Capital Flows and Asset Markets

This is a free preview of a paid episode. To hear more, visit www.russell-clark.com

Yen is cheap. In every possible way I look at currencies - Yen comes up as cheap. Using BIS data on real effective terms it is back at 1970s levels.

I also know two very successful fund managers who are openly long Yen. And they get very little push back on this view. The problem with this view is that it reminds me so much of the bearish JGB views I heard back in the 1990s. It made logical sense but was totally wrong. Yields on JGBs fell from 4% to 0% eventually.

What could cause a long Yen view to be wrong?

Why are large cap US stocks doing so well? I have been thinking about this a lot, as THE question for fund managers is whether this will continue to forever, or change in coming. I had thought that a trend change in bond yields would lead to a change in market leadership, but this view has been wrong. Leading stocks, and particularly tech, continue to dominate.

The more I think about how the US works, the more I realise that you need to square the political circle of being popular with voters, AND being able to raise the funds from corporates to fund a punishingly expensive political system. You end up with an economic system that focuses on keeping prices to consumer cheap, while allowing businesses that face other businesses to build huge cartels. It is best explained by Lina Khan's Amazon’s Antitrust Paradox. Generally speaking, if you are corporate, you are pretty much left to yourself. The government will not protrct you against other dominant corporates.

In practice, if you wanted to advertise on Facebook, or Google, you were likely to pay cartel prices, that is not a competitive price but the price the market could bear. Healthcare in the US is typically paid for by corporates, and so a system developed where list prices are extraordinarily high, making sure that corporates deal with a consolidated PBM sector. Cloud computing is going the same way, with three or so providers, but with limited ability to shift between providers, allowing pricing power. The leading companies in the US combine a free or low cost consumer facing business, with a heavily consolidated and powerful business facing business. Meta, Google, Apple, Visa, Mastercard, Walmart all have these two sided businesses.

The question here is when does dominant corporate power towards other corporates becomes a political problem? When do small businesses start to complain that social media cartel makes advertising too expensive? When do small businesses find that providing healthcare is too expensive? When do small businesses find the unavoidable expenses of payment systems unbearable? When do small businesses find the cost of cloud computing unappealing (which is what a surging Nvidia share price suggests)?

What is interesting has been collapsing small business optimism, at the same time as the stock market is surging. Old school macro fund managers would see this as a turn in credit cycle. This explains the continues enthusiasm for deflationary trades like long yen, and long treasuries. But I suspect that small business optimism is falling because corporate price increase by American cartels are extreme. In this case collapsing business optimism is not deflationary, but inflationary.

Just as there was a roadmap to power for Trump in 2016 by focusing on disgruntled union workers, I see a roadmap to power by focusing on small business owners, and reducing the power of American cartels. The problem of course is that taking on the US cartels would be taking on some extremely powerful business interests, and would likely tank the market, just as China taking on Tencent and Alibaba has tanked its market.

Perhaps the better trade will be to be long US small caps relative to its large caps? Certainly the Russell 2000 has lagged the S&P 500 in recent years.

The obvious conclusion of this would be that the current obsession with Chinese corporates is a dead end for US politicians. Banning TikTok only entrenches Meta and Google. Chinese corporates were the only potential competition for high end semiconductors, another area of increasing cartel pricing. China payment systems are small business friendly, but poison to Visa and Mastercard. Allowing Medicare to negotiate drug prices rather than privately owned PBMs would be disastrous for drug and insurance companies. For US small business, the enemy is within, not without.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.russell-clark.com/subscribe

1992 film “A Few Good Men” is a classic. Jack Nicholson, Tom Cruise, Demi Moore, Kevin Bacon and Kevin Pollak are all fantastic. And the scene we all remember - Tom Cruise demanding the truth, and Jack Nicholson telling him “You can’t handle the truth”. The irony of this statement, where Colonel Jessup tells him the truth - that you don’t want “nice” guys to be soldiers on the front line, makes him the perfect bad guy - as you can understand why he does what he does even if you don’t accept it. The irony of this scene is that Daniel Kaffee then gives Jessup a truth that he could not handle either - that no one is above the law.

