90 seconds at 9 am: Gigantic bond losses

China pushes for replacement TPP; China local authority debt emergency; Japan GDP growth surprises higher; huge bond market losses; UST 10yr yield at 2.21%; oil lower, gold down; NZ$1 = 70.8 US¢, TWI-5 = 75.8

15th Nov 16, 7:35am by David Chaston

Here's my summary of the key events overnight that affect New Zealand, with news of enormous losses in the bond markets.

But first, China is pushing ahead with its drive for more regional free trade deals that will include New Zealand. The US promoted TPP may be dead, but Beijing said it plans to finish by year's end negotiations on the Regional Comprehensive Economic Partnership (RCEP), which is a trade agreement between ASEAN, China, Japan, Korea, Australia, New Zealand and India. And it has flagged a more ambitious and broader Free Trade Area of the Asia Pacific (FTAAP) as "core" to it's agenda and said Australia and New Zealand are countries making efforts to advance this deal. The FTAAP negotiations are coordinated by APEC, whose boss is our own Alan Bollard.

Staying in China, they have adopted emergency measures to deal with risks from burgeoning local government debt levels. Meanwhile data out overnight showed China's retail sales up +10% in October, and factory production up +6.1%. Both data series were flat or lower than earlier months.

In China, the numbers are always big. New home sales growth slowed in October from a year earlier, suggesting the push by policy makers to rein in runaway prices is getting traction. The value of homes sold rose +38% to US$138 bln last month from a year earlier, according to data released yesterday. The increase compares with a +60% rise in September. China's property infatuation is getting crazy.

And here's an interesting and disturbing Chinese fact - half the Chinese population is pre-diabetic, and one in ten have it, almost exclusively type-2 diabetes.

According to data released overnight, Japan's economy grew by an annualised +2.2% in the third quarter of this year. This was much better than the expected +0.8%, but it does little to alter downbeat assessments of Japan's domestic prospects, with much of the momentum coming from overseas demand. Indeed, net trade contributed 1.8 percentage points to quarterly annualised growth, with export volumes rising and imports falling in spite of the strengthening yen. Meanwhile, recent efforts to kick-start the domestic economy continue to disappoint, with both consumer and business spending lackluster.

In New York, the UST 10yr yield has now reached 2.21%, another sharp rise. Bond markets are doing it very tough and these sharp increases in yields translate to sharp fall in bond prices. So far its a US$1 tln loss, and counting. Some Kiwisaver conservative and default funds will be under real pressure. Our wholesale rates rose also sharply yesterday and may get another push up today, especially at the long end.

The US benchmark oil price is lower yet again, down -US$1 and is now just over US$42.5 a barrel, while the Brent benchmark is on US$43.50 a barrel. We haven't seen prices this low since July.

The gold price is lower ast well, down another -US$7 to US$1,218/oz.

The New Zealand dollar will start today lower than this time yesterday, at 70.8 US¢. On the cross rates it is now at 94 AU¢, and against the euro at 66 euro cents. The NZ TWI-5 index is at 75.8.

If you want to catch up with all the local changes yesterday, we have an update here.

The easiest place to stay up with event risk today is by following our Economic Calendar here ».

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29 Comments

by Chris-M | 15th Nov 16, 9:08am 1479154126

Japan GDP growing by 2.2%, population falling by 0.2% per year, no pressure to spend lots of money on housing and infrastructure, 3% unemployment, real wages dropping, public debt 230% of GDP and rising strongly, record corporate profits, record exports but falling industrial production, strong persistent deflation. It is an odd set of circumstances.
Clearly their debt is a huge and worsening problem. How much longer can they go on like this?
People are not spending because their incomes are falling and they are having to eat into their savings.
As ever their exports are strong while their internal economy languishes
It looks to me like they need a shake up and restructure in they way their internal economy works. This is consistent with what I observed on visits quite some time ago so they have obviously not made much progress in this area. I imagine that their strong culture is a barrier to this.

by David Chaston | 15th Nov 16, 9:43am 1479156210

The one "positive" thing about the Japanese debt is that it is substantially internal. That is, the Japanese government owes the Japanese central bank and other Japanese banks and people. It is the sort of debt that can be ultimately sorted out by a simple journal entry. The liability to external parties is relatively low, and that portion is easily covered by their current account surplus.

