to continue raising rates and shrinking its balance sheet is a good assumption that long-term rates will continue to rise. 10-year US Treasury yields recently exceeded 4%, and yields are at local highs. That is why risk assets like cryptocurrencies are taking a hit. The market believes that long-term yields will damage infinite-duration assets like stocks and cryptocurrencies.

In his latest note, Daddy Felix predicted a serious market correction for all assets, including cryptocurrencies. He seems to be as valuable as ever. I need to generate income and withstand market valuation losses in crypto. My portfolio is adjusted precisely for that.

I believe I have the correct future diagnosis because the Fed has already indicated that bank reserve balances must increase, and predictably, the banking industry was not pleased. Rising long-term US Treasury yields are a sign of serious decay in market structure. China, oil exporters, Japan, and the Fed are not buying US Treasuries for various reasons. With the usual buyers on strike, who will step up to buy trillions of dollars worth of debt that the US Treasury must sell in the coming months at low yields? The market is heading towards the scenario predicted by Dr. Calomiris, where failed auctions will eventually force the Fed and Treasury to act.

So, what did you think?
In particular, the idea that prices due to inflation will return to 2% is a pipe dream, and my opinion aligns with Global Macro Research on this. Even if it were true, it would mean "deflation" would occur, which would simultaneously lead to rising unemployment, making it seem no different from saying, "We're about to start destruction."

It is also true that the number of dispatched/contract workers is on the rise.
Indeed, as summarized in the article by Ogawa Seisakusho, it is as follows:

281 Male Part-time Employment Rate - Japan's Recent Sharp Rise

I was a bit surprised to learn that the number of sole proprietors is decreasing, as I had thought it was on the rise.

So, what will happen next?
Perhaps we should prepare for further inflation.

See you next time.