Japanese officials including those at the Bank of Japan have been acting very erratic of late, eschewing the more traditional financial setting of vagueness. First it was NIRP that immediately blew up in their face, leading to very loud rumors of additional bank “stimulus” to offset NIRP only to have the BoJ instead do nothing at its last policy meeting. They are behaving as if both desperate and increasingly unsure what to do about it.

Yesterday it was Japanese Finance Minister Tara Aso’s turn to wander far from the polished script. He outright threatened intervention rather than played coyly about how the government and BoJ would “act appropriately” as has been the standard cliché. Not only that, Minister Aso repeated his strong words again today. Specifically mentioning “one-sided moves”, it is unusually clear that he (speaking for the government) does not think the recent appreciation in yen is proper (my word).

ABOOK May 2016 Japan Yen ABOOK May 2016 Japan Yen Longer

While it is easy to consider Aso’s rejection of yen appreciation only under Abenomics, meaning the specific intention of QQE to devalue the yen as some kind of export “stimulus”, there is much more going on here. After having successfully pushed the yen wherever it wanted (to no avail, of course, but that isn’t relevant to orthodox economists’ calculations that are devoted only to past correlations not actual results) the Bank of Japan now finds itself unable to get much beyond very temporary bursts. When the BoJ unleashed NIRP in late January, the yen did respond by falling back below 121.00 but only a week later it was back up to 116.00 and then 111.00 by February 11 despite it.

In other words, NIRP “somehow” did nothing for the yen but cost the BoJ a great deal in money market disruption and growing (still) dysfunction. From that view, you can appreciate Aso’s “one-sided” charge as all of sudden Japanese officials are disrobed very publicly, turned powerless as if there is some greater force at work.

Obviously, the timing of these moves gives that away. This all took place during the global liquidations of January and February, suggesting (very strongly) that the yen and Japanese financial resources were a full part of them. Rather than being a mystery, this is not the first time that a well-respected even feared foreign central bank has fallen victim to the “dollar”; since the start of 2015 it has become an almost regular occurrence. First the SNB was forced off its peg, then the PBOC succumbed in spectacular fashion. The “dollar” has now, apparently, set its sights upon Japan.

I think it is important to understand why and how Japan fits into the “dollar short” and thus the growing “dollar shortage.” I published an anecdote this weekend behind our paywall that examines one aspect of it that I believe is important enough for these purposes to republish in part here. I still find China as perhaps the primary source of potential general and global disturbance, but I also get the growing sense that Japan as separate from China bears very close scrutiny in that same regard. I find evidence for that in funding markets that barely budged after February 11 in direct, sustained contradiction to the hard, 180 degree shift in sentiment that spread throughout risk markets and even economic commentary.

ABOOK May 2016 Japan Yen Eurodollar Futures


The Japanese maybe more than any nationality were betting on the global recovery. That meant not just an economic rebound but perhaps more so the financial re-institution of the eurodollar standard in close approximation to what it had been prior to 2007. I doubt that anyone believed that the “dollar” would be rebuilt exactly as it was, but at least in the earliest stages of recovery after the panic and with global central banks demonstrating their commitments there was real possibility of the eurodollar coming out systemically similar if at least leaner and wiser.

The events of 2011 were such an abrupt intrusion into that fantasy and in so many different ways. In Europe, the renewed disruption was more obvious because the whole world was forced back into the maelstrom in the most public fashion. That did not mean, however, it was the only part of the system that ran into trouble. The Japanese have been a significant part of eurodollars going back to their earliest days in the late fifties. It really isn’t surprising to see the post-2008 reconstitution attempt take on the flavor of Tokyo.

On May 7, 2010, Mitsubishi UFJ and Morgan Stanley unleashed their much-heralded joint venture. Born out of the worst days of the panic, in November 2008 MUFJ injected $9 billion in emergency “capital” (for a 21% stake) into Morgan Stanley forming the basis of Japan’s biggest bank’s search for greater global (“dollar”) exposure. There is no way the timing was intentional, but you really have to appreciate the launch date in the context of the eurodollar’s aborted restart: the day right after the flash crash in the US and three days before the first (and related) SMP bailout by the ECB. In other words, MUFJ Morgan Stanley launched at exactly the moment the “dollar” system (global wholesale finance) fell back into serious trouble.

