CURRENCY WARS - Hot Money into China

China's "Hot Money" Time-Bomb 03-11-13 Zero Hedge

Over the weekend, FT noted that China’s central bank reported that companies and individuals sold RMB 684 billion ($109 billion) worth of foreign exchange and bought an equivalent amount of Chinese currency in January, a record for a single month. On the chart below, please point out the Chinese "hot-money" inflationary ticking time bomb (hint: highlighted).

Why "time bomb"? For the answer, we go to the simplest definition of inflation, which is as follows: "when too much money chases too few goods and services."

In January, the money in domestic circulation via FX conduits just soared by a record amount, without a comparable increase in goods and services. All else equal, this is called the "hot money" effect, and manifests itself in a surge in Chinese inflation usually with a 3 month lag to whenever the Chairsatan starts experiment with the US monetary base.

January just happens to be about three months after Bernanke announced QEternity. It also explains why China has been doing everything in its power in the past several weeks to reduce excess liquidity in its economy, and to telegraph that suddenly its economy is once again slowing down drastically, while inflation is ramping up.

Take home: China has had enough with the global, and certainly Japanese, reflation efforts as further proven by last week's repeated warnings by the entire Chinese political elite against currency wars.

How much longer will the "developed world" be able to push Chinese inflation before, like in 2011, it all just snaps?

VOLUME - Completely Disconnected from Market Action

NYSE Matched Volume Drops To New Decade Low In February 03-11-13 Zero Hedge

Someone is obviously not complying with the central-planner script and rotating fast enough into equities. In February, total NYSE matched volume (defined as the number of shares of equity securities and exchange-traded products executed on the NYSE Group's exchanges), dropped 13.6% from a year ago, 9.4% from January, and at 20.5 billion shares in the 19 trading days of February, represents a fresh decade low for the exchange (source).

Perhaps it is time for central planning to take it up a level and restore some more confidence in equities as an asset class, by having the Chairman release some 30 minutes before the start of trading what the closing price for the DJIA will be every day. Only this way can one truly the Fed's dedication to getting every hotdog vendor back into the ponzi scheme that are global stocks, which unlike the last time the Fed lost control and saw the S&P cut in half in a few months, will never happen again. Cause this time it's different.

OFFSHORE CASH - Politicians Won't Be Able To Keep Their Hands off These Cash Hoards

More U.S. Profits Parked Abroad, Saving on Taxes 03-10-13 WSJ

U.S. companies are making record profits. And more of the money is staying offshore, and lightly taxed.

A Wall Street Journal analysis of

• 60 big U.S. companies
• Parked a total of $166 billion offshore last year.
• That shielded more than 40% of their annual profits from U.S. taxes, though it left the money off-limits for paying
  • Dividends,
  • Buying back shares or
  • Making investments in the U.S.
• The 60 companies were chosen for the analysis because each of them had held at least $5 billion offshore in 2011.

The practice is a result of U.S. tax rules that create incentives for companies to maximize the earnings, and holdings, of foreign subsidiaries. The law generally allows companies to not record or pay taxes on profits earned by overseas subsidiaries if the money isn't brought back to the U.S.

Big American companies are booking more of their sales in faster-growing foreign markets. But companies also are moving more of their earnings overseas by assigning valuable patents and licenses to foreign units.

Untaxed foreign earnings are part of a contentious debate over U.S. fiscal policy and tax code. The current system attracts criticism from many points of view. Business groups want the U.S. to tax profit based on where it is generated, as many countries do, rather than globally, as the U.S. does now. Moreover, they point out, tax rates are higher in the U.S. than in many other nations, putting American companies at a disadvantage. Others say that the growing cash hoards often are the result of sophisticated corporate maneuvers to shift profits to low-tax countries.

Within the group of 60 companies, the Journal found

10 parked more earnings offshore last year than they generated for their bottom lines.

They include Abbott Laboratories, whose store of untaxed overseas earnings rose by $8.1 billion, to $40 billion. The increase exceeded the pharmaceutical maker's net income of $6 billion, which was weighed down by a $1.4 billion charge related to early repayment of debt. Including that charge, Abbott reported a pretax loss on its U.S. operations. An Abbott spokesman declined to comment.