The problem is for foreigners. Some of that massive Japanese debt monetisation leaks out of the country as cheap funding, essentially exporting deflation. Remember, Japan is the world's third largest economy, so policy there impacts many of its trading partners, just like the US and China.

by Roger Witherspoon | 15th Nov 16, 9:59am 1479157198

Nice one David, why so many commentators who should know better think that Japanese debt owned by the central bank is not owned by the government beats me. It is just debt that has been paid off but not cancelled and could in theory be resold.

by Roelof | 15th Nov 16, 11:32am 1479162769

Its basically the monetization of a Govts debt.... The stuff of history and past civilizations..

I'd never thought I'd ever witness it in my lifetime!!

Equally amazing, for me, has been the growth in Money supply and credit in China.
It has been and is... mind blowing..

This is all a little alice in wonderland... for me.

by scarfie | 15th Nov 16, 11:54am 1479164081

Not enough questions are being asked about this, even Richard Duncan who talks about debt cancellation doesn't follow the dots far enough. I will have to think about the Japan case a little more, but this debt cancellation is still resulting in the consumption of resources. The government pays it workers, who all have to eat and buy stuff. If you want to know the outcome follow the resources, not the proxy that is debt or money.

When people are having spend savings, that is the resources they hoped to consume in the future. What happens when the savings run out? Savings really being just a liquid asset, so for accuracy it is people spending their assets to survive.

by Roelof | 15th Nov 16, 12:30pm 1479166230

When u debase a Currency....everyone ends up paying for the consumption of those resources.
( The only beneficiary...who pays nothing...is the Govt )

When a squirrel runs out of nuts...he has no choice... he has to get to work..!!... or steal nuts from others..!!

by Stephen Hulme | 15th Nov 16, 11:57am 1479164236

If that is the case, the Bank of Japan could simply extinguish the bond asset (government liability) currently offsetting the stagnant credit liabilities owned by the institutions that delivered the sovereign securities under QQE in exchange for the later.

by Roelof | 15th Nov 16, 12:26pm 1479165998

Much simpler to call .... " the stagnant credit liabilities" .... , "Money".. ( kept under the mattress..?? )

by Stephen Hulme | 15th Nov 16, 12:47pm 1479167238

I don't think so - bank liability ledgers are generally not convertible into what some may call money (currency). The bank ledger liability base in NZ is currently ~$423 billion, circulating currency ~$5.5 billion.

A full part of the reason for all that is simple and clear, as Fisher also grasped in his speech with his usual dramatic flair. Interjecting Charles Dickens, he recalled Dickens' apt description of insurance, "A person who can't pay, gets another person who can't pay, to guarantee that he can pay." But where Fisher only uses that simplified truth in limited circumstances as he saw them then, it counts for the entire monetary basis that we see both then and now. In other words, what Dickens admonished of insurance had been turned into the very basis for the world's reserve currency. As China's PBOC Governor Zhou Xiaochuan correctly pointed out at almost the same time, the world had been not on a dollar standard but a credit-based dollar standard; everything of the past decades is contained within that single distinction. Or, paraphrasing Dickens, a bank that has no dollars, gets another bank that has no dollars, to guarantee that everyone has dollars. Read more and more

by Roelof | 15th Nov 16, 1:18pm 1479169083

Maybe I misunderstood..

I thought u were referring to the money the JCB created to buy Govt Bonds from those institutions..???

by Stephen Hulme | 15th Nov 16, 4:34pm 1479180858

Yes I was, but the US hosts the world's credit based dollar reserve standard which is emulated globally as a derivative in other jurisdictions. Access to Japanese publications explaining the same are not readily available to me. A central bank is what it is - bank to a nation's banks.- it employs the same ledger balance principles, hence the Bank of Japan QQE government bond purchases act as collateral to the permanent loans made to the domestic banks. In the US (possibly Japan) they also act as a funding source for IOER paid to the banks.

by Roelof | 15th Nov 16, 3:53pm 1479178419

Ok.... Then I think my analogy is ok...