When these kinds of combinations are made tangling up wholesale firms with traditional style banks of different currency and national systems, not much if any thought is given to what that actually means and how it comes about. On the surface it seems relatively easy, where the IB firm in Morgan Stanley’s role flexes its rolodex to find prospective deals, puts together the numbers and negotiations, and then funds it all with the backroom approval of the bank. It’s far more complicated than that even where everything remains under one domestic grouping, but it’s much more so where “financing” starts in yen and transposes into “dollars” and maybe further into something else (or several somethings).

MUFJ Morgan Stanley hit that wall straight away. Less than a year after launch, the joint venture booked a ¥145 billion loss, with nearly ¥100 billion of that in the January-March 2011 quarter. Where did these missteps originate?

Officials of the joint venture at the news conference declined to provide details on the nature of the loss-making transactions, but, according to people familiar with the matter, the losses were mainly from “swaptions”—a complex financial product for buying and selling rights to swap fixed and variable interest rates…


Mitsubishi UFJ Securities had increased its exposure to derivatives for several years prior to the joint venture, and continued to raise the exposure after the joint venture with Morgan Stanley in May, even though Morgan Stanley is considered to have better risk management. The brokerage officials said both banks had discussed these positions as part of their due diligence and had agreed to keep them within a certain limit.

Whenever the media gets to talking about derivatives the commentary doesn’t take on much depth, and most people conceive of them no differently as if they were some kind of investment like a bond if only more complex and mathematical. In reality, as I try to show constantly, derivative transactions particularly in and among banks aren’t investments at all but funding. In this case, given the circumstances of that time and then the losses, it was surely launching into the renewed “dollar” storm that left MUFJ Morgan Stanley stung; the key term in the quote above is “swaptions.”

I last brought up the idea of swaptions in reviewing some particulars about China and its relation to the “dollar” a few weeks ago:

In April 2013, the CNY exchange was appreciating from about 6.20 to as high as 6.12 by that June (which meant that it would have made more sense to buy a 3- or even 6-month RMB forward and a related currency swaption for around that maturity, but I am getting too far ahead). If we assume that the price of the swap was 6.17 and the principle value was $100 million, that means upon maturity in April 2016 the multination is expected to deliver RMB 617 million, which is exactly the same amount as it received three years earlier. To rollover the swap, however, would require a refiguring to the current exchange, which is 6.50 to 6.46.

Swaptions, as the name itself implies, are the marriage of swaps and options – an option for a swap. While it’s certainly a more complex contract in an already ridiculously complex system, in general currency terms (as briefly mentioned in the example above) a swaption is just an altered or potentially deferred funding commitment with different characteristics and risks. If you were, to use the Chinese example above, of the belief that the RMB was going to continue upward and wrote the swaption for six months forward only to find that you were wrong about the direction, and not just wrong but really wrong, you are forced to fund that derivative commitment (the swap part) at option expiration at a very unfavorable price. If that disfavor is in yuan there isn’t too much pain; in “dollars” is a different story.

Like the London whale of early 2012, MUFJ Morgan Stanley seems very likely to have thought very wrong about the direction of the “dollar” not just in terms of the systemic decay but the more immediate problems of 2010 and really 2011. It seems likely (and I have to be careful to point out that this is speculation on my part since there is no “confession” or hard data to confirm or deny, only partial media reports that discuss “derivatives” or in the rare case as shown above with actual reference to “swaptions”) MUFJ Morgan Stanley was writing delayed funding commitments in “dollars” at a very bad moment to be doing so. When the swaptions were exercised starting around Q1 2011, this “short dollar” position was far, far more “expensive” than ever anticipated (even with the eventual QE2).

