00:00:02
Speaker 1: Bloomberg Audio Studios, Podcasts, Radio News.

00:00:18
Speaker 2: Hello man, welcome to another episode of the podcast.

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Speaker 3: I'm Tracy Alloway and I'm Joe.

00:00:23
Speaker 4: Joe.

00:00:24
Speaker 2: I think I know the answer to this question, But do you ever write to do list?

00:00:29
Speaker 4: No?

00:00:29
Speaker 2: Yeah, I figure, well, I make a half hearted attempt every day where it's like podcast recording one, podcast recording two, do the newsletter, reply to the following emails. But as of last week, I have seen the most epic to do list.

00:00:48
Speaker 5: Oh yes, yes, presumably, yeah, yeah, yeah, I saw the Scott Bessett to do list.

00:00:55
Speaker 3: It was basically like by the end, right.

00:00:57
Speaker 2: Right, so US Treasury Secretary Scott bessen there was a photo taken of him. Presumably he did this on purpose, one would hope. But he had a to do list and it basically just said buy Japanese yen and he put in the jp wy yeah, five to ten billion.

00:01:17
Speaker 4: Yeah.

00:01:18
Speaker 5: So it's pretty clear that he was not referring to personal purchases in some vacation.

00:01:23
Speaker 2: If that's the only thing on the Treasury secretaries to do list, he's not that busy, right.

00:01:29
Speaker 5: He's not, but he presumably is fairly busy. We know that the en had been weakening dramatically. We know that there has been a recent sharp strengthening. There's always talk of a en intervention here and there.

00:01:39
Speaker 3: I don't really.

00:01:40
Speaker 5: Understand fully why the end is so weak, why the US feels compelled that it's important to get involved in that market, et cetera. I have many questions.

00:01:49
Speaker 2: Yeah, so the US did intervene together with Japan in the yen to stop it from weakening. And what's really interesting about all of this. I mean, we love Big four and currency stories anyway, but what's interesting is this was kind of a new type of intervention. So the US actually sold euros, which was very interesting, and they also used a fed repo facility that I had completely forgotten about as well. So there are all these interesting questions about this particular incident, let's say, including the big one, which is will this be enough to stop the end weakening? And it's still very surreal to me. Whenever I look at a chart of the dollar exchange rate, the yen will always be one hundred and ten to the dollar for me. Yeah, yeah, because that was my allowance when I was there. I got one thousand yen every week and it was like roughly ten dollars, and so I have that stuck in my head, and whenever I look at the chart it's now at like one hundred and fifty five.

00:02:46
Speaker 3: It's kind of crazy.

00:02:47
Speaker 5: Yeah, no, it's pretty wild. I mean, for so long, for like the first half of our careers, the story was like strengthening and strengthening yen, lower and lower rates. At the long end of the Japanese yield curve. People used to talk about the widow maker trade because many people had gone to short various forms of Japanese paper on the expe expectation that it will blow up in some way. But it has a really blown up. But it's been quite a reversal on both the rates in the end. And again, the question I have, in addition to the tools is why is this an important thing now for the US to get involved and why do we feel so I have many questions.

00:03:22
Speaker 2: All right, So whenever we have big questions about capital flows or FX moves, we shine our Brad setzir bat signal into the sky and he magically appears on the podcast. So we do, in fact have the perfect guest. We are speaking once again with Brad Setzer, senior fellow at the Council on Foreign Relations. So Brad, thank you so much for coming back on odd blots.

00:03:43
Speaker 4: It's always fun.

00:03:45
Speaker 2: Maybe just to begin with, let me ask the obvious question. If your currency is weakening to the degree that you think in intervention is necessary, why doesn't the boj the central bank just raise rates.