In my view reserves held in a Banks' acct with the JCB.... is as good as cash..
Credit is a claim on money and in that regard , even thou the ledger balance principles are the same, there is a Big difference between a Central Banks Balance sheet and that of one of the Private Banks..
( I know money is a Central Bank liability on their balance sheet... BUT ..that is just an "accounting convenience ".... in the same way that a counterfeiter would have to show his "money creation" as a liability on his balance sheet... In terms of common sense, there is no liability ..its a little absurd.... )

by Stephen Hulme | 15th Nov 16, 4:45pm 1479181555

There is no money in central bank ledger liabilities - domestic banks cannot convert them to vault cash (currency) and sovereign nations do default - the US did as much when it came off the gold standard.

by Roelof | 15th Nov 16, 5:24pm 1479183898

domestic banks cannot convert them to vault cash (currency)

They can simply "write a cheque" against those reserves.. ( as good as cash )

As far as I know ..US has never defaulted on fiat paper money... It tends to be the people who repudiate fiat money..
( money that is a claim on gold is a different subject )

If Central Bank liabilities are not $ Dollars.. then what are they..???

by Roelof | 15th Nov 16, 5:48pm 1479185289

Technically... Banks could convert reserves into cash.... it is feasible
But practically... that would never happen.... it is unrealistic.... just a little !

https://www.newyorkfed.org/aboutthefed/fedpoint/fed01.html

by Stephen Hulme | 15th Nov 16, 9:22am 1479154952

US military oversight in the Pacific subordinates economic considerations?

Key said he would raise the TPP with Trump.

"I will say to him 'look, if you take a step back, I think that TPP was very much about US leadership in the region'. I still strongly believe the United States still gains more than it actually gives from free trade and I'd urge him when he gets a chance to sit back and get some advice on how we might be able to progress it." Read more

by Chris-M | 15th Nov 16, 11:07am 1479161272

I feel very apprehensive about being reliant on trade deals with either China or the USA. They are both bullies and tending to charge about like out of control elephants, particularly at the moment. Any thing could happen with them and I would prefer not to be stomped in the melee. I would prefer more equatable trade relationships with more moderate and smaller partners.

by Roger Witherspoon | 15th Nov 16, 9:56am 1479156973

There is a point of view that free trade deals are irrelevant for small economies. Big economies need them but small ones do not. I will see if I can find the link....

Aha. Got it, Prof Minford:
https://www.youtube.com/watch?v=leKEUT1TiLU

by Chris-M | 15th Nov 16, 2:47pm 1479174477

Thanks for that Roger. Excellent discussion. On that basis we were best placed before we started signing trade agreements because being a small totally free trading nation, our export production would be steered toward what other nations really want and are prepared to pay top dollar for. The negative effect of trade agreements is clearly crystallized by Fonterra hijacking most of our milk production to supply our close trade partner China with a low value commodity. The best example of a small nimble free trader is Tatua making high value products that customers are prepared to pay top dollar for and in the process return the farmers a very high payout. So in going down the trade agreement path our governments have taken the easy way out that enables our exporters to sell low value products without putting in the effort of moving up the value chain. We seem to have had the view that we should have a right to sell low value commodities and that it isn't fair that counties resist this with tariffs, trade deals are a way around this. Unfortunately all that this does is make it easier for us to remain a low value producer. I think that I disagree with him when he says that tariffs only hurt the countries applying them. They do effectively stymie free trade and I think that highlights a distinction that was not made in the discussion. Trade pacts with tariff barriers as per the EU are bad, but a purely free trade deal must surely do some good. Trouble is that these deals we seem to be headed toward may not be free and open.

by workingman | 15th Nov 16, 12:50pm 1479167441

I strongly agree, Roger and Chris-M. These ideas deserve a hearing. If you're producing, and trying to sell, things which bring no strong value-differentiation with them, you need to similarly flatten all trading barriers. Basically, because your products have no demand profile - and, crucially, no congruent strengths in price and margin - to carry them over the fences. And the linked flattening of trade barriers and flattening of producer-customer value describes our trade policy, our commodity economy thinking and our commodity exports. The result is a flattened national economy.