Honeywell International HON +2.12%Inc. boosted its store of untaxed earnings held by its offshore subsidiaries and earmarked for foreign investment by $3.5 billion last year to $11.6 billion, a rise equal to the industrial conglomerate's annual profit, excluding a pension adjustment. The company said the increase resulted from $2.1 billion of pretax earnings from its foreign subsidiaries and changes in estimates. Chief Financial Officer Dave Anderson says Honeywell needs to invest outside the U.S. to fuel foreign sales, which accounted for 54% of Honeywell's revenue last year. He also says the tax code is part of the equation.

"The anachronistic tax system that we have penalizes companies for their success outside of the U.S.,"

The amount of money at stake is significant, particularly when the U.S. budget deficit is high on the political agenda. Just 19 of the 60 companies in the Journal's survey disclose the tax hit they could face if they brought the money back to their U.S. parent. Those companies say they might have to pay $98 billion in additional tax—more than the $85 billion in automatic-spending cuts triggered this month after the White House and Congress couldn't agree on an alternative.

The Joint Committee on Taxation estimates that changing the law to fully tax overseas earnings would generate an additional $42 billion for the Treasury this year alone.

Congress enacted a temporary tax holiday in 2004, prompting companies to repatriate $312 billion in foreign earnings. The law was intended to stimulate the U.S. economy, but studies found that few jobs were created and most of the money was used to repurchase shares and pay dividends. Another such holiday is considered unlikely in the next few years.

The Journal's survey of new regulatory filings found that the total earnings held by the 60 companies' foreign subsidiaries rose 15%, to $1.3 trillion, from $1.13 trillion a year earlier.

The trend was most pronounced among the 26 technology and health-care companies in the Journal survey. Collectively, they parked $120 billion in foreign units last year, accounting for nearly three-quarters of the total.

At some of these companies, foreign subsidiaries hold almost all the company's cash.

Johnson & Johnson JNJ +0.57%says its foreign subsidiaries held $14.8 billion in cash and cash equivalents as of Dec. 30, out of a total of $14.9 billion.

Not all of the earnings parked offshore are in cash. Some of the money is used to build plants and buy equipment overseas. In a paper last year, Wharton School accounting professor Jennifer Blouin and two co-authors estimated that 43% of the offshore earnings were held in cash.

A Senate committee last year found that many tech and health-care companies have shifted intellectual property—such as patent and marketing rights—to subsidiaries in low-tax countries. The companies then record sales and profits from these lower-tax countries, which reduces their tax payments. "There are opportunities to basically wipe away your tax on your intellectual property," says Ms. Blouin, the Wharton professor.

Software maker Microsoft Corp. boosted the holdings of its foreign subsidiaries by $16 billion in the fiscal year ended June 30, 2012, to $60.8 billion, the third-largest holding in the Journal survey. The growth in Microsoft's overseas holdings nearly equaled its net income for the year of $17 billion—in part because Microsoft said its foreign operations accounted for 93% of its pretax profit last year.

In its report, the Senate committee said Microsoft had shifted intellectual property to subsidiaries in Singapore, Ireland and Puerto Rico, to avoid roughly $4 billion in U.S. taxes in 2011. Licensing rights, and revenue, sometimes traveled through more than one subsidiary to minimize the tax bill.

"Microsoft complies with the tax rules in each jurisdiction in which it operates and pays billions of dollars in U.S. federal, state, local and foreign taxes each year," Bill Sample, Microsoft's corporate vice president for world-wide taxation, told the Senate committee in September. A Microsoft spokesman declined to comment further.

Oracle Corp. reported holding $20.9 billion in its foreign subsidiaries as of May 31, 2012, up 30% from a year earlier. Oracle lowered its tax rate last year to 23%, from 25.1% in 2011, raising its bottom line by $272 million. In a securities filing, Oracle said the tax rate fell in part because it "increased the number of foreign subsidiaries" in low-tax countries; the filing listed four Irish subsidiaries that weren't listed the prior year. Oracle said it expects the new subsidiaries to help it maintain a lower tax rate. An Oracle spokeswoman didn't respond to requests for comment.