On December 21, 2010, the Fed and Bank of Japan announced they had extended the dollar swap line reinstituted in May 2010 past the original January 2011 expiration. The swap line was extended again at the end of June 2011. By early August, during what would be the broadest global liquidations associated with the 2011 “dollar shortage”, the yen and Japan were once again right at the forefront of illiquidity. From August 14, 2011:

Yen currency-swap spreads expanded to the widest level since the collapse of Lehman Brothers Holdings Inc. froze credit markets in 2008, signaling that banks are facing tighter dollar funding.
Investors exchanging yen for dollars are accepting interest payments 54 basis points, or 0.54 percentage point, below the London Interbank-Offered Rate for the Japanese currency in a one-year swap, according to Bloomberg data, the lowest since October 2008…


Bank of Japan Governor Masaaki Shirakawa said last week that the central bank may provide banks with foreign currencies should domestic financial companies face difficulty in funding.

But where European and American banks read the events of 2011 as beginning of the end, there is every reason to believe that Japanese banks did the opposite. In many ways, what choice did they have? In the year of the tsunami and then another financial wave, staying in Japan full of QE was a losing proposition. Unlike “dollars”, there was no shortage of anecdotes that the eurodollar system was shifting from European-centric (in terms of the banks supplying the balance sheet capacities, not where they did so) to Asian-centric in the years following 2011 (if not before, as MUFJ’s reference to its growing derivatives book suggests).

Perhaps the apex of this Asian shift was MUFJ Morgan Stanley’s nearly solo involvement in Suntory Holdings’ January 2014 acquisition of Beam, Inc. At $13.6 billion overall, Suntory put up ¥600 billion of its own cash and took on ¥1 trillion in bridge-financing that curiously was not syndicated as is usual but financed entirely by Bank of Tokyo-Mitsubishi. For Suntory, it was the reality of Japan:

“Companies like Suntory have no choice but to go abroad because of the aging population in Japan,” Mitsushige Akino, chief fund manager at Ichiyoshi Asset Management Co. in Tokyo, said by telephone today. “They have acquired a blue-chip company with stable cash flow, so overall it is positive.”

But what is true for their purchase of Beam is also true of MUFJ and it supplying “dollars” to get it done; they see Japan’s economy for what it is, not what the Bank of Japan wants it to be. Thus, they are “forced” overseas on that count alone but even more so under QE’s and then QQE. They have yen and have no need to borrow it. But they don’t have “dollars” and thus have used these kinds of conduits and Wall Street core “competencies” to attain them rather than the traditional concepts of deposits and “capital flows.” Japan went all in on wholesale “dollar” rebirth and kept at it right through at least 2014.

As I wrote last week, this is not quite the carry trade as it represents some key differences:

To accomplish more overseas activity, using the carry trade basis or schematic as an example, Japanese banks already have the first part in hand as bank reserves. What they lack is the swap into dollars. Therefore, from the perspective of Japanese banks, their “carry trade” is not to first “borrow yen”, they have all the yen they might ever need, but to “borrow dollars.” It is an important distinction that is almost never appreciated.

It is impossible to know for sure exactly how big of a funding gap Japanese banks have made for themselves because the mainstream works in accounting relevant to the world of the 1950’s. We can make some rough assumptions of a shortage of “dollars” based on some ancillary indications, especially prices like record negative cross currency basis swaps. Like 2011, it is very likely that Japanese banks have found themselves once more in the wrong direction facing a “dollar” they didn’t think would happen. After all, when MUFJ closed its financing deal for Suntory in January 2014 Ben Bernanke had just started to taper QE because, he promised, everything was good and would only become much more so in relatively short order. Janet Yellen would continue in her first months claiming financial “resilience” at nearly every opportunity.

Instead, as we well know, the “dollar” went the other way. If you have been, as MUFJ, seriously short even in a synthetic, carry trade-like position of these kinds of swaptions and basis swap funding arrangements it has been a bad place to be and a position that only gets worse (more illiquid).

All the BOJ “stimulus” in the world can’t fix a “dollar shortage.”  It can, however, make it worse for Japanese banks long since participated in it.