00:04:01
Speaker 4: That is a very obvious question. For whatever reason, the Bank of Japan has been very slow to raise rates. So the short term policy rates about one percent. Inflation is clearly above that. They're different measures. Inflation has been above that for a long time. The stated reasons for the hesitation, as you know, the Bank of Japan has worked for so long to get inflation back to two. They don't want to prematurely cut off this shift in behavior to kind of they don't want to fall back into the zero rate, zero inflation economy. I think there's also probably a few technical reasons that I'm sure that you Hada wanted the yield curve to steepen, and it has a lot before short term rates went up, and you know, short term rates affect the cost of all the yend deposits, so it's they impact the liability side of the banking system. The banks have a lot of low yielding assets on their balance sheet. So does the Bank of Japan, so there may be some concern about pushing up the cost of funding on the banking side too fast. The theory of some in the market, not me, is that this is out of concern about how it impacts the government's overall funding cost and that if you pushed up short term rates that would push up the fiscal deficit interest costs too much. I think it's a little overstated, but that is certainly one of the considerations.

00:05:34
Speaker 5: I want to ask about why the yen has been so weak in the first place. But I actually before that, maybe we zoom out bigger, because like weakness in East Asian currencies in general has been a story of twenty twenty six. And you know, it's not obvious to me why East Asian currencies at all would be particularly weak these days, because all I ever read about in headlines is extraordinary. You know, current account surpluses, not in Japan per se specifically, would be the big one.

00:06:06
Speaker 3: It's not intuitive to be at.

00:06:07
Speaker 5: All that at a time when like the big chip makers are making money hand over fist, that they would be particularly weak currencies. Why do you give us this sort of view from the Asia Pacific view generally and then the Japan specific view on this year's currency moves.

00:06:25
Speaker 4: Well, look, you're right, the global trade surplus is now all in East Asia. The chip electron you know, basically San Francisco decided to spend a lot of money on kit that basically comes from you know, in the first instance, Japan, Korea, and Taiwan, but feeds into a lot of parts from Japan. It's pushing you know, it's help in China too. So you know, we have like really record trade surpluses throughout Asia East Asia except for Japan. We'll get to Japan later. And like, you know, Korea's current account surplus is going to go from one hundred billion and changed to somewhere between three and four hundred billion. Massive. You know, Taiwan's is probably gonna double, and you know it was big to begin with. So we're doubling means going from like fifteen to twenty five to thirty percent of GDP. These are insane numbers. With Taiwan, it's a bit different. The central bank doesn't want its currency to strengthen. It has engineered a weakening of the Taiwan dollar compared to last year by reversing crudential regulations basically letting the lifers unhedged their foreign assets. And then with Taiwan in particular, it's almost one company TSMC, and you can kind of lean on that company to tell it when it converts and when it doesn't. Bloomberg actually did one of the best stories I've ever seen about the Central Bank of China Taipei and how it is managing Taiwan's dollar without actually using this balance sheet. Korea is different. Korea has been strange. It's been this story where the better the news is for Korea, the more the Korean stock market goes up, the more foreign holders of Korean stocks have to sell because they're hitting concentration limits. And that has created a weird situation where good news for the equities for Korea's equity, so you know, Heinez and Samsung was leading to an outward flow and producing record weakness in the Korean wand that is layered on to outflows from the pension system. That is layered on to this whole story about you know, Korean day traders who used to do buy levered US ETF single stock ETFs and then Korea let them by levered single stock Korean ETFs, and that didn't turn out to be a great idea, but you know, it's sort of we end up with a world where you have this enormous positive terms of trade shock enormous that is producing record weakness, and that's in the it's in that context where we can think about the end as being another of these countries currencies that is, you know, kind of fundamentally okay. Japan has a current account surplus of five percent of GDP its investment income. It's not a trade its trade accounts would be improving butt for oil thanks to the AI stuff. It's got one of the biggest foreign asset portfolios in the world. The government of Japan has you know, still probably close to one point two trillion in reserves, that's a big number. It has nine hundred billion plus in the government pension fund foreign assets. That's a big number. GDP is now down to four trillion, so you know, the government is sitting on a foreign asset position of close to fifty percent of its GDP. The weakness was it has been throughout Asia a bit counterintuitive, but for slightly different reasons. And with Japan, you obviously have the very low ring story as a central part.

