Senkaku Island Row May Turn into a Bond War as China Threatens to Dump Japanese Government Bond It Holds

Uh oh...now we're talking serious matters. Are Messrs Ishihara, Noda (not to mention Bank of Japan Governor Shirakawa) ready for this?

(Talk about fiscal cliff... See the chart near the bottom of the post.)

First, from Ambrose Evans-Pritchard at The Telegraph (9/18/2012):

Beijing hints at bond attack on Japan

A senior advisor to the Chinese government has called for an attack on the Japanese bond market to precipitate a funding crisis and bring the country to its knees, unless Tokyo reverses its decision to nationalise the disputed Senkaku/Diaoyu islands in the East China Sea.

Jin Baisong from the Chinese Academy of International Trade – a branch of the commerce ministry – said China should use its power as Japan’s biggest creditor with $230bn (£141bn) of bonds to “impose sanctions on Japan in the most effective manner” and bring Tokyo’s festering fiscal crisis to a head.

Writing in the Communist Party newspaper China Daily, Mr Jin called on China to invoke the “security exception” rule under the World Trade Organisation to punish Japan, rejecting arguments that a trade war between the two Pacific giants would be mutually destructive.

Separately, the Hong Kong Economic Journal reported that China is drawing up plans to cut off Japan’s supplies of rare earth metals needed for hi-tech industry.

The warnings came as anti-Japanese protests spread to 85 cities across China, forcing Japanese companies to shutter factories and suspend operations.

Mr Jin said China can afford to sacrifice its “low-value-added” exports to Japan at a small cost. By contrast, Japan relies on Chinese demand to keep its economy afloat and stave off “irreversible” decline.

“It’s clear that China can deal a heavy blow to the Japanese economy without hurting itself too much,” he said. It is unclear whether he was speaking with the full backing of the Politburo or whether sales of Japanese debt would do much damage. The Bank of Japan could counter the move with bond purchases. Any weakening of the yen would be welcome.

(Full article at the link)

Mr. Evans-Pritchard, on-again-off-again Keynesian (currently "on"), seems to think Bank of Japan would be happy and willing to absorb the dumped JGB should it occur. But reality-based Tyler Durden at Zero Hedge has a different take:

Should this stunning recommendation be enacted, not only would it be the first time in world history that insurmountable credit is used as a weapon of retaliation, it would mark a clear phase transition in the evolution of modern warfare: from outright military incursions, to FX wars, to trade wars, culminating with "bond wars" which could in the span of minutes cripple the entire Japanese fiscal house of cards still standing solely due to the myth that unserviceable debt can be pushed off into perpetuity (as previously discussed here).

Not needing further explanation is the reality that should China commence a wholesale Japanese bond dump, it may well lead to that long anticipated Japanese bond market collapse, as creditor after creditor proceeds to sell into a market in which the BOJ is the buyer of only resort in the best case, and into a bidless market in the worst.

The immediate outcome would be soaring inflation as the BOJ is forced to monetize debt for dear life, buying up first hundreds of billions, then trillions in the secondary market to avoid a complete rout, matched by trillions of reserves created out of thin air which may or may not be halted by the Japanese deflationary gate, and which most certainly could waterfall into the economy especially if Japanese citizens take this as an all clear signal that the Japanese economy is about to be crippled in all out economic warfare with the most dangerous such opponent, and one which just defected from the "global insolvent creditor" game of Mutual Assured Destruction.

Further complicating things is that Japan has no clear means of retaliation: it owns no Chinese bonds of its own it can dump as a containment measure. Instead, Japan is at best left with the threat of damages incurred on the Chinese economy should Japan be lost as a trading parting.

Tyler's conclusion, to which I agree:

One thing here is certain: Japan picked on the wrong country when two weeks ago it "purchased" the disputed Senkaku Islands. If it thought that China would just forgive and forget with a wink, it was dead wrong.

It now has several two options: undo all that has happened in the past fortnight, in the process suffering tremendous diplomatic humiliation, leaving Senkaku in the "no man's land" where they belong, or push on, and suffer the consequences. And the consequences for the country represented by the question market in the chart below, would be tragically severe, as would they for the entire "developed", insolvent and daisy-chained world.

The world could literally collapse over some inconsequential pieces of rock in the South China Sea.

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10-Year Treasury Note Auction Result Is In

And judging by the market reaction, it is not good. Both stock market and bond market are sinking deeper.

I frankly don't know what the traders were expecting, for them to get disappointed like this. The key numbers of the auction is posted in the right-hand column, next to this post. (Here's the original announcement.)

Foreign participation was slightly better than the last auction, and bid to cover ratio is also higher than the last. What spooked the traders may be the yield.

Over 46% of the auction was allotted at the high yield at 3.99%.

In the last auction, only 22% of the auction was allotted at the high yield. Right before the auction result announcement, 10-year note yield was 3.94%.

Higher foreign participation demanding the higher yield for the risk they are taking.... Hmmm, it looks like bond vigilantes are intensifying their attack.

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Bond Vigilantes Are Back With Vengeance

Bond Vigilantes Confront Obama as Housing Falters (Bloomberg)

"For the first time since another Democrat occupied the White House, investors from Beijing to Zurich are challenging a president’s attempts to revive the economy with record deficit spending. Fifteen years after forcing Bill Clinton to abandon his own stimulus plans, the so-called bond vigilantes are punishing Barack Obama for quadrupling the budget shortfall to $1.85 trillion. By driving up yields on U.S. debt, they are also threatening to derail Federal Reserve Chairman Ben S. Bernanke’s efforts to cut borrowing costs for businesses and consumers. "

Who are these "bond vigilantes"?

"The bond vigilantes are being led by international investors, who own about 51 percent of the $6.36 trillion in marketable Treasuries outstanding, up from 35 percent in 2000, according to data compiled by the Treasury. "

"“The vigilante group is different this time around,” said Mark MacQueen, a partner and money manager at Austin, Texas- based Sage Advisory Services Ltd., which oversees $7.5 billion. “It’s major foreign creditors. This whole idea that we need to spend our way out of our problems is being questioned.”"

And what are they doing?

They've been selling the US Treasury notes and bonds, driving the yields up significantly. Compared to the levels in 1990's and early 2000's they are still very low, but 1990's and early 2000's the economy was expanding (last true bull market in stocks, measured by inflation-adjusted S&P500 Index - you can see it in here, and there are lots of other sites).

The charts show the yields of 5-year note, 10-year note, and 30-year bond in the past 9 months. 30-year bond yield is already back to pre-October stock market crash level.

The president of the US doesn't seem to care.

"Obama spokesman Robert Gibbs said the president is confident that his budget and economic plans will cut the deficit and bring down the nation’s debt.

“The president feels very comfortable with the steps that the administration is taking to get our fiscal house in order and understands how important it is for our long-term growth,” Gibbs said."

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