Japanese Float Idea of the Treasury Selling Yen-Denominated Debt

We have been mystified at the utter silence on behalf of our friendly foreign funding sources at their willingness to be patsies to continue buying Treasuries when the outlook for the dollar is far from rosy. The US’s funding needs are going to escalate sharply due to the need to pay for rescue programs. And we certainly aren’t going to raise taxes anywhere near enough to cover the tab, which means we will be dependent on the kindness of foreigners. And they may not be terribly well disposed towards us when we aren’t importing as much as we used to.

Add the fact that currency debasement is the standard economic prescription for deflation, and you can see why our credit purveyors might be a tad concerned about taking on more dollar exposure.

Ah, but you may say, the dollar has been rising, these worries are clearly misgiven. Not so fast. The appreciation is due largely to unwinding of dollar-based loans. If you, say, made an investment in Eastern Europe and funded it in dollars, and now need to repay the loan. you will need to provide dollars, which means selling local currency and buying dollars. That activity on a mass scale is pushing the dollar higher.

Selling foreign-currency Treasuries isn’t a new idea; the US offered so-called Carter bonds, which were Deutschemark-denominated Treasuries, in the late 1970s.

What has been interesting is that even though this idea is obvious (and unless the trajectory changes, inevitable) our foreign creditors have not said anything of the kind in a public forum. Given how forward the Chinese often are, and how they seem particularly unhappy about continues dollar accumulation (even though their currency peg is the proximate cause), they have been surprisingly quiet on this topic.

Japan, interestingly, seems to be playing the heavy. That actually in a perverse way makes sense (and one wonders if there was some orchestration of these trial balloons with other foreign interests, particularly since Japan is trying to make nice with both the US and China). After all, if America’s good buddy and military protectorate is making noises about foreign currency Treasuries, it is hard to dismiss the idea out of hand.

From Asia Times (hat tip reader Chris):

Japanese economists, increasingly concerned that the United States might seek to pay its enormous and growing debt obligations in a weakened US dollar, are looking to the possibility of US Treasuries being issued in yen.

The US government needs to borrow at least US$1 trillion in the coming year, excluding the US Treasury’s $700 billion plan to bail out the financial and other industries, said Kazuo Mizuno, chief economist in Tokyo at Mitsubishi UFJ Securities Co, a unit of Japan’s largest publicly traded lender by assets. That amount is likely to grow as the US government continues to rescue failed parts of the economy and has to raise more debt – that is, issue overnment bonds, or Treasuries – to fund such rescues.

Since 2004, when the amount of the government bond issuance reached an annual average of $400 billion, 94% of new buyers of US government bonds have been foreigners, Mizuno told Asia Times Online.

One measure of the increased concern at the ability of the United States to finance its enormous deficits in the future is the rising cost of credit default swaps bought as protection of Treasury debt. These traded near a record high on Tuesday, with benchmark 10-year contracts on Treasuries increased to 42 basis points, or 0.42 percentage points, from around 20 in early September. The contracts have also risen from below two basis points at the start of the credit crisis in July 2007.

While it remains unlikely that the US government will default on its debt, a weaker dollar would ease the burden of payment on existing debt.

In the past few months, the US dollar has strengthened against other major currencies, with the notable exception of the yen, even as the country has been at the epicenter of the deepening financial crisis. That dollar strength is not expected to last.

“There is no wonder the dollar will weaken,” said Eisuke Sakakibara, Japan’s former top currency official and now a professor at Waseda University. “The dollar now looks strong for a technical reason. The money the US financial firms had invested in the world is being repatriated into the homeland, causing dollar-buying. But once this conversion into the dollars is done, the currency will head south,” Sakakibara said …

Faced with the unprecedented growth of the US budget deficit and the prospect of an increasingly weaker dollar compared with the yen reducing the value of Treasury debt held by Japan, economists in Tokyo are calling for the administration of president-elect Barack Obama to issue US Treasuries denominated in yen and other currencies…

“The US will be forced to issue foreign currency-denominated US Treasures in its hour of need,” said Mizuno. “The US cannot finance its deficit by itself. The US financial system cannot survive without foreign investors. We will see ‘Obama Bonds’ in the future.”

With the US owing increasing amounts to foreign nations, the confidence in US Treasuries continues to be shaken, said Masaaki Kanno, chief economist at JPMorgan Securities Japan Co in Tokyo, said. “This will push up long-term yields, and the dollar will be sold,” said Kanno, speaking at the forum in Tokyo on Sunday….

