Thursday, December 6, 2012

Japan's Worst Case Scenario

Japan is in an incredibly tough spot.  GDP contracted last quarter, and the central bank and government are in the middle of a war of words regarding stimulus. 

Here is their worst case scenario going forward:

In the worst case scenario, the slide in the yen could be the catalyst for a rise in yields on Japanese government bonds, a market that is about the same size as the US Treasury market at between $11tn and $12tn. That in turn could set off a spiral in which non-yen based investors (a mere 8 per cent of the demand today, admittedly) insist on higher yields to compensate for possible losses on the currency, while Japanese banks, whose profitability has been minimal, would be looking at losses on their government bond holdings. In most cases, those holdings are larger than the banks’ domestic corporate loan books, as deposits from risk-averse households come into their coffers.