JAPAN: BLUFFING IN THE BOND MARKET

Written by Michael Thervil

Japan's Finance Minister Katsunobu Kato Photo by REUTERS/Issei Kato

The question that needs to be answered is why wait to see what Trump Administration does regarding trade tariffs when countries like Japan who hold over $1 trillion dollars of U.S. Bonds have the power to stop President Trump's tariff war in the palm of their hands? If that’s not enough leverage, there is China who holds roughly $765 billion in U.S. Bonds and has to ability to add a combined $1.865 billion worth of additional pressure on the Trump Administration to stop their trade war on the global economy. Again, what’s preventing countries like Japan and China from executing such a move.

Even though China has become the most dominant player in global trade, it’s also been in the process of decoupling from America and not the other way around for at least a decade. Geopolitical pundits speculate that because China is in the business of doing business, they themselves are just not ready at this point in time to absorb the financial blowback that would be sure to follow the fire sale of American Bonds. The current bet is that China will seek to invest more heavily into gold as a counterbalance. In the case of Japan, if they decided to dump U.S. Bonds off in a fire sale, they would have played their greatest and last hand at the geopolitical crap table. This would put them in the position to be at the mercy of America and all its retribution towards Japan.

If you're wondering what a “Bond” is, it is nothing more than a debt instrument that countries can sell as a sort of “IOU” (I owe you). In short, buy that country’s debt and they promise to pay you back. Put another way, it's another way to rob Peter to pay Paul only instead of it being a person-to-person transaction it is a county to debt buyer transaction. If the largest holders of U.S. Bonds were to liquidate (sell) their bonds in a fire sale liquidation, then that would result in a significant decrease in bond prices thus, significantly increasing the yields.

When this happens this causes the borrowing cost for a government to massively increase, with a trickle-down effect that negatively affects a country’s consumer (you). With countries being so intertwined in the global market, that same negative trickle-down effect will ultimately affect them too. This is why China hasn’t necessarily engaged in the mass selling off of U.S. Bonds. In the aftermath of the global blowback that would occur, the liquidation of the U.S. (or any countries) Bonds would increase the number of Bonds for sale from the host country in circulation, when that happens it cheapens the Bonds, making them less valuable and harder to sell. When that occurs, the revenue that a country like America would have made would no longer be in the same capacity and it would make it harder for America to pay down its budget deficit.

This would leave America in the place of having to hike up interest rates on the issuance of new Bonds and a decline in the faith of the U.S. Dollar. But our bet is that if Japan and China were to go the finically nuclear route and massively sell off their Bonds, America wouldn’t have enough money to pay back out on those Bonds. If Japan and/or China took this route it could spell out “mutually insured destruction” (M.A.D.) of the entire global market. The bet amongst both geopolitical analysts and financial gurus is that neither Japan or China will execute such a financially devastating move. For Japan, it would be the last hand they will ever play and for China they would be distracting themselves from conducting business as they typically do by watching the collective finical suicide of their country and others.