Imagine if we had a grape marketing board, stuffing low-value grapes into cardboard boxes, instead of a wine industry. In effect, that's the level that a host of sectors operate to. And there appears to be no leadership to move us out of this position. Instead we go round the world looking for the next lot of commodity buyers.

by Roger Witherspoon | 15th Nov 16, 1:11pm 1479168711

It is an interesting area. I thought Prof Minford's arguments were sound. It is as if we are talking about the wrong things, that we don't have the right intellectual tools to figure it out. When is free trade just exporting jobs? What are the really crucial things to watch out for? We are still running a sizeable current account deficit so they clearly don't deliver as advertised. I can't help thinking we are being outwitted.

by workingman | 15th Nov 16, 1:42pm 1479170532

Roger, I think we do have the intellectual tools. And, in a micro-environment like ours, it's possible - or should be possible - to be flexible in changing or adapting one's direction according to need or opportunity. As the saying goes, you may not be able to out-spend your competitors, but you can out-think them.

But against this, in my experience or understanding, there are several barriers to capturing new available value. One is low ambition (is this linked to low self-worth? to some doubt as to our New Zealand calibre in fields other than sport? I have no idea). I also see producers - farmers, horticulturalists, etc - anxious that others in their sector should gain no advantage over themselves, and afraid of the investment involved in developing longer-term or added value. Then, there's capital availability and the will to capital deployment. We don't, as a nation, invest sufficiently in business.

And, finally (in my top of mind anyway, although there are doubtless other considerations), we're used to thinking cost-plus, not value creation. There are only two things you can do for a customer - you can either try to save them money, or you can try to deliver increased value. The first may look easiest, but in a global trading framework, you're on a hiding to nothing.

Yes, we are being outwitted. Not because we haven't got the wits to succeed, but because we're not using them.

by KH | 15th Nov 16, 3:39pm 1479177542

Good stuff workingman. Alongside that we also need to make sure we continue to own our work. Remember that the ultimate benefit always flows to the owner. One thing we have done in past decades is sell off the productive stuff. Dumb.

by David George | 15th Nov 16, 10:27am 1479158828

It appears that China did threaten sanctions against our exporters to try and prevent any action from us over steel dumping and quality issues. "Our" government tried to cover it up at the time (a huge worry in itself) and the Chinese "coincidentally" blocked a ship load of Kiwi fruit on some fabricated quality issue.
So we've got the other party to our FTA blackmailing us and our government quite happy to throw Kiwi workers and businesses under a bus to curry favour with said blackmailer. Am I the only one that finds this deeply concerning?

by Alter Ego | 15th Nov 16, 3:12pm 1479175944

No, you are not the only one. Kiwidave.

I do not think they were "our" little Government. Certainly not mine.

by two otherguys | 15th Nov 16, 10:10am 1479157840

Hello Immigration NZ - NZ Health Services - Future NZ disability welfare

"Interesting and disturbing Chinese fact - half the Chinese population is pre-diabetic, and one in ten have it, almost exclusively type-2 diabetes"

by Ergophobia | 15th Nov 16, 3:30pm 1479177012

In a roundabout way, NZ is getting back fontera's fat.

by Boatman | 15th Nov 16, 4:02pm 1479178942

Wow , no offence intended , but you have go to hand it to the Chinese strategists , they are quick :-

To spot a risk that creates and opportunity
To spot an opportunity that slots in nicely with its self interest .

Trump is clearly seen as a risk to their trading interests , and they have picked up on this instantly

by gingerninja | 15th Nov 16, 8:20pm 1479194404

That is clearly the fine art of contingency planning on the part of the Chinese. Something completely absent in British politics.