One great things about markets is that there is always a price - and that price in the truth. Fund managers only get into trouble when they don’t believe the price - when they can’t handle the truth. The long bull market in the US has had many underpinnings. Share buybacks, a very forgiving Federal Reserve, supportive tax policy, deficit spending, nobbling of Chinese competitors, but the truth, which I chose to ignore was that US political system is set up to be very supportive of large corporates. Even when I read Lina Khan’s papers on the Amazon Antitrust Paradox, I took from it that US regulators will tolerate almost any business activity as long as prices to consumers do not rise. The corollary of this policy, is that businesses that serve other businesses are able to build cartels with relatively little regulatory scrutiny. App stores make money from other businesses, as does Google and Meta. Same with Visa and Mastercard. Thinking of tech as cartels makes understanding these charts make more sense. In 2000, the US moved against Microsoft, and perhaps recent moves against Apple will be a new watershed moment. But the price today is that the end of cartel systems is not the “truth” - not yet at least.

Thinking of a cartel boom, rather than a tech boom helps us square tech performance against the recent performance of the ARK Innovation ETF. The truth is that large cap stocks have dominant positions, pricing power, while also buying back shares. ARKK Innovation ETF is not invested in established cartels, and so the truth is plain to see.

For many years bonds were telling the truth of deflationary government policies. I did well when I embraced the deflationary message of JGBs. For years investors and traders had called the JGB markets a bubble, or irrationally priced, but in this case I could handle the truth, I embraced its message and prospered.

The problem for middle age managers is that truth changes. A very good example of this is Italy. In the early 1990s, Italy needed to pay a big premium of German bonds. Obviously, Italy was not Germany, and was far riskier investment. And then the Euro was introduced and Italy came to be seen as risky as Germany - and this was the truth at the time. Now what is interesting, is that from 2006 onwards the market was saying that Italy was not as safe as Germany, but I remember clearly that middle aged managers kept buying Italian debt, as they spread “was a bargain”. They could not handle the truth - which is that Germany was not offering unlimited backstops to Italy. If I was asked what the truth of current pricing was, it would be that the market reckons Italy is too important to be cut loose by the EU, but there is always a risk that spreads may be allowed to widen to teach them a lesson.

Having been around awhile, I often think that the best opportunities come from trying to find a truth that investors cannot come to accept. I have found old managers and young managers far more accepting of price action. Mid career managers often make their names by avoiding collapses, like the GFC or the dot com bust, or China or commodities in recent years, and typically don’t want the world to change. Older managers that have survived know that things can and do change, so have learnt to embrace it. What truth can people not handle? Almost certainly that interest rates and yields are going much higher. US 30 year treasuries yield 4.4%, which is high by recent standards, but look likely they are going higher to me.

Despite yields not being that high investors hare poured money into TLT - a long dated treasury ETF.

So why can’t investors handle the truth? Having talked to a lot of people in recent months, the truth is that most people have built their financial plans around yields staying low, or even worse have large mortgages that they cannot finance at higher levels. Of course young people, who are often renting, probably have no fear of higher interest rates, particularly if causes house prices to fall. Older managers will likely have paid off a mortgage. But it is easy to see how middle aged manager might reject the idea of higher interest rates if it would mean they need to change their mortgage plan or even worse, investment plans. Better to stay with what has worked for the last 15 years, right? 10% interest rates, you’re joking right? You can’t handle the truth.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.russell-clark.com/subscribe

1997 movie Gattaca has always been one of my favourite films, and I have rewatched it many times. Unlike my other favourite films, I seem to be the only one I know that loves this film. Films like Casablanca, Groundhog Day, Aliens, Little Miss Sunshine, Dark Knight, Sound of Music, I find other people love too, but my love of Gattaca seems to be a lonely affair.

(SPOILERS BELOW)

For those who have not seen it, the core story of Gattaca revolves around two brothers in a future where your DNA is the sole determinant of your success. The older brother is conceived naturally, and told that his DNA has condemned him to a second rate and ultimately short life. Despite that he dreams of being an astronaut, a role that is confined to only those with perfect genes. Ultimately, he prevails, overcoming those with better DNA. The message being that all the ability in the world is pointless without the drive and will to succeed.

When I watched this in my 20s, I felt a connection with this film. Growing up in a very middle class family in Australia, when I started to travel and work overseas, I became aware of the limitations of an Australian upbringing. I felt poor when I first went to Japan, and was made very aware of my inferior education. I still remember being told my maths was pretty good for a white guy. Discussion on my Japanese ability and pronunciation were also similarly brutal. In Australia, I had been a top student, in Japan I was as close to a dunce as you can get. But these trials and tribulations were all fuel for the fire in the belly, and I devoted myself to improving my Japanese.