00:10:10
Speaker 2: So when I hear the words currency intervention, I often associate that with currency speculation, right, and here central banks will come out and say, like, oh stern words to the speculators, you better watch out, and that sort of thing. With Japan, do we have indication of how much of this is actually speculation versus to your point earlier, like actual outward investment.

00:10:39
Speaker 4: There's a bit of speculation around the end. You know, there's not a clean measure of the speculative flow. But like you know, look, the end was one of the lowest yielding currencies, so it was a typical funding currency. I don't think the carry trade was on an enormous scale, but there were certainly hedge funds others who more or less thought that the Ministry of Finance was going to allow the yen to weaken beyond what it had weakened before. And since you know, the end shortening the en is positive carry. There's a higher yield on dollars than on yen. As long as it's stable, you make a little bit of money, and if the end appreciates, you make a lot more money. So there was a bit of speculative betting on it, not a ton, I would say. And then you have weird hedging dynamics. So there's a little bit of a head dynamic where when the NICK goes up, foreigners holding the NICK need a hedge a bit more because some do partially hedge. When the Nasdaq goes up, the GPIF doesn't hedge, so it doesn't generate an offsetting hedging flow. And then, despite all the hedge America stories from last year, in Japan, the key fixed income hedged investors seem to have gone a little bit less hedge. The lifer hedge issue has come down, so you don't so a lot of it is not quite your classic speculative flows, although there's a bit of that. A lot of this is hedging flows amongst real money investors, so that does add a little bit of a different dynamic. But I don't discount the fact that a bunch of investors, including a bunch of hedge funds, were basically making a bet that the end would go to one seventy because Yueita was behind the curve.

00:12:25
Speaker 5: So let's talk about it from the US perspective. What is the reason that the weakening of the end is something that would or should concern the Treasury Department.

00:12:39
Speaker 4: Well, I think the classic concern, which hasn't been the concern that Secretary Vestin has articulated, is that extreme weakness in East Asian currencies gives East Asia a trade edge over American producers. I mean, classically, a week end is bad for Detroit, A weak Korean land is bad for Detroit. Right, it's really you know, the traded goods pressure, most classically through the automotive sector, that has been the traditional driver of this. And to be clear, we are like fifty, you know, the ones come back a bit, but fifteen hundreds a crisis level of the wand and Korea is not in a crisis. One sixty is an insanely weekend on any big MAC index. It pushes the end below and inflation adjusted terms where it was in the nineteen seventies. We're back to the nineteen sixties. These are extreme undervaluations in my view. And so in that sense, the classic concern would be that this gives all these guys a huge edge over American manufacturers. That hasn't been what Bestin has emphasized. He's emphasized well, the weekend is putting pressure on the wand is adding to the generalized malaise bizarreness where good news is bad news for a lot of Asian currencies. And then and there's a sense that this could create pressure on the treasury market. Now, to be clear, if the yen just falls, that makes the value of Japanese investments in treasuries higher. So the impact on the treasury market would come if the Japanese resisted that use their reserves, and the excessive use of their reserves or the use of their reserves started to put pressure on the treasury market because they have to fund they would fund it by selling treasuries. So I think part of Besson's theory of the case is that by joining with the Japanese, first of all, you know, we're supporting the end from an incredibly weak level. It's arguably overshot. It has decoupled from five year ten year rate differentials for the past several months, past year even And by helping the Japanese, we're helping a friend, that's what the President says, and we can jointly intervene in a way that we're reduces the possible pressure on the treasury market. That would be I think the explanation I would give, but I you know Besson has n't been He's more I mean the President said it was to help a friend. Bessant has said is to avoid destabilization throughout the Asia currency complex.

00:15:17
Speaker 2: Why did they do it in euros or why did the US do it in euros? They sold euros?