Abbott runs manufacturing plants in more than a dozen foreign countries, plus Puerto Rico, and generated 58% of its $40 billion in 2012 revenue outside the U.S. In a securities filing, Abbott estimated that lower tax rates on its foreign operations cut its U.S. tax bill by $1.6 billion last year. A big Abbott subsidiary in Ireland, Abbott Laboratories Vascular Enterprises Ltd., reported profit of €1.1 billion for 2011 ($1.43 billion), the latest figures available, and paid no Irish tax, because it is incorporated in Bermuda, according to an Irish corporate filing.

Some companies are accumulating large sums of earnings that they say will remain outside the U.S. General Electric Co. reported $108 billion held offshore at the end of last year, up from $102 billion a year earlier; GE says most of that is invested in active business operations such as plants and research centers. At Pfizer Inc., PFE -0.28%the total rose to $73 billion, from $63 billion.

The swelling totals have sparked friction at companies such as Apple Inc., where investors want executives to distribute more cash through dividends and share repurchases.

• Overseas balances have grown in part because U.S. multinational companies are paying less tax on their overseas operations.
• Offshore subsidiaries of U.S. companies paid an average 14% tax rate in 2008, according to the most recent statistics from the Internal Revenue Service, down from 16% in 2004.
• Corporate filings offer a glimpse of the low rates companies pay outside the U.S.

Apple said it held $40.4 billion in untaxed earnings outside the U.S. as of Sept. 29, 2012. Apple estimated that it would owe $13.8 billion in tax if it brought that money back to the U.S. That is a 34% tax rate, just shy of the federal 35% rate. Since foreign income taxes are creditable on U.S. taxes, that means Apple has paid less than 5% tax on those earnings to date, says Ms. Blouin, the Wharton professor.

GE, Pfizer, Microsoft, Apple And Other Major US Corporations Are Parking More Cash Abroad To Avoid Paying Taxes 03-11-13 IB Times

WARREN BUFFETT - The Master of the INDIRECT EXCHANGE

WARREN BUFFETT: 'We Are Buying Stocks Now' 03-04-13 CNBC via BI

Based on Heinz' new best friend from Omaha's "best single measure of where valuations stand at any given momen," US equities are now over-valued for the first time since 2007. Buffett's measure - the percentage of total market cap (TMC) relative to the US GNP - as Cullen Roche indicates on Bloomberg's Chart of the Day, crossed 100% this week into stretched territory. As Gurufocus notes, this implies a mere return of around 3.3% annualized (including dividends) ove rthe folowing years - though as is clear from the chart below - the ride is extremely bumpy...

Buffett Still Buying Stocks, Sees 'Good Value' 03-04-13 CNBC

• "Anything I bought at $80 I don't like as well at $100. But if you're asking me if stocks are cheaper than other forms of investment, in my view the answer is yes. We're buying stocks now. But not because we expect them to go up. We're buying them because we think we're getting good value for them."
• He said stocks are not "as cheap as they were four years ago" but "you get more for your money" compared to other investments.
• "The dumbest investment, in my view, is a long-term government bond."
• Buffett revealed that a potential acquisition had been "mentioned" to him and he will be exploring the idea, no deal is imminent. "That's always a low probability. Whether it's a five percent or ten percent, who knows?
• "We're continuing to see a slow recovery," he said. "It hasn't taken off, but it hasn't stopped either." Buffett said that while the sequester will reduce the government's stimulus of the economy by cutting back on the deficit the remaining spending is still providing the economy a lot of "juice."
• "It's not galloping at all, but we are making progress bit by bit. Everybody would love to see it faster. But it's not going into reverse and I do not think the sequester will cause it to go into reverse."
• He said that rates near zero have pushed stocks higher than they would have gone otherwise and the global markets are on a "hair trigger," looking for any sign the central bank may start raising rates.
• "I think the Fed will try to give little signals here and all of that. But in the end, there are an awful lot of people who want to get out of a lot of assets if they think the Fed is going to tighten a lot." The results of higher rates, he said, "will be very noticeable" in the markets. While stocks will be hurt by higher rates, Buffett said other investments will also be affected and he still thinks equities are the best thing to buy now.

"when a person with experience meets a person with money, the person with the money gets the experience and the person with the experience gets the money."

