Global Bear Rally Will Deflate as Japan Leads World in Sovereign Bond Crisis

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by Ambrose Evans-Pritchard: Fears
of ‘Lehman-Style’ Tsunami as Crisis Hits Spain and Portugal



Milton Keynes
will be vindicated. Lord Keynes will lose some of his new-found
gloss. The Krugman doctrine that we should all spend our way back
to health by pushing deficits to the brink of a debt spiral –
or beyond the brink – will be seen as dangerous.

The contraction
of M3 money in the US and Europe
over the last six months will
slowly puncture economic recovery as 2010 unfolds, with the time-honoured
lag of a year or so. Ben Bernanke will be caught off guard, just
as he was in mid-2008 when the Fed drove straight through a red
warning light with talk of imminent rate rises – the final
error that triggered the implosion of Lehman, AIG, and the Western
banking system.

As the great
bear rally of 2009 runs into the greater Chinese Wall of excess
global capacity, it will become clear that we are in the grip of
a 21st Century Depression – more akin to Japan’s Lost Decade
than the 1840s or 1930s, but nothing like the normal cycles of the
post-War era. The surplus regions (China,
Japan, Germania, Gulf
) have not increased demand enough to compensate
for belt-tightening in the deficit bloc (Anglo-sphere, Club Med,
East Europe), and fiscal adrenalin is already fading in Europe.
The vast East-West imbalances that caused the credit crisis are
no better a year later, and perhaps worse. Household debt as a share
of GDP sits near record levels in two-fifths of the world economy.
Our long purge has barely begun. That is the elephant in the global

We will be
reminded too that the West’s fiscal blitz – while vital to
halt a self-feeding crash last year – has merely shifted the
debt burden onto sovereign shoulders, where it may do more harm
in the end if handled with the sort of insouciance now on display
in Britain.

Yields on AAA
German, French, US, and Canadian bonds will slither back down for
a while in a fresh deflation scare. Exit strategies will go back
into the deep freeze. Far from ending QE, the Fed will step up bond
purchases. Bernanke will get religion again and ram down 10-year
Treasury yields, quietly targeting 2.5pc. The funds will try to
play the liquidity game yet again, piling into crude, gold, and
Russian equities, but this time returns will be meagre. They will
learn to respect secular deflation.

Weak sovereigns
will buckle. The shocker will be Japan, our Weimar-in-waiting. This
is the year when Tokyo finds it can no longer borrow at 1pc from
a captive bond market, and when it must foot the bill for all those
fiscal packages that seemed such a good idea at the time. Every
auction of JGBs will be a news event as the public debt punches
above 225pc of GDP. Finance Minister Hirohisa Fujii will become
as familiar as a rock star.

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8, 2010

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