00:15:23
Speaker 4: I mean, you know, some of it is just Secretary Besson being a former currency trader wanting to have presumably a bit of fun. You know, we have euros, we can't use euros. We have a few more dollars, but only a few more dollars. I mean, you can debate. I mean, this was clearly an intervention, but you know, when you shift your the composition of your reserves around, sometimes that's not even viewed as intervention because you're not selling your currency to buy another guy's currency. I think he presumably did it because he wanted to be a bit cute and say, well, this isn't an This is not a view about the dollar that we still want a strong dollar. This is just a view about the yen. And we're just expressing this in a way that makes it clear that this is a view about the en. It also let him do like kind of surprising things, like there was the rate check in euro yen, which caused a lot of confusion in the market. But at the end of the day, the you know, we don't know the volume, we don't know if he actually did the five to ten. Maybe we'll see in a week or so. But the vast bulk of the intervention was from the Japan's Ministry of Finance, and it was in dollar yen, So fundamentally this was a dollar yen intervention, not a euro yen intervention.

00:16:34
Speaker 5: Brad, you mentioned that if you were to go buy something like the Big Mac Index, the dollar yen or the en is at historically weak levels. And of course there's all kinds of attempts to measure like what like fair value of a currency is, right, so you mentioned the Big Mac Index, and then there's like, I don't know, beer models and rear models and exchange rate differential models and GDP differential models. Do any of them work anymore? Are any of them consistently either predictive or useful? Or like, what is the state of all of these sort of classical approaches to determining fairvlie of any given currency.

00:17:18
Speaker 4: The Big MAC index is a version of purchasing parity that sort of prices, broadly speaking, should be the same if you're comparable levels of development. Recently, particularly visa the Asia, the market pressure, the financial pressures have pulled currencies further away from their purchasing power parity levels. So that hasn't as a predictive variable. That hasn't worked as an analytical tool. I feel think it's valuable. A behavioral equilibrium exchange rate model fundamentally looks at policy settings today and says, we know what's the impact of the policy settings, and then it says, we don't know the equilibrium value of the currency is, but we know what it is where it has been in the past. So given the policies and given the past, is the currency strong or weak? All the Asian currencies kind of score is weak on this because they are fundamentally incredibly weak. I mean, we haven't talked about China, but China has a big and growing trades are Plus, use a current account based model, you'll find that China's currency is undervalued. Certainly Korea's currency is undervalued on a current account based model. All these show is undervalued on behaviorable exchange rate based models. So basically, like what we know is that financial flows have pulled currencies quite far away from any of the more fundamental or purchasing power based measures.

00:18:45
Speaker 2: So I want to go back to the idea of avoiding additional pressure on the US treasury market. And a big component of this seems to be use of this FED facility that I mentioned earlier. It's called the Foreign and International Monetary Authorities REPO Facility very catchy or FEMA, and it basically allows foreign central banks to use their treasuries as collateral to get dollars. But from what I understand, and I should say, this facility I think came about during twenty twenty during the pandemic with the big treasury market route. From what I understand, it charges above market rates for central banks. And so one of the criticisms I've seen lately, or maybe concerns, is that the FEMA REPO facility is ultimately going to be uneconomical for central banks, like why would they want to use it if they could just repo treasuries at cheaper market rates. And then secondly, the facility is also capped at something like sixty billions, So if you need to intervene again, someone's going to have to raise that limit. What are the sort of pros and cons of using this particular facility in this way.

00:19:59
Speaker 3: You're a fan, right, I'm a fan.