Warren Buffett

Buffett Disappointed With Berkshire's 'Subpar' $24 Billion Gain 03-01-13 CNBC

INTRINSIC VALUE

Buffett notes that while he believes Berkshire's intrinsic value will probably beat the S&P 500 by a "small margin" over time, the company's relative performance is better when the market is down or unchanged. "In years when the market is particularly strong, expect us to fall short."

Even so, Buffett warned that he and partner Charlie Munger "will not change yardsticks.

"It's our job to increase intrinsic business value — for which we use book value as a significantly understated proxy — at a faster rate than the market gains of the S&P."

If they are successful, Berkshire's share price will beat the S&P 500 "over time."

Buffett also expressed disappointment that Berkshire didn't make a major acquisition last year. "I pursued a couple of elephants, but came up empty-handed."

ACQUISITIONS

Echoing what he told us after Berkshire announced two weeks ago that it's teaming up with 3G Capital for a $23 billion acquisition of H.J. Heinz, Buffett said even though that deal accounts for much of what Berkshire earned last year,

"we still have plenty of cash and are generating more at a good clip."

"So it's back to work; Charlie and I have again donned our safari outfits and resumed our search," Buffett said.

"We spent a record $9.8 billion on plants and equipment last year. We will keep our foot to the floor and will almost certainly set still another record for capital expenditures in 2013. Opportunities abound in America."

LOCAL NEWSPAPERS

Buffett still sees an opportunity in local newspapers. Berkshire has spent $344 million to buy 28 dailies, and Buffett expected more purchases of "papers of the type we like" at "appropriate prices."

Even though he still believes overall newspaper industry profits are "certain" to drop, Buffett likes smaller community-oriented newspapers that provide local news and information that can't be obtained elsewhere. "Wherever there is a pervasive sense of community, a paper that serves the special informational needs of that community will remain indispensable to a significant portion of its residents."

Buffett isn't a fan of giving that information away for free on the Internet, pointing out that an Arkansas paper has retained its circulation "far better than any other large paper in the country" after it was an early adopter of a pay model.For its fourth quarter, Berkshire's operating earnings per share came in at $1704, below the consensus estimate of $1755 from the few analysts who follow the firm.

DERIVATIVES - Selling Derivatives not Buying Them

The company's net earnings were $4.55 billion in the quarter, up from $3.05 billion in last year's Q4. That includes "paper" gains for derivatives contracts Berkshire has sold that provide insurance against losses for some corporate bonds and stock indexes. The bond-related contracts will expire in the next year. Buffett expects they will generate a $1 billion pre-tax profit. After unwinding about 10 percent of its exposure in 2010 at a profit of $222 million, the remaining stock index contracts will expire between 2018 and 2026.

STOCK HOLDER LETTER

Not a REPORT but Rather a LETTER

Readable versus a Legal Document

15 BIGGEST HOLDING

Berkshire Hathaway's 15 Biggest Stock Holdings

DEATH OF MAINSTREAM JOURNALISM - An Example

Sequestration And The Death Of Mainstream Journalism 03-10-13 Peter Klein at Organizations and Markets blog,via ZH

Much virtual ink has been spilled over the decline of the mainstream media, measured by circulation, advertising revenue, or a general sense of irrelevance. Usual explanations relate to the changing economics of news gathering and publication, the growth of social media, demographic and cultural shifts, and the like. These are all important but the main issue, I believe, is the characteristics of the product itself. Specifically, news consumers increasingly recognize that the

"mainstream media outlets are basically public relations services for government agencies, large companies, and other influential organizations."

Journalists do very little actual journalism — independent investigation, analysis, reporting.

1. They are told what stories are “important” and, for each story,
2. there is an official Narrative, explaining the key issues and acceptable opinions on these issues.
3. Journalists’ primary sources are off-the-record, anonymous briefings by government officials or other insiders, who provide the Narrative.

A news outlet that deviates from the Narrative by doing its own investigation or offering its own interpretation risks being cut off from the flow of anonymous briefings (and, potentially, excluded from the White House Press Corps and similar groups), which means a loss of prestige and a lower status. Basically, the mainstream news outlets offer their readers a neatly packaged summary of the politically correct positions on various issues. In exchange for sticking to the Narrative, they get access to official sources. Give up one, you lose the other. Readers are beginning to recognize this, and they don’t want to pay.

