Gregory Noble wrote:

From: Gregory Noble
Date: 2012/02/22

> my main concern has been to
> try to understand what factors might be driving Prime Minister Noda to
> persist in what appears to be the fool's errand of raising taxes, Me,
> too. Here are what I see as the possibilities:

1) Noda thinks he can get the tax hike and this achievement will keep him as PM and win the election for the DPJ

2) Noda thinks he can get the tax hike, but at the expense of his own post and defeat for the DPJ; however, it is so necessary and urgent that he willing to fall on his sword and take his party with him

3) Noda thinks he won't get the tax hike and his party will lose power, but the fight over it will make its eventual passage come sooner than it otherwise would have

4) Noda recognizes that he won't get the tax hike and that the second consecutive defeat of the DPJ over this issue will make other politicians more reluctant to pass it in the future, but he wants to do it anyway because he believes in it.

The first three are reasonable choices for a political leader even if they turn out to be miscalculations. The fourth makes no sense to me. My semi-informed guess is that option 2 is the predominant feeling among Noda's top allies.

> If banks take corporate governance
> and thus risk management more seriously (instead of just relying on
> government promises or
blandishments),
> won't they have to reduce their holdings of JGBs, or
at
> least slow down their purchases, thus forcing the Japanese government
> to rely more on foreign
investors,
> who would demand a much higher risk premium?

The banks are awash in cash and they're having a tough time finding other assets to buy. Deposits keep piling up despite the incredibly low interest rates being paid on deposits (just 0.154% for a ten-year $30,000 certificate of deposit). Meanwhile, households and firms are not borrowing despite ultra-cheap lending rate (a third of all oustanding loans charge less than 1%; 11% of loans charge less than 0.5%). So, here’s the end result. Back in 1994, banks lent out slightly more than they took in via deposits. Today, the banks have 40% more in deposits than they have been able to lend out. At the end of 2011, the gap between deposits and loans added up to ¥171 trillion, a bit more than a third of GDP.
In order to pay even a modicum of interest to depositors, the banks have to find some other interest-bearing assets. One of their answers is JGBs.
As a percentage of total bank assets, JGBs have risen from 4% back in 1994 to 19% today. JGBs are also attractive to banks because, as a risk-free asset under international rules, they don’t require banks to raise the capital required to back up loans. Over the last 12 months, total bank assets increased by 3.5% but holdings of JGBs increased by 14%.
JGBs do present a potential danger for both the banks and the Bank of Japan (BOJ). If interest rates on JGBs were to spike, the banks would suffer a very sizeable capital loss (the market value of already-existing bonds declines when interest rates
rise).* BOJ chief Shirakawa said that a 1 percentage point rise in bond rates would mean a Y3.5 trillion loss for the major banks and a Y2.8 trillon loss for the regional banks. So, banks face a dilemma. If they don’t buy JGBs, they don’t earn enough to pay off depositors. If they do buy them, they have to hope that interest rates remain low for much longer. In fact, because the BOJ bond-buying program has sent bond rates to record lows (three-year government bonds now yield no more than overnight money), the price of bonds has increased. So, banks have actually made capital gains on their existing portfolio.
During 2011, Bank of Tokyo-Mitsubishi UFJ created a task force that took six months to put together a plan on what to do if JGB interest rates started rising sharply. The bank believes that, if Japan starts running a current account deficit—which it worries could happen as early as 2016—then interest rates might spike from today’s 1% to as much as 3.5%.
If so, the bank’s plan is to sell JGBs with a ten-year maturity and put the money into government notes with a one-year maturity. The latter would involve a smaller fall in value in case of a rise in interest rates. The upshot is that the plan would not reduce the volume of JGB holdings, but simply shift the portfolio to bonds with a shorter maturity and thus less risk of a capital loss in the event of an interest rate hike. The government would still be able to sell all the bonds it issued.. All this puts pressure on the BOJ to keep nominal rates low to maintain bank stability, at least until deflation is overcome.

Foreign assets are also very risky. Suppose the yen/$ doubles in value from Y140/$ to Y70. In that case, a $1,000 US Treasury bond bought for Y140,000 is now worth only Y70,000.
Foreign investors have increased both their share of JGB holdings (now about 8%, I think) and their role in daily trades. Far from demanding a risk premium, they are buying even though rates are very low. For most of the dozen years since 1999, the 10-year JGB has yielded between 1.2% and 1.8%. Now, it's around 1%.
I hope this helps.