00:20:01
Speaker 4: I publicly, I privately pushed for it back when I was at the Treasury. I publicly pushed for it in twenty twenty. I think it is a useful tool. The basic idea is that central banks have a lot of really good collateral and if they need cash, they don't actually have to go and sell the treasuries into the cash bond market. They can just repo them at the FED, get dollars and then intervene that way, and it's zero risk to the FED, and the FED can always offset any monetary impact with its domestic operations, so there's no necessary monetary impact. It's just a way to allow in times of stress or times of pressure, a central bank to avoid having to immediately sell treasuries. And remember the in twenty twenty we kind of got into a downward spiral in the treasury market where central bank sales were sort of begetting begatting private sales, and the long bonds was really selling off and the FED had to come in and do a lot of direct bond purchases. So you know, it sort of makes sense to have this additional tool in the tool kit. You know, why do it with the FED rather than with a Well, first of all, I guess you know the FED, you know, not in this case is a little quieter as a counterparty. I mean, it is disclosed, but with a weak lag it is in theory. You know, if you get rid of the cap, it's unlimited in the quantities, and then the premium is there. It's not huge, but you know, you can debate where it is not. It was not meant to be used as a as a substitute for REPO in ordinary conditions, so it does have a premium. I think you can argue that right now, if you're the Ministry of Finance and you got a legacy five year bond with a pretty high coupond, you're better off using FEMA REPO than dumping it in the market. You're gonna be able to cover the cost of FEMA out of the cuban on the bond. And if obviously, if you sell the bond, you're never gonna get that bond and that heel back. It gives the you know, the Ministry of Finance a bit of flexibility at a minimum. It means it can intervene and then sell treasuries with a lag. It doesn't have to sort of immediately sell. Now, Japan does have a cash buffer. When they've intervened in the past, for whatever reason, they haven't used their cash buffer. They've pretty directly sold treasuries. So I think, you know, it just gives another tool to the Ministry of Finance and gives the Ministry of Finance more options about how it generates the dollars that it's self.

00:22:59
Speaker 5: Is there anything stuff upping Secretary Bessent from saying, you know what.

00:23:03
Speaker 3: One hundred and fifty dollars, one hundred and fifty end.

00:23:05
Speaker 5: Of the dollar. That is our line in the sand. We're not gonna let it weaken beyond that. And then you might not even have to spend a penny because you know, no one's gonna people might not want to test it, and you just say, we have unlimited, unlimited firepower because we're spending our own currency.

00:23:21
Speaker 3: We're just gonna cap it there.

00:23:24
Speaker 4: Yeah, there's something that limits Secretary Bestent from doing that, which is that he doesn't control the fed's balance sheet. Okay, Secretary Bessent just has the ESF. Right now, the ESF has ballpark twenty billion in FX ballpark twenty billion in like liquid dollar cash, and then the special drawing rights, which it has like one hundred and sixty hundred and seventy billion of a lot but not unlimited. And using the special drawing rights is kind of even more out there than using FEMA repo. You know, it's sort of so you know, the Treasury on its own probably doesn't have the firepower. Now you can argue that between the Treasury the MOTH, if Japan could through some magic change some of the pension funds operating guidance so that it started hedging its nine hundred and fifty billion dollar portfolio, there's more than enough firepower there collectively to set a target, sort of a yield curve control type target one p fifty probably be more like one sixty now, and thereby implement that so you know, whatever it takes, this is going to stay below one fifty or one sixty. The world does change. Oil shocks happen, inflation shocks, the FED maybe raising rates. People think the bank of demands is likely now to raise rates. So I think the risk on that is that you get locked into defending a level and then the world changes. But you know, conceptually you could try to do that. I think what the Ministry of Finance is trying to do is re establish fear in the market round one sixty. I mean that used to be kind of a level where you know, if you were going to go short the en, you'd be a little nervous that the moth might come in and whack you. But then when they.

00:25:11
Speaker 3: Didn't defend whacking, right, let me.

00:25:15
Speaker 4: Look, the weak side of the yen has been defined by the Ministry of Finance for the past several years. I mean, that's that's a conventional view in the market, given that the interest rate differential favors the dollar. By the way, we should discuss fiscal policy because US fiscal policy is way worse than Japanese fiscal policy. So I don't buy this is fiscal fears or whatever it is rate differentials, but the rate differential has favored the dollar and the limit for the past I would say three years on how weak the yen gets has been set by the mof and when the moth didn't intervene at one sixty, and then the last time an interviewed at one sixty two, you know, people thought, well, maybe they're going to allow further moves, and we'll make a bet that the moth is going to tolerate a week or yen, given that UAITE has been slow to raise rates. And so I think this is fundamentally about saying we're going to defend one sixty. There's a lot of risk around one sixty. Be careful if you want to just go short yen when you're close to that level, which is a softer version of the we're just going to defend one fifty to kingdom. Come all right?