Looking ahead to 2009, foreign buyers such as Japan, China and other emerging market central banks are likely to reduce their holdings of US Treasuries rather than increase them, as their own countries face massive funding needs to buoy their economies at home and as America will continue to face financial instability and deteriorating economic fundamentals.

Japan holds the world’s second-largest foreign reserves, totaling about $1 trillion, following China, which has about $2 trillion in forex reserves, including some $600 billion worth of US Treasuries. Japan plans to provide up to $100 billion to the International Monetary Fund, which would reduce the nation’s holding of short-term US Treasury bills.

China on November 9 announced its sweeping economic stimulus package valued at about 4 trillion yuan ($586 billion), to be spent over the next two years. Market players are speculating China, to secure financial resources, would reduce its holding of US Treasury securities rather than increase them.

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  1. Richard Kline

    Let’s not forget that Japan continues to accumulate dollars as well as an inescapable function of its export-driven macroeconomic strategy. And unlike China, which has considerable potential to support growth through domestic stimulus, Japan is much more exposed to economic down draughts _even as it continues to accumulate dollars_. It is no surprise that it is Japan, not China, which is already in recession. With regard to trade and currency, China and Japan are _highly_ correlated, and so inherently aligned. Neither one alone could likely effect serious policy concessions from the US; but both together . . . .

    These statements are the follow-on from the failed G20 ‘hillock,’ not to call it a summit. It was my view that Pres. Dufus’ only goal was to block action by the rest of the world; he succeeded, as rather than show discord by disagreeing, they yawned and went home, to await the Liberal Messiah who may prove amenable to reason. Japan’s announcements look to start the spin on the next negotiation. China and Japan have no option but to continue to trade with the US, which means continuing to hold debt issued by Americans. It would be nothing but hard, good sense to begin holding increasing portions of that debt in their own currencies. —And those wouldn’t be bad terms if we can still get them, to me, so long as we keep an eye on the cumulating totals.

  2. a

    Tokyo to U.S. : “Here’s rope, go hang yourself.”

    Actually, though, foreign-denominated Treasuries shouldn’t be much of a help.The choice Japan faces: buy U.S. treasuries in USD and face inflation; or buy U.S. treasuries in Jpy and face the U.S. going bust.

  3. Anonymous

    Wow! Finally Okinawa military base will show its value, isn’t it? Some people is really, really exilarating.

  4. Anonymous

    China and Japan have no option but to continue to trade with the US, which means continuing to hold debt issued by Americans.

    Not true. They can demand payment in their own currencies or any other currency.

  5. thomas j

    Brad Setser’s examination of the TIC data makes it pretty clear that both China and Japan are, if anything, actually stepping up their purchases of Ts in lieu of buying Agencies. So the primary assumption of the Asia Times article is simply not borne out by the data.

    By the way I anticipate the process of deleveraging will take many years if not decades to completely unwind. So I would be very careful about jumping back on the short dollar bus.

  6. River

    The US could reduce the currency exchange rate risk for the Japanese by printing Yen denominated bonds but that begs the question; How will the US aquire the Yen to redeem the bonds at maturity?

    Would the Japanese be likely to loan the US Yen to redeem their Yen denominated US bonds? Maybe, but I think it unlikely.

    The Yen denominated bonds would be secure from dollar inflation (currency devaluation) while the Japanese would be at greater risk of receiving nothing for US Yen bonds in the case of US soverign default. Japanese held US Treasuries in dollars would likely be worth something, even in the case of a US Soverign defaut.

    I see this as an awkward ploy by the Japanese to move away from a US Dollar denominated world financial system. Perhaps this is a gambit to further talks about a new world currency arrangement?

  7. wintermute

    The US government issuing debt in foreign currencies brings huge risks too – for the debt bubble favouring political leaders.

    Lets assume that USG issue $200bn in YEN treasuries. However, before maturity the dollar has depreciated 30% against yen. A loss of $60bn has resulted. This is real-world money that has to be earned via exports. Iceland and Argentina know all about this scenario – as do all other countries running an external deficit. It is however a new feeling for the USG.

    This is probably good for the world economy as it forces fiscal discipline on the US. But everything seen so far from Bush, Paulson, Bernanke et.al is that a debt bubble is the model that needs preserving. It affords better “growth” for less “pain”.

    USG weakening the benefit of its reserve currency status means it cannot always print money to get out of its problems. For that reason we are unlikely to see foreign currency treasuries in any quantity – until (as mentioned) USG is forced to issue them when dollar treasuries become unsaleable.

  8. Anonymous

    Japan faces the prospect of a currency resurgence as the carry trade unwinds and investors flock to safety. The short term forecast for the YEN has to be that it will soar, while its US treasury holdings fall in value. How long this will continue in the face of an economic downturn is questionable, but it shows that Japan is having a problem with hedging against currency changes or more likely they are baulking at the cost of that hedging.

