Subject: RE: Japan and the Limits of Keynesianism - McCardle - Atlantic
From: "Neil Callahan" <[email-masked]>
To: "'Michael Andrews'" <[email-masked]>, "'Devon Archer'" <[email-masked]>, "'Eric Schwerin'" <[email-masked]>, "'Curtis Hastings'" <[email-masked]>, "'Hunter Biden'" <[email-masked]>
Date: Tue, 28 Dec 2010 16:14:03 -0500

So we are working with a Securities firm who are underwriting counter party
trades they are calling the "Double-Short Japan" - predicting a default by
the government/bank of Japan  on their debt and the collapse of the Yen.
They are targeting a 300-1,000% return or total loss of principle.  John
Paulson and Paul Tudor Jones are big buyers of the short side of this trade.
They see the trade widow as being 18 months - 3 years.

If you look at how the Yen has trade starting in the summer until now, you
may be able to see the Short trades being put on.  So the short selling may
also help create a self-fulfilling prophecy.

Needless to say if the double short pays off 1,000% we will all be living in
card board boxes eating cat food, and maybe a 300% is just a global
depression/recession to look forward to.

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Neil Callahan

Rosemont Seneca

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From: Michael Andrews [mailto:[email-masked]] 
Sent: Tuesday, December 28, 2010 3:01 PM
To: Devon Archer; Eric Schwerin; Neil Callahan; Curtis Hastings; Hunter
Biden
Subject: Japan and the Limits of Keynesianism - McCardle - Atlantic

Japan and the Limits of Keynesianism

DEC 28 2010, 12:24 PM ET
<http://www.theatlantic.com/business/archive/2010/12/japan-and-the-limits-of
-keynesianism/68619/#disqus_thread> 30

Japan's budget is in a truly terrifying state.  Reading about
<http://online.wsj.com/article/SB10001424052970203731004576045232268132622.h
tml?mod=WSJ_Markets_section_Heard> the government's behavior reminds me of
the worst accounts of compulsive spenders on the verge of personal
bankruptcy--a sort of "What the hell, we're screwed anyway, so let's not
think about it and maybe go to Cabo for the weekend."  The budget's
structural position is what is known technically to economists as
"completely hosed";  <http://www.reuters.com/article/idUSTRE6BN0FQ20101224>
borrowing now exceeds tax revenue, and debt service costs now eat up almost
half of the tax revenue the government collects.  "Unsustainable" is too
weak to describe the situation; I don't know how they're doing it now.

To be sure, a lot of people have been awaiting the inevitable collapse of
the Japanese government's finances for the better part of a decade.  I know
all the arguments for why this isn't such a big problem:  their debt is
financed domestically, much of it through the postal savings system that
pays little for its borrowing, and the Japanese are extremely patriotic
about their nation's financial needs.  That may shift the locus of the
problem, but it doesn't actually solve it; eventually, no matter how
patriotic they are, the Japanese are going to want to use some of those
savings to support themselves in their old age.  Some sort of crisis
virtually has to ensue. 

When I was starting out as a journalist, I frequently had Japan used to
illustrate Adam Smith's precept that "there's a lot of ruin in a nation";
any time someone was tempted to get hysterical about government borrowing in
America or elsewhere, someone else would inevitably point out that Japan's
debt burden was well over 100% of GDP, and the country still hadn't
collapsed.  But while there is a lot of ruin in a nation, there isn't
actually an endless supply, and Japan may well be finally approaching the
limits.

Felix Salmon views this as a symptom of a broader political failure:

The situation in Japan is particularly depressing because the country has no
major ethnic or political rifts. Sure, there's political jostling, both
within and between the parties. But it's nothing compared to the vitriol and
mistrust that we see in the US, and somehow I can't imagine Greece-style
riots in Japan either. But still the technocrats can't make any headway.

The lesson here, I think, is that it's very, very hard for a government to
enact a serious fiscal adjustment unless and until the bond market forces
its hand. The Brits are trying, of course -- and we'll see whether or not
the coalition government can succeed. But as we saw with George W Bush, the
fiscal rectitude of one administration can be more than wiped out during the
course of the next.

Even now, with the attention of the world more concentrated on sovereign
fiscal issues than ever, the Japanese government can still contrive to raise
agricultural subsidies by 40% and send child-care payments soaring,
including payments to families who don't need the money. It's even getting
rid of highway tolls. Oh, and it's cutting the corporate tax rate.

From a bond-market perspective, this basically just means an ever-greater
supply of JGBs: we're still a very long way from any real credit risk, given
the political power of the owners of those bonds. But as a lesson in fiscal
political economy, Japan is much more worrisome.

I see it a little bit differently: Japan has simply reached the limits of
Keynesian policy in an economy which has never managed to jolt itself back
up to a healthy rate of growth.  Demographics is obviously a big contributor
to that slow growth, and there are a whole host of secondary factors one
could nominate, but whatever the reason, they have now had two decades of
anemic growth, which they have fitfully attempted to address with stimulus.
Maybe not enough stimulus, maybe badly designed, but they've certainly tried
to follow the basic Keynesian playbook:  borrow money and spend it when
times are bad, in the hopes that you can bring back growth.

But for Japan, at least, the growth has not materialized.  Few economists
would advise undertaking a fiscal adjustment, on the scale that Japan
requires, in the face of the current crisis.  The problem is, there hasn't
been a good time for retrenchment in 20 years.  I can't blame the
politicians for trying to restore some semblance of normal growth in the
run-up to elections.  But at some point, they're going to have to cut back,
whether or not it's a good time.  

Matt Yglesias suggest tha
<http://yglesias.thinkprogress.org/2010/12/mysteries-of-preemptive-fiscal-ad
justment/> t it's irrational to retrench ahead of the bond market, when what
they ought to be doing is trying to have more economic growth, but their
lack of economic growth really isn't for lack of trying.  I think every
economist who has ever had an opinion on currency has been solicited, at one
point or another, to come up with a plan for Japan, but they've all failed,
either because the plans weren't politically feasible, or because the money
supply simply stubbornly refused to inflate no matter how hard it was
pumped.

Given the menu of actual policy options, it would probably be best for Japan
to attempt fiscal adjustment now.  The earlier you deal with a fiscal
problem, the smaller the problem is . . . and doing it in advance gives you
rather more discretion about how and when the cuts are made, which gives
everyone, espeically the people who are now dependent on the government,
time to adjust.  But it's not hard to see why it hasn't.  Which of us would
volunteer to be the guy who cuts pensions and farm subsidies while there's a
recession on?