There is evidence that somebody is intent on pushing the Nikkei substantially higher. This effort, which started early in March, must be costing a pretty yen by now; which raises the question why it is being done. One possible answer is given here . If correct, it raises the potential for major problems if the ramp fails to succeed.

Indications of a ramp

I do an early morning 2 minute broadcast on the markets on local radio intended for commuters on their way in to the city. The time of the broadcast is just 1 hour before the stock market in Tokyo closes. What is happening there early in the global rading day is one of the points I mention regularly. From the beginning of March I noticed something new in the behaviour of the Tokyo market. As regular as clockwork, the close would be substantially higher than the state of the market an hour be fore the close.. Even when the market had been caught in a narrow band the whole day in Tokyo, prices would shoot up suddenly right at the end of trade, raising the Nikkei by a 100 and, on occasion, even 200 points, during the last few minutes. If the market had been up an hour before the close, it shot up even more at the end.

That, I believe, is typically the way someone would behave if he intended to force the market gradually higher. Do not push it higher right throughout the day – that would be very expensive on a day when sellers abound – but take advantage of the final few minutes only. Come in aggressively when normal demand has slowed just before the close; take out a few offers in the large index stocks and suddenly the index begins to move. Perhaps, if you are lucky, a few other prospective buyers will see this and also grab some other shares at the offer, adding impetus to your efforts.

If one can achieve a strong close, this will be noticed and people who are in the market to buy would have their bids in early the next morning and so help to establish a strong open for the market – which hopefully lasts through the day until you can come in again right at the end to give the final push for another strong close.

This has been going on since the beginning of the month and it must have taken a good deal of money to bring the index from just below 14000 points to well above 16000 points by Friday 19 March for an increase of more than 17%. Even if this was done with care and economy, whoever is doing this has deep pockets.

The question is: Why do it?

Why should somebody be trying to ramp the Nikkei?

A possible answer can be found in the matters discussed in 'A Japanese Tale' and its sequel. The case was put forward that there is a substantial shortfall in collateral for loans and mortgages in the Japanese banking system, perhaps as much as $2,5 trillion. Of this amount, recent estimates in the media claim that more than $1 trillion has already surfaced either as outright bad debt or as non-performing loans. In other words, that as much or even more than $1 trillion of the $7 trillion loan book of Japanese banks are probably already unrecoverable.

$1 trillion – just a nice round figure, but what does it really mean? And following on that, is something that happens in Japan really of any consequence to the rest of the world?

Let us explore these two questions a little further.

The American economy as measured by GDP is somewhere in the vicinity of $6,5 trillion and the Japanese GDP is about $3,5 trillion. To place this in a global perspective, the Japanese economy is reported to be about 16% of the global economy – with the US having a 30% bite at the really Big Apple. Combined, these two countries account for almost half the global economy, leaving the other 54% to be divided among the other 150 odd countries that make up the rest of the world.

Now 16% may not sound like much to get excited about, but Japan's contribution to the global economy is larger than that of Great Britain and France combined. To put it another way, Japan's population is about 120 million people – a mere 2% of the world population of say 6 billion people. Yet, on average Japanese produce 8 times more than the people in the rest of the world – not just 8% or even 80% more, but 800% more than the world average! Busy, busy, busy!

Americans, generally perceived to be a very productive nation, with perhaps 280 million people – 4,7% of world population – are responsible for 30% of world production. Which means they are 'only' 6,4 times as productive as the world average. The 'only' is because the Japanese are about 25% more productive per person than people living in the US!

Apart from their high productivity, Japanese have always been great savers. Household savings in Japan are reputed to amount to $12 trillion dollars. Again the amount is so large that it makes more sense to place it in perspective by looking at what each Japanese has saved, on average. The amount is about $100 000 for every man, woman and child in Japan. In other words, on average, a Japanese family of four – two parents and two children – have savings that amount to $400 000. Note carefully; this amount does not describe assets – that may include a house, a car, furniture and investments on the stock exchange – it consist of pure cash savings in the form of deposits in a savings account!

Obviously, older people have more savings per person than a young married couple just starting out in life, but the average is still so high as to be just about unimaginable for people living outside Japan. On the other hand, retired Japanese – of which there are a large number, as Japan has on average many more older people than the rest of the world – need a very large nest egg if they are to survive on interest income of less than 1% p.a. on their savings!