    I am guessing that this might have other implications as it spreads to the corporate world and to other countries. It also could imply that we will get a lot more currency volatility and corporate losses as currency hedging becomes too expensive. This currency hedging is currently acting as a bit of a prop to the US dollar so maybe this is just a friendly warning to the US.

  9. Anonymous

    This foreign financing problem all depends on what’s going to happen to the US current account deficit – not on how much the US Treasury requires. Nobody’s forecasting a big increase in the CA deficit – quite the contrary.

  10. ruetheday

    Borrowing in Yen would go down as the biggest financial mistake the US ever made. Having foreign debts denominated in a currency other than your own is the key prerequisite for a sovereign default and crisis. I don’t see us going along with this. I’m sure dropping a few hints about how maybe it’s time for Japan to start thinking about providing for its own military protection would shut them up pretty quick.

  11. Tom Lines

    Will foreign demand for US Treasuries be able to match the rising offer of them, whatever currency they are in?
    Russia’s foreign reserves are the third largest but according to the Financial Times they have fallen by a fifth in recent weeks, as oil and commodity prices collapsed and foreign investments were withdrawing. China’s exports also seem to be falling, so Beijing will have smaller currency surpluses to invest.
    The US can see its near future in the UK. The pound has fallen sharply since the bank bail-outs and the Bank of England’s cut in base rate. Now the Brown government is fending off Opposition claims that wider government deficits will lead to a full-scale run on the pound.
    How will the US finance its own budget deficit without either issuing non-dollar bonds (but could it repay them?), pushing interest rates back up, or just printing dollars and so creating inflation, even hyperinflation?

  12. Bob_in_MA

    Hey, if they float Yen denominated Treasuries, what do you want to bet there will be an ETF for investors here that will track it? The safety of Treasuries without the $ risk!

  13. Stuart

    B. Setser’s, well spoken analysis reminds me of so many other well written analytical reports that sub-prime was contained and its effects were limited. They all missed the point that, what is unsustainable, must end. The pace of US debt accumulation abroad is unsustainable. This cannot be credibly argued, irrespective of how well articulated evidence of actions taken to present day suggest the contrary and uphold the viewpoint of those who argue for a continuation of the status quote to perpetuity. Too much debt is accumulating by any measure. The status quo, Bretton Woods dollar hegemony must change.

  14. Anonymous

    “Bob_in_MA said…

    Hey, if they float Yen denominated Treasuries, what do you want to bet there will be an ETF for investors here that will track it? The safety of Treasuries without the $ risk!

    Excellent point!


    Mish seems to think that there will continue to be demand for US gov bonds, primarily from the banks who could simply hold them on their books and earn free interest from Uncle Sam on all the free money being thrown their way. I’m coming around to his thinking on this, which is contrary to conventional wisdom that if foreign buyers don’t show up to the auctions, we’re dead. Setser’s analysis of the TIC data suggests otherwise, but what do you think about Mish’s idea that US banks will fill any hole in demand for US treasuries?

  15. FGR

    it would be suicide for Japanese to let US issue in JPY. they have already trouble to issue their own debt (ie failed of illiquid-type JGB auctions, floaters & inflation-linked bonds despite them trading at a big discount ; discount of JGBs to the swap curve…)

    they dont want to have competitors.
    this wont happen

  16. hbl

    I wonder if a secondary objective of the Japanese, beyond offloading currency risk on the US, could be to slow the appreciation of the yen relative to the dollar in the near term?

    If the US government borrows in yen, I assume it would then be forced to sell yen to buy dollars, strengthening the dollar relative to the yen (until the bonds come due).

  17. Jesse

    Talk about beating a dead horse.

    Japan needs to hammer our a new industrial policy.

    Time for some fresh blood at MITI, in a manner of speaking. Put the knives away gentlemen.

    Its been a nice ride for the past forty years, but its time for a change.

  18. w

    What a joke. The two crack dealers who have artificially kept their currencies low to dominate manufacturing and destroy American exports now are a little upset that their little addict cannot pay for their drugs any more. Fine, issue debt in foreign currencies if China and Japan stop manipulating their currencies.

  19. David Merkel

    I’ve proposed this already. From my days of posting at RealMoney:

    David Merkel
    A Modest Proposal for Balancing the US Budget in the Short-Run
    1/9/2007 11:06 AM EST

    This is not meant seriously, but an easy way to balance the US Budget in the short run is to issue Japanese Yen-denominated debt. Current interest costs would drop rapidly, and the budget would balance.