Nowhere is this situation more apparent than the mainstream reporting on budget sequestration. The Narrative is that sequestration imposes large and dangerous cuts — $85 billion, a Really Big Number! — to essential government services, and that the public reaction should be outrage at the President and Congress (mostly Congressional Republicans) for failing to “cut a deal.” You can picture the reporters and editors grabbing their thesauruses to find the right words to describe the cuts — “sweeping,” “drastic,” “draconian,” “devastating.” In virtually none of these stories will you find any basic facts about the budget, which are easily found on the CBO’s website, e.g.:

• Sequestration reduces the rate of increase in federal spending. It does not cut a penny of actual (nominal) spending. 
• The CBO’s estimate of the reduction in increased spending between 2012 and 2013 is $43 billion, not $85 billion.
• Total federal spending in 2012 was $3.53 trillion. The President’s budget request for 2013 was $3.59 trillion, an increase of $68 billion (about 2%). Under sequestration, total federal spending in 2013 will be $3.55 trillion, an increase of only $25 billion (a little less than 1%). 
• Did you catch that? Under sequestration, total federal spending goes up, just by less than it would have gone up without sequestration. This is what the Narrative calls a “cut” in spending! It’s as if you asked your boss for a 10% raise, and got only a 5% raise, then told your friends you got a 5% pay cut.
• Of course, these are nominal figures. In real terms, expenditures could go down, depending on the rate of inflation. Even so, the cuts would be tiny — 1 or 2%.
• The news media also talk a lot about “debt reduction,” but what they mean is a reduction in the rate at which the debt increases. Even with sequestration, there is a projected budget deficit — the government will spend more than it takes in — during every year until 2023, the last year of the CBO estimates. The Narrative grudgingly admits that sequestration might be necessary to reduce the national debt, but sequestration doesn’t even do that. It’s as if you went on a “dramatic” weight-loss plan by gaining 5 pounds every year instead of 10.

This is all public information, easily accessible from the usual places. But mainstream news reporters can’t be bothered to look it up, and don’t feel any need to, because they have the Narrative, which tells them what to say. Seriously, have you read anything in the New York Times, Washington Post, or Wall Street Journal or heard anything on CNN or MSNBC clarifying that the “cuts” are reductions in the rate of increase? Even Wikipedia, much maligned by the establishment media, gets it right: “ sequestration refers to across the board reductions to the planned increases in federal spending that began on March 1, 2013.” If we have Wikipedia, why on earth would we pay for expensive government PR firms?

SEQUESTRATION - Nothing But Delusional Propaganda & Public Manipulation

What "Austerity"? 03-10-13 Zero Hedge

Sequesters; continuing resolutions; "spending brakes"; government shutdowns; fiscal restraint..... austerity.  For all the ceaseless talk about the "prudent", "responsible" action out of Congress, even if it is a result of the president-proposed, and Congress endorsed automatic spending cuts enacted as a result of the August 2011 debt ceiling fiasco, we have a minor problem identifying just where this so-called spending restraint is manifesting itself. Perhaps that is because we look at the facts, not the propaganda, or the empty rhetoric. Here as the facts: in the year to date period of the past four fiscal years, starting October 1 and going through the current day in March, the current year has seen the issuance of exactly $635 billion in Federal Debt, which as of Friday crossed the "psychological barrier" of $16.7 trillion. This is the second highest cumulative debt issuance in one fiscal year, surpassing both 2010 and 2011, and lower only compared to the $726.7 billion raked up in Fiscal 2012... just after President and Congress swore to cut back on spending following the US downgrade by S&P.

Incidentally, now that the US officially has no debt ceiling, and which despite all the endless bluster out of the GOP may be gone indefinitely, the US has managed to rake up $270 billion in debt in just over one month. 

Still think there is a difference between the "democrats" and the "republicans"?