In my mid 20s, when I started working in finance, I again became acutely aware of my limitations. Most of my peers had been focused on joining an investment bank for years, and had worked on the connections and the qualifications well before I had even realised this was a career option for me. Starting as a graduate at 25 years old, I could tell some thought I was already a “has been”, particularly as I only had a bachelors degree. But like the hero of Gattaca, I was playing the long game, and I was willing to do what it takes.

And when I was younger, there was one scene that really struck home to me. The two brothers play a game of chicken when they swim out to sea as far as they dare, and the older genetically inferior brother keeps winning. "Vincent, How are you doing this?” asks the younger brother. To which he replies, “Do you want to know how I did it? I never saved anything for the swim back” And for me, I have tried to live my life that way, always and everywhere. If you really want it, you never save anything for the swim back.

When I used to look at other people, I would ask the same question. Are they saving for the swim back? Are they committed? And so often people would say that they wanted to be this or that, but when words did not translate into actions, then I knew that was not what they really wanted. Are you willing to do what is necessary to achieve your dreams? For me that was the message of Gattaca, and the message I took from watching it in my 20s and 30s.

But as I watched it again, knocking on 50, I realise that I missed so much of the message of Gattaca. The drama in Gattaca comes from the main character trying to avoid detection before his departure for Titan. Vincent used blood, skin and urine samples from the genetically superior Jerome to pass DNA tests. A murder has led the police to investigate his workplace, and finding an errant eyelash from Vincent they begin to look for the obvious killer, a genetically inferior member of society impersonating a superior member. The tension is heightened as we discover that the lead detective is his younger brother.

As the circle tightens, his willingness to do whatever it takes is no longer enough. You become aware that more and more of the characters in the film are aware that Vincent has inferior DNA, but are willingly overlooking this to help him evade detection. The implication is that they recognise a system that focuses purely on potential, and not on drive and determination is a failed system. Or perhaps it is just that most natural of human emotions, rooting for the underdog. Either way, it is clear that the system is not universally supported or loved.

While the message from Gattaca remains one of chasing your dreams, and never saving anything for the swim back, it also has a message that the trial of chasing a shared dream can bind people together. Those around Vincent can no longer just passively support him, but to actively support him. They need to take risks themselves. Ultimately, Vincent requires those around him to give up love, freedom, life and duty for him to achieve his dreams, and they give willingly. As Jerome, the man that Vincent pretends to be, says at the end, “I got the better end of the deal. I only lent you my body. You lent me your dream.”

And the lesson I now learn from Gattaca, is not just never saving anything for the swim back, but that when you are chasing a dream, you are never really alone. Seeing someone pursue and achieve their dreams is something that we all want a part of - and everyone around you is helping you achieve. Chase your dreams, but remember everyone around you is helping you chase your dream too.

You may be wondering why a substack that is largely about economics and finance is talking about the lessons to be learnt from 1990s sci-fi film. Well the changes in my views on Gattaca, match up with my changes on my views on what it takes to have a successful hedge fund.

In my 20s and 30s, I would have taken the view that you need to be the best. You never saved anything for the swim back. Or in more financial terms, in a bull market the most bullish wins, and in a bear market the most bearish wins (and by wins I mean has the best hedge fund). That was certainly the mindset I lived by. I remember being very deflationary and bullish on bonds, and at some point, the numbers said to me to buy long dated JGBs. They were only yielding 2%, but the spread between 30 years and 10 years seemed very wide to me, and I did not think the 10 years would sell off, so I bought them. It was a great trade, but buying it felt like crossing a Rubicon, completely committing to the deflationary trade that I saw. Buying 30 year JGBs was committing to an investment theme, with no way back.

Coming up on 50, I still have the same attitude. You need to commit to succeed, but I also realise my success was coming from the explicit and implicit support of others. Colleagues, investors, supportive websites (hello Zerohedge!) and many many others. And I find myself dreaming of shorting again, I wonder if I can find others to share that dream. Will others follow, or at least will me on into the great dark unknown, offering at least tacit support. I think they will, but I don’t know for sure. So now, all that is left to answer is when do I strip off, and start swimming out to sea, saving nothing for the swim back?