Apart from their high internal savings rate, Japan has become a very wealthy nation through their exports, which earn far more foreign currency than what they spend on imports. Their trade balance with the rest of the world – including the US – has been positive since time immemorial, or at least back to the early 1960's. Which, for the majority of today's traders is time immemorial!

In the process they acquired a very large sum of foreign currency of which a major portion is invested in the US and elsewhere, either as financial investments in capital and equity markets or in factories that take advantage of lower production costs outside Japan.

In other words, to describe the position in terms that make sense of the large numbers, the following applies to Japan: in having to write off as much as $1 trillion in bad debt and perhaps even more, Japan as a country faces the prospect of saying goodbye to about 28% of their national annual income, which is about $3,5 trillion. Now, you the reader, should spend a moment and think what financial position you and your family would find yourself in if you had suffered an irrecoverable loss equal to 28% of your gross annual income?

What would that do to your standard of living and how long would it be before you would again be free of the burden that had been placed upon you, so that you could return to the kind of life you enjoyed before the calamity struck?

Of course, in Japan that sort of burden is not (yet) spread evenly over the population, but is concentrated in the banks, who somehow have to make good on the losses they are facing through unrecoverable loans that have far too little collateral to make up the amount of the bad loan.

At the moment private individuals are not yet overly concerned about the precarious situation of the banks, as they still have government guarantees that safeguard every yen of their savings. It is the banks that are in trouble, because the bad loans have to be written off against the bank's own capital and reserves. More on this later.

Time is running out

Two changes are on their way to affect this situation. Firstly, the current safety net for individuals has a limited duration – to the best of my knowledge, the unlimited guarantee of money on deposit ends when a new, limited guarantee takes effect on 1st April 2000. From that date, government will only assume liability for the first $100 000 of the amount on deposit in banks and other financial institutions. In other words, after that date the average family of four stands to lose as much as $300 000 – of their $400 000 in savings – if the bank system should fold.

Secondly, the Japanese government is budgeting a very large amount in the new financial year, starting in April, to assist the banks with their bad debt problem.

I would think that if a bank desired to obtain assistance under this program, they have to declare all losses and write-offs prior to some date in the new financial year, perhaps even by the end of their financial year on 31 March. For some banks the effect of doing so could be so severe that if they declared the true position of their finances, the bank could find itself unable to do any further business, as its capital base would be so eroded that the bank is effectively bankrupt.

What does this mean?

The ability of a bank to lend money is determined by many factors, prominent among which are the assets available to the bank – mainly deposits – and also the capital base of the bank. The latter is needed to cover the bank's depositors against the risk of a bad loan. Using a ratio that defines the probability of default for various categories of loans, the amount of capital available for the bank sets a ceiling for the amount that can be lent. If a default does arise, the loss must be made good from the bank's own capital – keeping depositor's funds protected. The bank's capital includes any reserves the bank may have accumulated. This reduction of the capital base after writing off a bad loan has the effect of lowering the ceiling on the amount than can be lent by the bank..

If a bank in Japan should acknowledge the full extent of its bad and non-performing loans, for example to claim government assistance – and if the situation is as extreme as what is hinted at – its capital base could be reduced to where it may no longer issue new loans and even to the extent that it is forced to call in existing loans. Then it can no longer function effectively as a bank..

Of course, the banks can continue as they have done in the past – make themselves look better than they are by concealing the true situation through all kinds of accounting maneuvers; which includes increasing the loans of insolvent debtors for the purpose of paying the interest on their loans, to avoid the loans being classified as non-performing! But if they do so, they undoubted cannot claim assistance from the government for these bad loans. A good example of being caught between a rock and a hard place!

Now we come to the reason why there could be an attempt to ramp the Nikkei for a strong close on 31 March.

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A matter of boosting capital reserves

Japanese banks have very large investments in the Japanese economy. They own large blocks of shares that were purchased during the hey-days of steep growth in the economy during the 60's and 70's. It has been reported that the average price of these holdings correspond to an index value of about 14000 points on the Nikkei Index.

Japanese regulations allow a bank to add any unrealized profit on its investments on the stock market to its capital reserves. For Japanese banks that are in trouble, a strong Nikkei towards the end of March will be a major advantage, as it would boost the bank's reserves by a substantial margin – the higher the Nikkei can close the month of March above the 14000 point level, the bigger the increase in the capital resources of the banks.

And the better their chances of survival beyond 31 March

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The Nikkei bottomed at 13921 points on March 2 – a level where the contribution to reserves from investments in the Nikkei are negligible at best.