    What’s that you say? What if the Yen appreciates versus the Dollar? The US has an ill-disclosed balance sheet, with many of its liabilities omitted, or merely disclosed as footnotes… Medicare, Social Security, the old Federal Employee defined benefit plan, etc., are all off the balance sheet. (And on the plus side, so is the value of most of the property of the government, as well as the present value of its taxation capabilities.)

    Leaving aside other things that are off-budget (e.g., Iraq, Katrina relief), borrowing in foreign currencies is just another tool that the Federal government can use to put off today’s costs off to a future date. It’s something that our government does well.

    Position: none, though I own TIPS, realizing that they are only second best to developed market foreign currency debt, and the US Labor department controls the CPI calculation…

  20. Lune

    How might this play out? I suspect when people begin to price in the expectation of long-term dollar depreciation into their calculation of treasury yields, the treasury will find that the interest rates it’s forced to pay for USD denominated debt is much higher than it would be for JPY or EUR denominated debt.

    How much of a spread the treasury is willing to bear in exchange for not having to choose the politically toxic option of foreign denominated sovereign debt is the real guess. As it is, JPY long bonds yield 2.5% while corresponding treasuries yield 4.5%. In other words, we’re already paying a 2% premium to keep our debt in USD (something the Yen carry traders currently take advantage of). Exactly how much of a premium are we willing to pay?

    All that said, I’m not sure the U.S. will take this option before exhausting a second option, namely currency controls. Many countries that have found themselves staring down the abyss of a rapidly depreciating currency and accumulating debts have gone this route (cf Russia in the ’90s, many Asian countries during the Asian crisis, etc.).

    While it’s certainly not a long-term solution in a country that runs massive current account deficits, it can provide some short term relief, albeit at long term damage to one’s reputation (and in the case of the U.S., likely irreparable). And our Government has been known to occasionally follow such shortsighted policies from time to time (cf. TARP, TAF, TSLF, short selling ban, etc. …)

  21. Stuart

    19:16 USD/JPY: Trades Lower After Minutes New York, November 19th. USD/JPY has traded through its low of the day after Fed minutes projected a 2009 growth rate of -0.2% to 1.1% and unemployment rising to 7.1% and 7.6%. This mixed with headlines that the equity markets have not reacted as sharply but banks and commodity stocks are lower. The ten-year yields are trading sharply lower with talk of central bank demand. Rumors are that the Fed is buying the long-end of the curve in order to get mortgage rates lower. USD/JPY is trading 96.10. Robert.Fullem@ThomsonReuters.com /rd

  22. S

    ruetheday said…
    The Japanese could go nuclear next week, thus I wouldn’t overplay the value of the US security blanket. There have been vocal calls for a more active defense, witness the JDF patrols of Korean fishing boats, the tussle with China over the islands and the participation debate in Afghan/Iraq.


    How do the Fed swaps play into this? ed has put massive swap lines in place and has said that this could become a permanent fixture. Might this be used as the hose to wash the money through? Like a big money laundering oepration.

    As for Mis and the banks arbitrage. This sounds like the same argument peopl;e made in 2006 as for why house prices will not go down. indeed there was a HArvard chap who wriote it was becasue of regulatory arbitrage. The treasuryt market is to 2008 what subprime was to late 2006.

  23. Anonymous

    it would be suicide for Japanese to let US issue in JPY. they have already trouble to issue their own debt

    Ummm… 30 year Japanese bonds are yielding 2%. They are having difficulty issuing debt? I wish I could borrow at 2%.

  24. aj2006

    Why the USD is going higher

    1. Assumption: 50-60% foreign participation in treasury securities must abate…
    Response: Why? what other asset that central banks own has performed nearly as well? Why are they selling? What are they buying instead?

    2. Assumption: $1.5-$2trn in treasury issuance will overwhelm demand…
    Response: Capital markets are CLOSED…Corp issuance and pvt mkts are shut (how many non IG-credits are pricing?) so capital allocated to fixed income will move accordingly..
    3. Improvement in crude component of CA deficit worth about $450bn at $50 vs $150 oil
    4. The US consumer DID save at one time and will do so again. Losing your home (and tighter credit + lighter 401k) will do it
    5.How many who disparage the USD predicted it’s recent rise? In my world, those who are consistenly wrong get eliminated (unless you’re Abby Joseph Cohen)

  25. Anonymous

    The US is just Matt Demon!

    Matt Demon!

    Matt Demon!

    It never listens to voices of the rest of the world.

    Matt Demon!

    Go and do it in your way. But in the near future, no one wants to trade in the dollar…Just you!

    Matt Demom!!

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