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.russell-clark.com/subscribe

When I started to add political analysis into my market analysis, I was given some very good advice by someone who shall remain nameless. Politicians are simple - they will do whatever they need to do to be elected. The corollary of this is that in true democratic nations, like the UK, US or Australia, there are never really “populists or extremists” - they are just politicians that are just responding to what voters want. However, I think you can take this analysis one step further, and politicians will do their best to ensure their political success going forward. Thinking about this allows for a deeper and better analysis of markets and politics since World War II, and perhaps give a better method to understand where we are going.

I am going to use the UK as politics here is very clear cut - the party in power tends to have almost unlimited power to enact policies, without the countervailing influence of state government or a supreme court. One of the defining features of the post World War II era was the surge in union membership. The Labour government that came to power after World War II probably noticed that union members tended to voter Labour, so encouraging unions AND the nationalisation of major industries would put an overwhelming number of voters as natural Labour voters.

With the staglfationary 1970s, voters were fed up with these “pro-labour” polices, and opted for Thatchernomics. As can be seen above, a combination of anti-union laws, AND privatisations greatly reduced the number of union members, and natural Labour voters. The Conservatives no doubt noticed that shareholders, homeowners and business people tend to Conservative voters. So many Thatcher era policies where aimed at creating exactly these type of voters. One of the key policies of Thatcher was the transfer of state owned housing to private ownership. The Thatcher government gave the right of tenants in social housing to right to buy the properties they were living in.

Other policies pursued in the Thatcher agenda was the privatisation of key businesses. This served the dual benefit of moving move workers from public to private sector, which reduced the chances of them being unionised, while also encouraging the public to become shareholders, both greatly increasing their chances of voting Conservative in the future. British Telecom was one of the most successful nationalisation, and was directly marketed to the public, greatly increasing participation in the stock market.

Finally, a policy of reducing corporate tax rate to encourage business growth and investment was the final policy. Corporate tax rate in the UK fell form 51% in 1981 to 19% in 2023, but in the most recent budget rose to 25%.

From 1980 to 2007, these policy measures would have been seen as both economically sensible and politically popular. That is they almost worked as a poltical “flywheel”. The more voters liked these policies, the more voters that were likely to like these policies were created. So much so, that Tony Blair, Labours most successful politician, is seen as an heir to Margaret Thatcher by many political commentators. The problem is that many of the core Thatcher policies now alienate more voters rather than create new supporters. Housing is probably the most key one. The housing associations were key builders of homes in the UK. Together with the right to buy, which saw the transfer of homes from the state to private hands, also saw the state reduce its role in building homes. Home completions were around 300,000 homes a year in 1970s, have been running at 200,000 homes a year since the 1980s.

This has led to the obvious problem of house prices in the UK becoming expensive. This is dual aspects of a policy that weaken unions, keeping wages low, and policies that limited supply of housing, both core policies of the Conservatives. Voting intentions of the young to Conservatives are at the lowest levels ever.

While this benefits older voters that own homes, it has completely alienated younger voters.

Finally, privatisation was combined with rising share ownership, and increase competition. This allowed the public to participate and gain in the improved efficiency gains of better private sector management. IPOs and share offerings were a way to bind the public to the ideals of free market capitalism. But in the current world of private equity, venture capital, unicorns and share buybacks, the capitalist system tends to favour the few rather than the many.

The falling allure of right wing economic policies means that there is an increasing focus on cultural issues, rather than economic issues. It explains why Boris Johnson was and remains a far more popular politician than Rishi Sunak. The obvious response to the above trends is to raise taxation on corporates, which has begun. Build more homes, which Labour is proposing, raise wages, which is also happening, and to raise interest rates. Another policy, which would make sense in a Labour policy dominated world would be to raise the birth rate. An aging population tends to be more conservative, so I expect to see numerous policies to promote increasing fertility. The most important one will be to get housing costs down, but I suspect other policies will also be implemented.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.russell-clark.com/subscribe

Being the reserve currency has enormous benefits. And in the entirety of financial history, the US is the first and only fiat reserve currency. Sterling, and any other reserve currencies derived their value from the ability to maintain their value to gold. With the two World Wars, the US came to be seen as the government most able to honour its commitments, and saw huge inflows of gold, but in the 1960s, gold started to flow back to Europe and elsewhere, and in essence, Nixon decided that higher interest rates needed to maintain the link to gold price was not worth the effort, and cut the link to gold price.