From then on it improved at a steep rate to gain more than 17% by 19 March. At the beginning of March the banks had practically no unrealized profits on their stock portfolios. By the 19th of March their reserves had been boosted by about 17% of their total investment in the stock market – an absolutely massive improvement that should add many billions of dollars to their capital base, and one that can help them ride through a very difficult year end on 31 March.

On condition, of course, that the Nikkei at least maintains or perhaps further improves its level by then. If the Nikkei should trend downward towards the end of the month, the situation of the banks would worsen correspondingly as the index value approaches the level of 14000 points.

It was clear from intra-day behaviour that there was a force working to ramp the Nikkei from the beginning of March. By starting so early in the month, the intention clearly was to obtain the maximum effect over the full month. This calls for very deep pockets, but if the goal is survival then success would be worth every yen of the cost. The amount spent on pushing prices higher, large as it might be, still would be peanuts compared to the amount of the improvement in the banks' reserves if the effort is successful and the Nikkei can increase to say 17000-18000 by the end of March.

The mere fact that this effort was started so early and that a very large amount of money clearly has been made available for this purpose, must be perceived as a clear sign that the Japanese banks are now in severe trouble and are using all possible means to survive.

What lies ahead?

Not only must the banks try to qualify for government assistance, which require them to reveal their true situation with respect to bad loans, they also have to get their books in order and earn credibility before the start of the next financial year, in April 2000. From that date, individuals will no longer be as complacent about their deposits in the bank as they are at the moment, because from that date only the first $100 000 will be protected by the government umbrella.

Unless the banks can prove their health quite soon, and do so convincingly, there will be a run on the banks as 1999 nears its end – assisted by any Y2K fears that might ignite in Japan – when people withdraw funds from savings deposits to look for other less risky avenues of investment for their savings. Which should include some gold, of course.

Using estimates made earlier, the amount of funds on deposit in savings accounts that could leave the banks and other financial institutions for safer pastures could be of the order of ¾ of all savings. If each family left $100 000 of their savings in the banks, where its would be covered by the government umbrella, they would be looking for a new home for about $300 000. Therefore, of the estimated $12 trillion of household savings, perhaps as much as $8 trillion – 20% more than the US GDP and a substantial chunk of Wall Street's market capitalization – could be on the move. by late 1999 if Japanese banks fail to get their collective house into order. Even if only 10% of this amount actually goes on the move, it will be a tsunami through global financial markets.

Keep an eye on the Nikkei.

Any investor who is trying gauge the future of world financial markets in an attempt to evaluate the risk of his or her investments, should for the next few days carefully monitor the Nikkei index and also for any information about the Japanese banking system that comes out of Japan. If the Nikkei should collapse before Wednesday for any reason – say, the Dow takes a plunge or perhaps because there are simply too many shares on offer in Tokyo to sustain prices at current levels – the banks in Japan could find themselves in a most uncomfortable situation come reporting time.

Even if the Nikkei should close well above 14000 on the 31st of March, say at its current level near 16000 points, it is pure guesswork to try and anticipate what level for the Nikkei is really needed to get the majority of the banks onto safe ground. What is really required – 16 000 points, 18 000 points or 20 000 points? We cannot even begin to guess.

We don't know what would be a safe margin, but it is clear from the signs in the market and the effort going into the ramping that a month end value for the Nikkei too close to 14000 points or below may well be a prelude to disaster for Japanese banks.

And its effects won't be limited to Japan.

Japan is the world's banker, as touched upon in 'A Japanese Tale Revisited'. When your banker goes bust and starts to call in loans, it creates havoc for everyone who is in a tight spot, with a significant load of debt. Even if it is within your means to cope, having to suddenly pay back a large amount of money really ruins your standard of living for some time to come.

And if you cannot cope, then, of course, you go bust as well.

The daily chart of the Nikkei through to Thursday 25th March shows that the index reached resistance at the top of a 30-month bear channel on the 19th March. Line P has a value of about 16200 points and the rising trend line has resistance at 16400 points.

A break higher through resistance early this week would mean the banks are in the process of winning the day. However, if enough disappointed investors want to use this 17% jump in the Nikkei index to get out of the market – and they know they have to do so before month end – or if markets in the US take a dive, the Nikkei may find it difficult or impossible to break higher and could then fall much lower into the channel.

On Friday the Nikkei closed only 30 points higher after trading in a narrow range about the breakeven point. So, it all depends on what the Nikkei does from Monday to Wednesday this week.

29 March 1999

© March 1999 Daan Joubert

daanj@mweb.co.za