00:26:24
Speaker 2: Well, on that note, perhaps the biggest question other than you know, why did all of this happen? Is is it going to work? And I mentioned earlier the yen is trading at like one fifty five six to the dollar. That's better than where it was before this intervention, but it is starting to weaken ever so slightly again. And on that note, Adam Posen had pretty funny quote in the Financial Times. Did you say yet so basically saying, verbatim quote the irony of the guy working for Sore and Stanley drucken Miller who broke the Bank of England back in ninety two. Pretending that you can do FX intervention alone and lastingly defend a currency is just amazing. So again this idea of like how much firepower does the US actually have? Does this need to be more coordinated? Do you think this is enough?

00:27:19
Speaker 4: I think it will be enough if the Bank of Japan is going to raise rates and maybe raise rates several times. I think the only reason why it wouldn't be enough if the Bank of Japan is going to raise rates. And look, I think if the Bank of Japan doesn't raise rates in September, this will be tested clearly. I mean, that would signal there's not full commitment inside Japan to defending the currency. And even in the classic sense, the monetary and fiscal authorities have different views. But if the Bank of Japan does raise raids, the other side of the currency pair is the dollar, and so it depends a little bit on what does. But if the Bank of Japan is raising rates faster than the FED from this point on, I actually do think this will work. You know, there's Adam never believes currency intervention works by the way, So it's not at all a surprise that he has this view, and I think he should reflect a little bit on why the yen and why currency traders are nervous around key levels, because in the short run, most market people I talked to say intervention can work in a over a reasonably short period of time, and it can work over a longer period of time. If the currency is overshot. I would say the yen has overshot if the fundamentals are evolving in a way that is going to be eventually favorable to that currency. You can make that argument with Japan. You know, oil prices, if you know, that depends on what happens in the Strait and with Iran, but oil prices are not at their highs. That helps Japan. The BOJ seems likely to raise rates in September. Certainly, the BOJ could be on a path that brings short term rates up too closer to you know, inflation, so on a path that leads it to two over time, that should support the end if the FED stable. Long term Japanese rates have converged with long term US rates, so the long run interest rate differential is now actually at odds with the en. It's given this rate differential, the end should be stronger. The current account is actually quite solid five percent of GDP. Japan's getting ever more money on the same level of its US portfolio because US rates are now higher than they were when Japan bought his original bond, So that's not really at risk. And you know, the key thing is that you got to change expectations, and the expectations have been that the EN's going to stay weak and maybe get weaker. So in that context, this huge foreign portfolio of Japanese institutional investors is generally becoming less hedged over time. You change that, and I think you change the dynamics. And where I probably differ a bit from people like Adam or more like the conventional international macroeconomics school, is that, you know, I do think Japan is unique in a couple of ways. One way it has been unique is that, you know, the companies that have this massive foreign presence make enormous profits abroad. Those profits translate into enormous gen profits, but they don't actually bring the dollars euros you on that they earn a broad back home. They tend to reinvest, so that doesn't generate a flow, and then the irony is a lot of the non FDI foreign assets are held by the government. You know, the bulk of the unheaded, unheedged portfolio is actually in the hands of them off and the GPIF, the pension fund, and they typically don't repatriate, so you know, they're generating. You know, the reserves were generating thirty five to forty billion an interest a year, but in normal times that just was compounding Abroad, the GPIF gets dividends, it gets interest, it doesn't repatriate that. Now there's some portfolio rebalancing. There's some additional complexities. I won't go into that, but in the normal course of action, all this interest income that goes to the government, which is well above you know, it's well above a percentage point of GDP, it's heading towards two percentage points of GDP, doesn't hit the FX market. So in a sense, I think in order to equilibriate flows, you're gonna need to see a way to you know, have the winner of a weekend, which in a financial sense has been the government of Japan takes some of its winnings and bring them back home. And so in that sense, I tend to view this a little more favorably. I think this is part of these conditions needed to set a floor under the end over time, together with the Bank of Japan. So to me, you got to have the Bank of Japan and then you have to have the flow dynamics. And the interesting thing about Japan is that the government is by far the biggest actor on the flow dynamics. It has the biggest foreign asset position, and it has the biggest capital gains from yen weakness.