Moving from a gold based currency to a fiat currency has had enormous benefits for the US. First of all is that it no longer needs to ever run a current account surplus. That is it never needs to reduce consumption or imports, which is a huge political benefit. The norm since 1980 is for the US to have a current account deficit.

The US also does not need to balance the budget. The budget was balanced in 2000, but this was probably now seen as a tactical error on the part of the Democrats.

What I find most interesting about the transition from gold to US treasury backed financial system is how Asian nations, despite a long history of using gold, accepted this system. China and Japan have some of the largest foreign reserves in the world, but their holdings of gold are limited. Even India holds a relatively small amount of gold as foreign reserves.

Japan is the most interesting, where almost all of its foreign reserves are held as US treasuries. Unfortunately US treasury data on foreign holders only begins in 2000, but I have no reason not to believe the Japanese were big buyers in 1990s as well.

Why do the Japanese only buy treasuries? Well for most of the time since 1980, treasuries have been much better investments than gold. They offer an income stream, they are very liquid, and they have a natural pull to par, which means that there is never a need to book a loss - which will have powerful appeal to bureaucrats. From 1980 to 2000 long dated treasuries consistently outperformed gold, while from 2000 its has been far more of mixed bag.

Typically when people talk about reserve currency status, they talk about the size of the US economy or its military might, and basically imply that this can never end, so US dollar reserve status is forever. I think about the US dollar as a reserve currency I think it is something more akin to Microsoft, or Google. The product is not that good, the management is of debatable quality, but because everyone else uses it, its just too hard to switch. Given the infrastructure, and ease of using the US dollar for almost all financial transactions, why would anyone bother to use a different system? And even as US trade deficits exploded this just left more money for Asian exporters to recycle back into treasuries. The flywheel worked for all parties.

As pointed out in the last post, the US itself has started the process of creating a parallel financial system, by basically trying and failing to cut off Russian energy exports from the US financial system. For years the Russian wanted to price their oil in non-US dollar form, and made little headway, but the US basically did the job for them.

What would be the next step in the US dismantling the US centric financial system? For years I have wondered why the Hong Kong dollar has remained pegged to the US dollar. Why not just repeg to Chinese Yuan? Hong Kong could then sell large chunks of its foreign holdings, and reducing the scope of the US to influence trade in HK.

Of course changing from USD to peg to a CNY peg would be hassle for all the existing contracts and present financial and legal problems, which no doubt would fan more resentment of Beijing in Hong Kong. A far better solution for Beijing would be for the US government to begin sanctioning HK businesses, and changing the legal status of HK, a process that has begun under the Trump administration. All this involves doing is China integrating Hong Kong into its political system, and the US will predictably react. It is hard to see how this process could be reversed.

The problem for the US is that Russia has been cut off from the US financial system, and not imploded. That makes the fear of sanctions more tolerable. The Euro/Ruble exchange rate, which is as a good of as a measure for Russian economic health shows that the sanctions have had an effect, but not as dramatic as hoped. That is there is life after sanctions.

The political calculation for US attitude towards China is now very difficult. The more financial sanctions that it applies to China, the more it weakens the case for the US treasury as a reserve asset, but without applying sanctions, China has a chance to continue to grow to be the largest economy in the world. We can already see a change in behaviour in Asian governments. Vietnam has been a huge beneficiary of the move away from China. It now runs a huge trade surplus with the US. This is larger than Japan.

But we do not see Vietnam accumulating treasuries likes South Korea, Japan or China.

There is no guarantee that all this money will end up in gold. But whenever I see GLD/TLT trade well, I feel that the US is losing ground.

As mentioned previously, the US politically and culturally probably feels compelled to defend its position at the largest economy in the world. Can it do this without losing its special status as the reserve currency of the world? Without a political collapse in China, I doubt it.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.russell-clark.com/subscribe

One thing I struggle with is the market’s view of Chinese policy. The almost universal view of the world is that the Chinese communist party is exerting more and more influence over the economy, and that this makes China almost uninvestible. If you believe that China is turning communist, then it’s only a matter of time before the landlords are rounded up and shot, and the Chinese army starts invading its neighbours to spread the communist gospel. This is where the logic of current thinking in the West on China naturally leads. This seems wrong to me.

