Keeping a Close Eye on the Japanese Bond Market

Nothing much to report from the markets. The Dow gained 28 points yesterday. Gold lost $6. The dollar was weak…as was the bond market.

The Fed came out with a report from its regional banks. Almost all the indicators showed a slowing economy. Not that we’re headed into a double-dip. We haven’t even gotten out of the first dip yet. Here’s Bloomberg with the news:

Banks: ‘Widespread Signs of a Deceleration’ in Economy

The Federal Reserve said the US economy maintained its expansion while showing “widespread signs of a deceleration” in mid-July through the end of August, according to a survey by 12 regional Fed banks.

‘Major Disappointment’

The report is “a continuation of the view that was discussed at Jackson Hole that the chairman put forth,” John Taylor, an economist at Stanford University and creator of an interest-rate formula used by central banks, said in an interview on Bloomberg Radio. “It’s not a double dip, it’s not another recession within a recession. But it is a major disappointment in terms of a recovery.”

The regional survey, known as the Beige Book for the color of its cover, offers anecdotal evidence that will help central bankers determine whether more stimulus is needed to reduce a jobless rate stuck near a 26-year high and protect a recovery from the deepest recession since the 1930s. The policy-making Federal Open Market Committee next meets Sept. 21.

President Barack Obama, speaking in Parma, Ohio today, said he recognizes that the recovery has been “painfully slow” and called on Congress to enact measures to cut taxes for businesses and middle-income Americans while letting rates rise for the wealthiest.

Home sales declined in recent months, the Fed said.

Probably the most often asked question in the financial world now is: when is the bond market going to crack? If the economy really were gathering speed, however slowly – as the Fed insists – you’d expect a rise in inflation…and a fall in the bond market.

Practically everything is connected to the bond market. If bonds crack the dollar won’t be far behind (or ahead). If bonds crack there will be one heckuva lot of money looking for a new home. Where will it go? Gold? Commodities? Stocks?

Yep. Probably all of those things.

Bonds are a “risk off” investment. You buy them when you’re afraid that the economy may not recover quickly. You buy them when you suspect that the “risk on” investments won’t turn out so well. Bonds are a retreat…a safe house…a bolt hole…where you can wait out a bad spell in the market.

But wait? Could this be a scary movie? Could investors be like a young couple taking refuge in an abandoned house in the woods…and then discovering that the place was not completely abandoned?

Is there a maniac loose in the bond market?

Well, yes…in a manner of speaking…

We’ve been meaning to warn you.

You’re probably sick of hearing it, dear reader. We’ve been saying it off and on for the last ten years. The US is following in Japan’s footsteps. It will stay in Japan’s tracks – in a long, slow, soft depression – as long as it can.

Not only that, but America’s financial authorities are doing the same thing the Japanese did. And they’re getting the same results – a nation of zombies.

Japan has been in a slump for 20 years. But the worst is still ahead. So far, they’ve been able to cover their stimulus budgets with the savings of their long-suffering people. But now, the deficits are bigger than ever…the debt is the highest in the world…and the people are becoming zombies too. That is, they’re retiring…and expecting to live at the expense of the government.

Only trouble is, the government spent all their pension money.

And now the Japanese will have to borrow from…from whom? That’s the funny part…there isn’t anyone.

The public sector bailed out the private sector. Now, who’s going to bail out the public sector? No one. It’s going broke.

Not a big deal, as far as we’re concerned. But we wouldn’t want to be holding a huge pile of Japanese Government Bonds (JGBs) when the issuers go belly up.

That’s why our modified trade of the decade has us selling JGBs and buying cheap, Japanese small-cap stocks. We’re not so sure the stocks will work out as planned, but we’re confident about the JGBs. If they don’t crack before the end of the decade, we’ll eat our hat.

And guess what? The US bond market will crack too.

We’re on record. The Daily Reckoning says the bond market will crash. But not any time soon. The Japanese managed to keep digging themselves a grave for a long time. We’ll do the same – most likely.

Investors will get even more comfortable with bonds. They’ll settle in…like the young couple in the “abandoned” house. They may even start foolin’ around. Having fun. Making money as bonds rise and yields fall.

But beware. There are maniacs on the loose. And zombies too.

Don’t go down into the basement!

Bill Bonner
for The Daily Reckoning