I just finished reading the first book of Kim Stanley Robinson’s trilogy, “Red Mars”. One of the characters is a Japanese scientist named Hiroko Ai, who often says “shikata ga nai” when referring to situations that the Martian colonizers cannot control, meaning “it can’t be helped”.
When I was thinking about the title for this “short” article, that phrase suddenly came to my mind. This article will focus on the Japanese banks that have become the sacrificial lambs of the “Pax Americana” monetary policy, unable to pay their debts. What have these banks done? In order to earn substantial returns from yen deposits, they engaged in carry trades of US dollars against yen. They borrowed money from elderly savers in Japan and, given the near-zero yields of all “safe” government and corporate bonds in Japan, concluded that lending to the “Pax Americana” via the US Treasury market was a better use of capital, with significantly higher yields even after fully hedging the foreign exchange risk.
But then, when the United States experienced inflation due to cash bribes to appease the public and accept being locked down, and experimental drugs to combat the Baby Boomer flu, the Federal Reserve had to take action. The Fed raised interest rates at the fastest pace since the 1980s. This was bad news for anyone holding US treasuries. The rising yields led to the worst round of bond issuance since the War of 1812. Shikata Ga Nai!
Starting in March 2023, the first wave of casualties hit the underbelly of the US financial system. Within two weeks, three major banks failed, leading the Federal Reserve to provide full support for all US treasuries held on the balance sheets of any US or foreign bank’s American branches. Unsurprisingly, the Bitcoin price surged in the months following the announcement of the bailout plan.
Since the announcement of the bailout plan on March 12, 2023, Bitcoin has risen by over 200%.
To support the approximately $4 trillion bailout plan (my estimate of the total amount of US treasuries and mortgage-backed securities held on US bank balance sheets), the Federal Reserve announced in March this year that the discount window would no longer be the kiss of death. If any financial institution needs to inject cash quickly to plug the holes caused by “safe” government bonds on its balance sheet, it should make use of this window without delay. What can we say when the banking system is inevitably rescued by currency debasement and the violation of human labor dignity? Shikata Ga Nai!
The Fed’s actions towards US financial institutions are correct, but what about the foreigners who have also been buying US treasuries in large quantities during the global funding surge from 2020 to 2021? Which country’s banking system is most likely to be destroyed by the Fed? It is undoubtedly the Japanese banking system.
We learned from the media why the fifth-largest Japanese bank in terms of deposits, Norinchukin Bank, is selling foreign bonds worth $63 billion, most of which are US treasuries.
Japanese Norinchukin Bank to sell $63 billion of US and European bonds
“US and European interest rates have risen and bond prices have fallen. This has reduced the value of foreign bonds purchased by Norinchukin at high prices (low yields), leading to an expansion of its book losses.”
Norinchukin Bank is the first bank to surrender and announce that it must sell bonds. All other banks are engaging in the same trades, and I will explain below. The Council on Foreign Relations gives us an idea of the massive amount of bonds that Japanese commercial banks may sell.
According to the IMF’s coordinated portfolio investment survey, by 2022, they (Japanese commercial banks) held about $850 billion in foreign bonds. This includes nearly $450 billion of US treasuries and about $75 billion of French bonds – a number far exceeding the bonds issued by other major countries in the eurozone they hold.
Why is this important? Because Yellen will not allow these bonds to be sold on the open market, pushing up US treasury yields. She will demand that the Bank of Japan (BOJ) buys these bonds from the Japanese banks it regulates. Then, the BOJ will use the Foreign and International Monetary Authority (FIMA) repurchase tool established by the Fed in March 2020. The FIMA repurchase tool allows central banks to pledge US treasuries and receive newly printed US dollar bills overnight.
The increase in the FIMA repurchase tool indicates that the global currency market has increased US dollar liquidity. You all know what this means for Bitcoin and cryptocurrencies, which is why I think it is necessary to draw readers’ attention to another form of hidden printing. I read an Atlanta Fed Research report titled “The Offshore Dollar and US Policy” and realized how Yellen is preventing these bonds from flooding the open market.
Why now?
At the end of 2021, as the Fed indicated it would begin raising policy rates from March 2022, US treasury prices started to plummet. It had been more than two years; why would a Japanese bank that has endured two years of pain suddenly crystallize its losses? Another odd fact is the consensus among economists you should have heard: the US economy is on the verge of a recession. Therefore, the Fed is only a few meetings away from cutting rates. Rate cuts would push up bond prices. Again, if all the “smart” economists tell you that the bailout is imminent, why sell now?
The reason is that Nochu’s foreign exchange-hedged purchase of US treasuries has gone from a small positive to a large negative. Before 2023, the exchange rate difference between the US dollar and the Japanese yen was negligible. Then, the Fed and the Bank of Japan diverged, with the BOJ keeping rates unchanged at -0.1% while the Fed hiked rates. With the interest rate differential widening, the cost of hedging the dollar risk exposure embedded in US dollar bonds exceeded the higher yields.
Here’s how it works. Nochu is a Japanese bank with yen deposits. If it wants to buy high-yielding US treasuries, it needs to pay in dollars. Nochu would sell yen and buy dollars to purchase the bonds, which is done in the spot market. If that was all Nochu did, and the yen kept appreciating against the dollar between now and the bond’s maturity, it would lose money when it sells the dollars back into yen. For example, if you bought $100 with 100 yen today and sold the dollars for 99 yen tomorrow because the dollar weakened and the yen strengthened, you would lose money. Therefore, Nochu would typically sell dollars and buy yen to hedge this risk. It would roll the hedge every three months until the bond matures.
Normally, 3 million is the most liquid. That’s why banks like Nochu use a 3 million rolling forward to hedge a 10-year foreign exchange purchase.
Due to the widening interest rate differential, the 3 million forward points became so large that the hedging cost of the dollar risk exposure embedded in US dollar bonds against yen exceeded the yield premium over yen-denominated Japanese government bonds. This is what you have seen since mid-2022, represented by the red line crossing below zero on the x-axis, which represents the dollar. Please remember that Japanese banks buying yen-denominated Japanese government bonds have no foreign exchange risk, so they don’t need to hedge.
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Now, imagine that everything I did was to buy US treasuries, which only pay 0.5% more in yield than equivalent tenor Japanese government bonds. I would need to pay a 0.5% negative carry to do this trade. If that were the case, Nochu or any other bank would not engage in this trade.
To be continued…