What seems far more likely is that the China and US disagree over who should have the largest economy in the world. The US has been the number one economy for over a century, and politically and culturally is very much of the belief that this should continue. China, as far as it has a policy, targets China becoming a middle income nation. The issue is of course, with a population four times larger than the US, means that the US needs to ensure that the average Chinese person remains only one quarter wealthy as the average American. 2011 was when fears of China overtaking the US probably peaked. As the Economist shows, Goldman Sachs thought China would overtake the US in 2026 in 2011. This has been pushed back to 2035 by Goldmans, while Capital Economics predicts this will never happen. I think China is accepting short term econmic pain to help conjure a non-US dollar financial system into existance.

The issue is that like Japan in 1980s, even if China suddenly became democratic, it is hard to see how Americans could ever accept China having a larger economy. If you look at US-Japanese relations in the 1980s it was all about how to restrain Japanese economic might, even with Japan being democratic and staunch US ally. Given the history of China relations with the West, relative economic decline is not political acceptable in China. This leaves China with only one option, to replace the US financial system with it own system. Strangely, China seems to me to be making enormous progress in this aim.

First of all, with Russia’s invasion of Ukraine, the West looked to isolate and destroy the Russian economy. This policy has signally failed, with Russian exports of energy to the rest of the world remaining stable. This trade is largely conducted outside of the US dollar financial system, not only for energy products, but for the shipping of these assets too. Russia exports 10% of total oil exports, all of which now needs to be outside of the US financial system. The recipients of this oil, must also have the financial system in place to handle this trade, meaning that the non-US dollar financial infrastructure is now in place in major nations such as India, China and Brazil to name a few.

Secondly, to reduce Chinese influence in the global economy, you would need to see Chinese imports shrinking. Despite nearly 7 years of tariffs and other political pressures on China, including a collapsing property market, Chinese imports still remain well above 2016 lows.

I also like the GLD/TLT trade as natural consequence of setting up an alternative financial system to the US should see natural flows away from treasuries to gold or alternative reserve assets. It continues to perform well.

I think the swing factor for a future financial system is India. With the largest population in the world, it faces the same long term issues with the US as China. Does India wish to retain strategic autonomy to grow as it wishes? If so, then its national interest more closely align with China, and the building of an alternative financial system to the current US centric system. It has been a keen buyer of Russian energy, so by extension is supporting this proto financial system.

The US also does itself no favours by showing no political will or ability to control fiscal deficits. Why are you buying treasuries when the US government shows no ability to collect the revenues to service it?

A study of history finds that the establishment (read the West) always underestimates the ability of contenders. The American Revolutionary Army, Napoleon, the Red Army, the PLA were all seen as unsophisticated weak contenders until they were not. And almost all were driven by the conviction they were fighting an unfair system. To me, the US takes its financial position for granted. Without some change, this proto alternative financial system will keep growing until at some point change will be forced on the US. Given the entrenched interest in the US corporate sector to avoid taxation, and the support this has in the Republican Party, crisis seem inevitable to me.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.russell-clark.com/subscribe

One of the factors that was identified as a cause of the Japanese bubble economy was the intercompany dealings of Japanese conglomerates - keiretsu (系列). Broadly speaking, they were groups of companies, often centred around banks, that helped each other out, and often had cross shareholdings in each other. Korean chaebol (재벌) are very similar. Keiretsu banks often lent to other keiretsu members at favourable rates. There was also a great deal of cross shareholder ownership, which protected control, and reduced the amount of capital needed in these businesses. When the Plaza accord led the Yen to soar, BOJ stimulated to offset the deflationary pressures and the banks soared. The Topix Bank index rose 700% from 1984 to 1989.

After the bubble economy burst, the cross shareholding structure came under severe criticism, and with the failure of many banks, the core keiretsu structure was problematic. Banks came under pressure to sell their shareholdings into the market. Japan’s biggest bank, Mitsubishi UFJ Group, is still selling down its holdings even today. All the big banks have similar experience, and the slide below gives an idea of the scale of selling.

This put Japanese banks in a difficult situation. For MUFG, the value of these other assets (cross shareholdings) were greater than the equity in the bank. In 2002, MUFG has 9 trillion of Yen in equity holdings compared to 3 trillion of equity. Banks were better considered leveraged Nikkei ETFs than banks. By being forced sellers of equities, this created downward pressure on prices, which would create pressure on the balance sheet, in a vicious circle.

