The next financial ticking time bomb


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While many eyes are focusing on Europe and America when it comes to the next financial crisis, one sector that people aren’t focusing on is the bond market in Japan. Many investors might not realize it, but Japan might be the next financial ticking time bomb..

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The next financial ticking time bomb

  1. 1. Next Financial Ticking Time BombBy Sasha Cekerevac for Investment Contrarians | Jan 9, 2013While many eyes are focusing on Europe and America when it comes to the nextfinancial crisis, one sector that people aren’t focusing on is the bond market in Japan.Many investors might not realize it, but Japan might be the next financial ticking timebomb.How does a financial crisis in the bond market affect the average person? On a basiclevel, the bond market prices move based on supply and demand, which affect interestrates. With greater demand in the bond market, this pushes up prices and lowers interestrates. A lower interest rate obviously helps prevent a financial crisis from occurring, as ittakes less money to pay off the debt—much like a credit card interest rate being reduced.Conversely, if investors are worried about their funds in the bond market, this will causeselling or a reduction in purchases, a decline in prices, and a rise in interest rates. Forcountries that have a large amount of debt, higher interest rates will cause a financialcrisis, as the funds available to maintain that debt are limited and could run out.Much like a person who racks up very high credit card debt, at some point the incomefrom the person’s job is not enough to make the minimum payment, let alone pay downthe principal. The end result is a financial crisis.Japan has a massive debt-to-GDP (gross domestic product) level of 211%, much higherthan America’s or even Greece’s debt burden. (Source: Trading Economics, last accessedJanuary 7, 2013.)Even though Japan’s 10-year bond interest rate is only 0.79%, a full 25.0% ofgovernment revenue is being spent to service its huge debt burden. If the bond market
  2. 2. lost faith in the ability of Japan to pay back its obligations, the bond market would have asharp selloff, and a massive financial crisis would ensue, certainly spreading globally.(Source: “The Greece of Asia Japan’s Growing Sovereign Debt Time Bomb,” DerSpiegel, January 3, 2013.)As it stands right now, the reason the bond market in Japan is so complacent is that mostof the money being raised is from domestic sources. However, Japan’s population isaging, which will necessitate redeeming funds, and the debt level continues to increase tosuch a level that external investors will be needed.I personally don’t believe that international investors would be willing to lend Japanmoney at less than one percent for 10 years when there are far better alternatives in theglobal marketplace.Once the bond market starts to feel the effects of international investors, this could be thefirst crack of the next major international financial crisis. There is no way Japan can copewith a weak bond market. While Japan is trying to prevent this by having the central bankprint money, at some point, this mechanism will stop working and investors will loseconfidence.Even the Bank of Japan Governor, Masaaki Shirakawa, freely warns, “If we don’t deliverfiscal reform, then the yield on Japanese government bonds will rise.” (Source: DerSpiegel, January 3, 2013.)Most Americans are unaware of the danger if a financial crisis were to begin in Japan.Many international markets are interlinked, with financial institutions predicated on theassumption that the global bond market has a certain level of stability.If a panic were to ensue in Japan, the third-largest economy in the world, this couldcertainly spread to every major developed nation, including America.The danger of a weak Japanese economy has emboldened voters into electing a newPrime Minister, Shinzo Abe, who has stated his intention of a massive stimulus plan.Reports are coming out from Japan that the Abe government will shortly announce a$136-billion fiscal package to help stimulate the economy and prevent a financial crisis.(Source: “Abe Seen Spending 12 Trillion Yen to Boost Japan’s Economy,” Bloomberg,January 7, 2013.)The bond market has begun taking increased spending into account as the 10-yearJapanese government bonds increased to the highest level since August 21, at 0.84%. The30-year government bond is now at a 13-month high, yielding two percent. (Source:Bloomberg, January 7, 2013.)
  3. 3. The Japanese bond market is still sanguine due to the nature of the constituents, namelydomestic investors, who are buying in this market. If the bond market continues toweaken over the next few years and interest rates rise substantially, Japan could begin tosee the same sort of financial crisis that many parts of Europe have experienced, namelythe inability to maintain and repay its debt, causing further panic in the bond market anddriving interest rates even higher.Due to the level of debt in the Japanese bond market and the extent to which financialinstitutions are interlinked globally, this situation could unravel into a massive globalfinancial crisis. Obviously, no one can predict the future; however, we should be awarethat there are potentially dangerous pitfalls for the global markets over the next fewyears.