00:32:14
Speaker 5: By the way, for those who don't know the numbers, you know, as you mentioned, the long end of the curves in the US and Japan converge somewhat, but you know, the FEDS current rates there's between three and a half and three and a quarter. Bank of Japan is till one percent. So that's really where this gap persists. We'll see, as you mentioned, if the BOJ closed it. Before we wrap, let's talk about fiscal policy for a moment, because you know, going back at twenty sixteen, the yield on the Japanese thirty year was like zero point h five, like something like truly nothing, and now it's like around four percent. There are these because the debt to GDP is so high there are these fears that if rates rise across the curve, a significant share of government expenditures are in the form of payments. That further is the information problem than you have what people call fyscal dominance. It spirals out of control. The central bank can't fix it. That is sort of like the classical version of why some people think that you should short the end because it will one day be worth confetti or something like that.

00:33:16
Speaker 4: What is wrong with.

00:33:17
Speaker 5: The theory that this is the piper being paid? Is that a phrase, the piper being paid for years of overly loose fiscal policy.

00:33:27
Speaker 4: Well, I like the way you phrased it as years of overly lose fiscal policy, because you didn't say today's fiscal policy is overly loose. What has changed, certainly compared to twenty fourteen, even compared to twenty sixteen, is that the primary balance, so excluding interests, government revenues relative to expenditures, is now in balance. It's now flat. There's no primary deficit. That makes Japan one of the better G seven economy, certainly better in the United States, certainly better than the UK, certainly better than France. I think better than Germany now too. I mean, I think if you count the defense spending, so Japan no longer has a big primary deficit. It's primary is actually trending towards a primary surplus. The moth loves to play games where if you don't do a stimulus, you actually tighten, because the way they structure the budget, they sort of force the government to go out and argue for a stimulus to offset what they mechanically have baked in as a tightening, which is why we've ended up. You know, Japan has outperformed the IMF's forecast this year. It's really you know, at a primary balance rather than in a modest one percent primary deficit, and so you know, you're not in a position where things are on the edge of spiraling out of control. Now. It is certainly true that the interest burden will go up if the Bank of Japan hikes rates, and it will actually go up even if the Bank of Deman doesn't hike rates, because there's an awful lot of bonds that were issued at the past at very very low rates. They will mature, they'll have to be refinanced with higher inflation, higher nominal growth. The debt dynamics don't go crazy because you have higher nominal rates, but your nominal rates aren't wildly out of line with nominal growth. Real rates are probably still below or equal to real growth, and your primary is in an okay position. The other weird thing about Japan is that the government of Japan holds on its balance sheet. So the Ministry of Finance is part of the government. It holds the reserves. The reserves in Japan make money. They are in dollars with this higher interest rate compared to the short term cost of funding and yen. The gpis the government pension fund makes money. It has higher yielding foreign assets. So the net interest payments on Japan are actually for at times they've been close to zero. Now that's a function in part of the backward looking low rates, but it's also a function of the fact that Japan's government has this massive foreign asset position. Long winded way of saying there is you should worry if nominal rates go way up and inflation doesn't go up. But if nominal rates converge to levels that are consistent with inflation, and if the primary stays where it is, Japan's debt dynamics are actually not bad. The net debt levels have been falling in five years without much change, net debt in the US will surpass or be close to that of Japan. And remember when you're shortened the end and to go long the dollar, you're going long US fiscal And I would argue, if you look at the full range of variables, not gross debt, but the dynamic path of net debt, the primary absolutely the fiscal balance one percent of GDP in last year, and that's not the US. We're at six. We were five ish last year, but we're now at six. We're heading up. That's before the defense spending. I think what has gotten people nervous is Takeichi doesn't want, at a minimum, to get a bigger surplus. She's pushing back against the moths plans. She may want to go back to a modest primary, and she expresses this in a way that generates a lot of anks. But the underlining fiscal performance of Japan. Stack up Japan using the IMF fiscal monitor variables against the US, and then compare that to the rhetoric that is tossed around, and I would say there's a very big gap.