This balance sheet weakness then lead banks to issue shares to boost equity. From 2002 to 2010, the share count at MUFG grew more than 300%.

The idea behind forcing banks to sell equity holdings was to allow third parties to come in and encourage free market pricing and behaviour. While good idea in practice, the BOJ became impatient with equity weakness. In 2013, the BOJ became big buyers of ETFs linked to the Nikkei and Topix. Current BOJ assets are put at 37 trillion (on a cost basis). MUFG - largest bank in Japan has peak equity assets of 9 trillion. It seems that the BOJ has basically replaced the commercial banks as key shareholders of Japan Inc.

So the BOJ has managed to soak up the unwinding of the cross shareholdings by becoming a large holder of Japanese equities. This seems to somewhat defeat the purpose. It has also transferred leverage from the private sector to the public sector. The BOJ balance sheet shows assets of 741 trillion yen supported by equity of 5 trillion yen.

Of course, this has had the very pleasing outcome of allowing the Nikkei to take out its all time high set in 1989.

It has also had the pleasing effect of separating the idea of growing production from asset values. Japan industrial production remains well below peaks.

Likewise, nominal GDP and GDP per capita have become divorced from the stock market.

The BOJ has also managed to create one of the most extraordinary charts in finance. The old BOJ that defended living standards and the currency was able to get gold in Yen in 2000 back to levels seen in the early 1970s. The new BOJ has managed to get gold to skyrocket in Yen terms.

The BOJ policy is trying to recreate the “magic” of the bubble economy. The problem is that is only affecting assets prices, and is not leading to rising wages, or rising industrial output. How much more public wealth needs to be transferred to private hands?

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.russell-clark.com/subscribe

This is a free preview of a paid episode. To hear more, visit www.russell-clark.com

The key trade of GLD/TLT continues to recover from the sell off seen in later 2023.

And key lead indicator on treasuries, 30 year JGBs, still points to higher treasury yields.

But elsewhere in markets, liquidity still reigns supreme.

Many days I still feel like a young man, with much to learn. But then other times, when I muse on the changes that I have seen and lived through, I realise I am more likely the adult in the room. One thing I love about the UK is that its politics is so open and competitive, but also winner takes all. If you capture the House of Commons, you can pretty much do whatever you want (see Boris Johnson). Looking at announced Labour Policies, it plans to rejuvenate the NHS (largest employer in the UK), build 1.5m homes (a chunky number in a country of 28m households), raising corporation tax and a number of other policies. The home building one I find intriguing. The cost of buying a home in 1970s was very low, I usually thought because interest rates were so high, but as usual, strong supply was probably a more important reason.

Increasing home building seems like a great policy, and in line with the needs of Labour’s core voters, the young. I just wonder where the workers are going to come from? Unemployment in the UK is already at levels seen when the UK was building 300k homes a year as the future labour government is proposing. With mass immigration a no-go policy, it seems a distinctly “wage inflationary” policy.

BOE boss, Andrew Bailey made it clear that rising wages was a key cause for inflation. But wages in the UK are well below that of the US, and for tradesmen below that in Australia. Labour policy looks like to put upward pressure on wages. The BOE certainly seems to have noticed. They are proposing selling their entire bond portfolio

The BOE has often left me dumbfounded. Sterling has fallen from 2 USD to 1 GBP to 1.2 USD to 1 GBP since the GFC, something I would consider inflationary.

Likewise, soaring house prices to income I would also consider inflationary.

Given the weak pound, and rising house prices relative to incomes, the burden on workers became too much, and wages began to rise.

Rising wages were eventually seen as a reason to raise interest rates. Of course, if BOE had raised rates earlier to keep sterling strong, and house price in check, then current increase would have been unnecessary (policies that China enacted - and has not had inflation or interest rate increases).

In economist speak, the BOE has a revealed preference of high asset prices and weak wages. In realpolitik speak, I think their is an entrenched bias to try and restrain the success of left wing parties through tight monetary policy. Or in other words, central banks try to engineer recessions to keep the supply of labour loose. Giving the political liability that has become the Conservative Party, I think we can expect 10 years of pro-labour policy so buying 10 year UK gilts at 4.2% strikes me as very foolhardy indeed. 10% looks more likely to me.

War is politics by other means. So is monetary policy.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.russell-clark.com/subscribe