May 25th, 2014
in Op Ed
by EconMatters, EconMatters.com
There has been a trend of late to compare European and Japanese Bond yields to that of the United States and England so I think it necessary to define some large flaws in these comparisons.
Japan Comparison Let us start with Japan, Japan has an aging demographic, little immigration, very limited natural resources, and have not been a major player in anything other than heavy industry specific nuclear applications and autos since the mid-1980s. In fact, Japan has been on a steady decline since the 1980s, and mind you the world hasn't been on a steady decline since the 1980s in terms of many of the industries that Japan once dominated like technology, South Korea has taken over the Pacific-Rim mantle in technological innovation where Japan once reigned supreme. Plain and simple, Japan just got old and became outdated and uncompetitive in most areas of technological advancement and innovation that were so prominent during their glory days of the 1980s era. Further Reading - Debt Crisis: Forget Europe, Check Out Japan
Let's juxtapose this with the United States who has a very vibrant demographic because of immigration both skilled and unskilled, an abundance of natural resources, and major players in energy, entertainment, technology, agriculture, financial markets, engineering, and architecture. Furthermore, the US is actually not on the decline in any of these areas but still very innovative and relevant, and may even be on the rise in areas of energy and manufacturing which have been areas of outsourcing for decades.
To compare Japanese bond yields in order to justify an argument for US bond yields staying historically low once the Federal Reserve is completely out of the bond buying business is a failed comparison. Japan wishes they could wake up from their demographic and cultural malaise and have the US future from a competitive and opportunity standpoint. Shoot Japan with all their nuclear troubles would love just to have our natural gas reserves. Further Reading: The Worst Risk/Reward Trade on Wall Street
America Still the Land of Opportunity
For all those who downplay America's bright future and how the American Dream is dead, there sure are a lot of people around the world who want to immigrate to the US because it offers some of the best opportunities for those individuals motivated to achieve through hard work and creativity. This goes for skilled labor, unskilled labor and all levels of the social economic scale. America truly does offer a relatively high quality of life, and many types of opportunity.
For example, the guy who installed our big screen TVs doesn't have a college education, speaks less than stellar English, but probably makes over $250,000 net per year because he identified a market need, had the skillset to be efficient at supplying that need, and yes he wasn't born here in the United States.
The US still is the land of opportunity for those willing to work for said opportunity, and strive to better themselves. And our bond yields will reflect this fundamental difference between the US and Japan once the Federal Reserve normalizes monetary policy which they are in the process of undertaking. There is no comparison whatsoever between the US and Japan, and this short-sighted and uneducated view is patently false.
This brings us to the European comparison, Europe has seen a slow growth to slightly negative growth, mature region for decades - this is nothing new for these countries as they have never had pro-growth capitalistic business underpinnings, and their economies have reflected mature, steady mere maintenance of the status quo with bastions of historic wealth and property retention passed from generation to generation. Most of these countries are un-competitive on a global scale, and haven't been relevant for centuries not decades - this is social Europe we are talking about, they don't have a capitalistic bone in their bodies.
I could continue on with why any comparison between Europe and the United States is flawed, but Europe is a bastion of stored wealth and power, while the US was built and founded in response to a lack of opportunity in Europe for hard working, creative, free-enterprise individuals looking to better their standard of living and quality of life. These immigrants also had a vibrant sense of adventure and these same values are necessary for not being satisfied with the status quo and taking on risk for greater future reward.
This fundamental philosophical mindset, even though critics believe some of this entrepreneurial spirit has died, is still fundamentally underpinning core values in the Unites States, and provides a nice backdrop for pushing the creative envelope in many industries in this country.
If bond yields are forward looking and represent growth prospects for the next ten years, look at how many industries the US is dominant in, and getting stronger versus Europe. Again, there is no comparison to be made between the most capitalistic country on earth, and a region that prides itself in social programs and business stagnation. And for those who think Obamacare is a social program, it may have started out that way, it may have been the original intention, but once the lobbyists of the capitalistic healthcare industrial complex started putting their capitalistic imprints on the policy, in the end it is probably more capitalistic and pro-businessprincipled than most would believe.
The Yield Positive Carry Trade
The main reason bond yields are so low is because there has been so much cheap money available to lever up in enormous sums and chase the positive yield trade, plain and simple. Once the Fed gets out of artificially supporting this trade, which they are in the process of doing, the next step will be the raising of the fed funds rate, expected in 6-9 months if the current trend in economic growth and improvement in the overall economy continues on course. This trade works really well until investors start to be faced with the notion of losing more in principle versus what they can make in heavily levered yield trades in a stable, low volatility bond market environment.
This Time Is Different Mentality
The world of finance just loves these trades, and they usually always end badly with everybody running for the exits at the same time, and this time will be no different. I know investors think this time is different with faulty notions like the US is Japan logic, to justify this as a good risk versus reward trade at this stage in the monetary, business, and economic cycle but they are flat out wrong.
More money will be made by taking the other side of the "this time is different hubris" on the bond chasing yield trade as inflation and economic growth in the United States dictates that the Federal Reserve normalize monetary policy with a Fed Funds Rate target around 4 to 4.5 percent.
That is a whole lot of principle to lose, and have at risk chasing a little yield, and the fact that so much leverage is used to make the trade profitable, the unwind is going to cause the biggest squeeze in exiting than any market repositioning we have seen since the sub-prime housing crisis reallocation of capital. In short, the Chasing Yield Positive Carry Trade unwind is going to be long, nasty and brutal for investors.