00:37:40
Speaker 2: All right, Well, On that note, Brad, thank you so much for coming back on the show. Really appreciate it.

00:37:45
Speaker 4: Oh thanks, thanks for letting me explain my this is one area where I'm not the most conventional. And just remember this last thing. Just always remember Japan is selling dollars at by between eighty and one hundred depending on when they bought it, and somewhere around one sixty. This and the worst you can say this operation. It reduces gross debt in a really big way.

00:38:14
Speaker 3: That was excellent.

00:38:15
Speaker 2: Thanks Brad.

00:38:17
Speaker 3: Hopefully talk to you soon, but not too soon, Joe.

00:38:32
Speaker 2: Always good to catch up with Brad and get his perspective.

00:38:35
Speaker 3: Yeah, a few things.

00:38:37
Speaker 2: Stood out from that conversation. So one, it is kind of crazy how long the memory of the lost decade is lingering here. And we see this time and time again, both in economics and the business world, which is like people just remember the past cycle, right, and it influences their current behavior understandably so in the case of Japan. The other thing that stood out to me is this idea of Okay, the treasury has done this sort of creative intervention in order to ease pressure on long term treasuries, but there seems to be a tension there with what the Fed's doing ye at the moment, right, So Warsh is like, ah, you know, like markets, you you have more of an activist, say, and where treasury yields are going, it shouldn't all be about the central bank. And so we've seen longer term treasure yields go up. So now you have this weird situation where like Treasury clearly wants them to come down, whereas the FED is kind of like do your own thing.

00:39:35
Speaker 3: Totally, there's lots of in there.

00:39:36
Speaker 5: One of the first things that Brad said that I thought was interesting and it sort of and it speaks to your point about the last decade is he's like, oh, the bojsn all this work to get inflation back to two percent. And in my mind I was thinking, like, oh, yeah, right, like they must when he says all this work, they're trying to get inflation back down. But then I remember that in other direction, and so like you know, for years the story is like no inflation, No, maybe they just want to let it run hot a little while. To fully put the lost really multiple decades of like no inflation truly in the past. I also think it is interesting and probably no one really talks about it, the idea that Japan's fiscal position, at least by a certain objective measures, clearly improving, clearly looking better than the trajectory of the US these days, at least if you're looking at a primary deficit. And then to his point, you know, there's numerous you know, the classical metrics that economists use to measure the valuation of a currency. We know none of them are that great as metrics go, but they all point it to the end in fact being undervalued.

00:40:40
Speaker 2: Yeah, all right, I think we should end it there before I make a terrible turning Japanese.

00:40:47
Speaker 5: Oh you know what I thought it would pun but someone had already used it was keep calm and carry in.

00:40:55
Speaker 3: But uh yeah, right, Oh.

00:40:56
Speaker 5: You know it's like I'm saying it act usually been used a handful of times. Uh yeah, I just looked it up. It's just a few random you need to.

00:41:03
Speaker 2: Make those posters. I see them on the wall.

00:41:06
Speaker 1: Yeah.

00:41:06
Speaker 5: If I had been the first, I would do it, but I was not.

00:41:08
Speaker 3: All right, shall we leave it there, Let's leave it there.

00:41:10
Speaker 2: This has been another episode of the aud Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway and I'm Joe Isn't All.

00:41:17
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00:41:39
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