Japan Sells Foreign Reserves For the Third Straight Month
Japan’s Ministry of Finance (MOF) announced that Japan sold another 3.5% or $43.4 billion worth of foreign reserves in October.
October represents Japan’s second largest foreign reserve sell-off ever following the September sell-off of 4.2% or $54 billion. The sell-off is the largest Yen-buying, Dollar-selling intervention the Bank of Japan has ever done.
What is Happening?
Japan is the third largest economy and has a severe printing addiction. Japan has printed so much money that it has been doing yield curve control since 2016. Yield curve control is a blank check policy to buy as many bonds as necessary to keep interest rates at a fixed rate. Japan’s goal is to keep interest rates between -0.25-0.25%, so Japan will buy as many bonds as necessary at any price to keep the interest rate stable. Japanese yield curve control is a looser policy than American quantitative easing.
The quantitative easing used in the U.S. is a very loose monetary policy as the Fed buys a specific number of bonds monthly and keeps interest rates low. Yield curve control is a manageable policy during periods of low interest rates, like the last decade. However, when the pendulum swings the other way and rates rise like now, yield curve control is poison in the well.
There is an investment axiom that says, "money flows where it is treated best." It is essential to understand the basics to understand how this applies to Japanese bonds. Japanese bond investors have been receiving around 0.25% interest on ten-year bonds. At the time of writing, the U.S. ten-year note pays 3.854%. Which yield would you rather have? Japanese bond investors are not unique and will allocate their money where it is treated best. As one would expect, Japanese bond investors sell their bonds, usually for a profit, and immediately put the money into U.S. 10-year notes. For Japan, it is the worst possible scenario.
For Japan to maintain the yield curve, it must pay whatever price the market demands and buy every bond. Buying all issued bonds is a costly venture. If Japan had the cash to buy the bonds, Japan wouldn’t have needed to sell the bonds in the first place. Japan has a growing liquidity crisis to satisfy its bond investors. Japan is selling its foreign reserves to get the cash needed to buy its bonds and prop up the Yen. The situation began in March when the Fed began raising interest rates. As the Fed aggressively raises interest rates to quell inflation, Japan’s liquidity situation becomes increasingly precarious.
Japan has been a frequent discussion on this blog. On April 26, I warned Japan would have a liquidity issue requiring it to sell its treasuries to pay its bond investors.
“Since Japan will not be able to sell bonds, they will only have three options: continue printing, raise taxes, or liquidate assets from their balance sheet. There is a 100% chance they will keep printing, but that is not working anymore. Raising taxes will be the last resort. This leaves selling assets to raise capital. It is speculation which assets they would sell, but one BOJ option to fund their yield control is to sell or trade U.S. Treasuries to pay bondholders. The BOJ currently holds 1.3T worth of Treasuries.
It is pure speculation that Japan would liquidate their Treasuries, but it is a scenario we should consider. Treasuries and gold are both considered cash equivalents and will be attractive options to pay for their yield curve liquidity crisis. The BOJ will want to use paper assets before their tangible precious metals. My assessment is that there is at least a 40% chance Japan will eventually liquidate a substantial amount of Treasuries to cover its liquidity liability. Depending on how many they liquidate, it could significantly pull down the international bond market within a handful of months. If it is not Japan's debt problem unraveling the international bond market, it will be something else that leads to a massive market sell-off. With so many crises happening in so many places, the dollar and stock market both seem to be very vulnerable to a massive, systemic market revaluation.
When I wrote those words, the Fed had only made one interest rate hike of 0.25%. Since then, the Fed has aggressively raised rates five more times for an additional 3.5%, and Japan’s liquidity crisis is on full display. Japan began selling treasuries rapidly after the fourth-rate hike in July when interest rates rose to 2.25%. (Side note: The Yen has 11.03% less purchasing power against the dollar, the stock market is down about 17%, and bonds are down about 10% since that article was published.)
So, what is the problem?
The Federal Reserve and the Bank of Japan are the two largest purchasers of U.S. Treasuries. The Fed is selling treasuries to remove cash from the system to fight inflation, meaning the two largest buyers are now sellers of Treasuries. The U.S. operates on a deficit and funds the government with Treasury-issued debt, i.e., Treasury bills, notes, and bonds. The Treasury will still try to sell Treasuries as well. Many Treasuries are flooding the market by three huge players with different and opposing agendas. The BOJ wants to defend the Yen. The Fed wants to bring down inflation, and the Treasury wants to fund the government. It is a strange market scenario like trying to predict a three-person boxing match. There are too many variables to calculate the exact outcome, but it will be brutal. The obvious question is, who is going to buy all the Treasuries? Will Americans be forced to buy them? Probably, but not yet.
The chart above shows the monthly buyers and sellers of Treasuries. There are still several net buyer countries, but they are not buying anywhere near the recent influx of Treasuries into the market. The rules of supply and demand say prices go down when more goods are in the market than dollars chasing those goods. Treasuries are no different. Prices will go down on Treasuries, but yields will have to go up to attract buyers. The situation will turn from bad to worse when this happens. Remember, money will flow where it is treated best. If government bonds secured by a printing press and the U.S. military yield, say, 10% and corporate bonds yield 6%. The corporate bonds will need to increase their yield accordingly. The government will raise taxes to prevent liquidity issues. Bing, bang, boom, and corporate profits drop significantly, and there is another wave of market crashes. The problem with a paper-based economy is that a bit of fire in the market burns it all away. Precious metals don’t behave like paper. If you heat gold to its melting point, it will still hold the same value. Try that with a Dollar bill and see how much someone will give you for its ashes.
There is no gentle or easy way to be blunt. However, if you appreciate honesty, this is for you. Numbers don't lie. Things will get worse before they get better. It may be years before the economic dust settles. Whether or not you do anything to protect yourself, there is unimaginably severe economic pain coming. It could come today or five years from now, but it is coming. Your life savings, retirement accounts, and legacy are all in harm’s way. The number one-way people have protected themselves throughout history is through tangible assets like precious metals. The truth is that you have a choice to listen or ignore the warnings. You can be an ostrich or a lion, but lions don't put their head in the sand to pretend nothing bad is happening.
If heeding warnings makes sense to you, call the U.S. Gold Bureau before it's too late. If a cataclysmic economic event occurs, most unprepared people will panic since they don’t have a plan. They will simultaneously try to get precious metals and probably not be able to find any. Inventories are already tight due to global challenges. In that scenario, the demand will significantly outpace supply. If someone could find precious metals, it would be the worst time to buy them. A time is coming when people will need precious metals to buy a new currency. I could be wrong about buying a new currency. Still, seven months ago, I told you Japan would sell its Treasuries before it happened. Do you want to risk it? Would you rather have gold and not need it, or need it and not have it? We will know your answer by what you do next.
Call the U.S. Gold Bureau Today.