Source: TreasuryDirect

GORDONTLONG.COM

READ: Sequestration And The Death Of Mainstream Journalism by Peter Klein at Organizations and Markets blog, via ZH

ANALYTICS - High Market Cap Concentration

These 10 Stocks Account For Over 20% Of The S&P 500's Market Cap 02-18-13 Goldman Sachs via ZH

The S&P 500 represents the broad US equity market. It is the bogey for countless herding asset managers and is seen as the professional's index as opposed to retail's Dow. But, a scratch under the surface of the magnificent 500 company index shows it to be extremely top-heavy. From Intel to Apple, the following 10 companies represent over 20% of the 500 name index - and these 20 stocks account for 42% of all S&P 500 margin.

Click to Enlarge

ANALYTICS - Markets Typically Don't Fall As a Result of Inflation Until it is ABOVE 4%

Inflation, Mean-Reversion, And 113 Years Of Bond & Stock Returns 02-10-13 Credit Suisse via ZH

FINANCIAL REPRESSION - Global Real Rates Now Negative

Inflation, Mean-Reversion, And 113 Years Of Bond & Stock Returns 02-10-13 Credit Suisse via ZH

The Real Interest Rate Risk: Annual US Debt Creation Now Amounts To 25% Of GDP Compared To 8.7% Pre-Crisis 01-13-13 Zero Hedge

By now most are aware of the various metrics exposing the unsustainability of US debt (which at 103% of GDP, it is well above the Reinhart-Rogoff "viability" threshold of 80%; and where a return to just 5% in blended interest means total debt/GDP would double in under a decade all else equal simply thanks to the "magic" of compounding), although there is one that captures perhaps best of all the sad predicament the US self-funding state (where debt is used to fund nearly half of total US spending) finds itself in. It comes from Zhang Monan, researcher at the China Macroeconomic Research Platform: "The US government is now trying to repay old debt by borrowing more; in 2010, average annual debt creation (including debt refinance) moved above $4 trillion, or almost one-quarter of GDP, compared to the pre-crisis average of 8.7% of GDP."

This is a key statistic most forget when they discuss the stock and flow of US debt: because whereas the total US deficit, and thus net debt issuance, is about $1 trillion per year, one has to factor that there is between $3 and $4 trillion in maturities each year, which have to be offset by a matched amount of gross issuance just to keep the stock of debt flat (pre deficit funding). The assumption is that demand for this gross issuance will always exist as old maturities are rolled into new debt, however, this assumption is contingent on one very key variable: interest rates not rising.

It is the question of what happens to this ~$4 trillion in annual debt creation by the US, as well as other key ones, that Monan attempts to answer in the following paper on what happens to the world if and when the moment when rates truly start rising, instead of just undergo another theatrical 2-4 week push higher only to plunge over fears the Fed may soon pull the punchbowl.

By Zhang Monan, published first in Project Syndicate

The Real Interest-Rate Risk

Since 2007, the financial crisis has pushed the world into an era of low, if not near-zero, interest rates and quantitative easing, as most developed countries seek to reduce debt pressure and perpetuate fragile payment cycles. But, despite talk of easy money as the “new normal,” there is a strong risk that real (inflation-adjusted) interest rates will rise in the next decade.

Total capital assets of central banks worldwide amount to $18 trillion, or 19% of global GDP – twice the level of ten years ago. This gives them plenty of ammunition to guide market interest rates lower as they combat the weakest recovery since the Great Depression. In the United States, the Federal Reserve has lowered its benchmark interest rate ten times since August 2007, from 5.25% to a zone between zero and 0.25%, and has reduced the discount rate 12 times (by a total of 550 basis points since June 2006), to 0.75%. The European Central Bank has lowered its main refinancing rate eight times, by a total of 325 basis points, to 0.75%. The Bank of Japan has twice lowered its interest rate, which now stands at 0.1%. And the Bank of England has cut its benchmark rate nine times, by 525 points, to an all-time low of 0.5%.

But this vigorous attempt to reduce interest rates is distorting capital allocation. The US, with the world’s largest deficits and debt, is the biggest beneficiary of cheap financing. With the persistence of Europe’s sovereign-debt crisis, safe-haven effects have driven the yield of ten-year US Treasury bonds to their lowest level in 60 years, while the ten-year swap spread – the gap between a fixed-rate and a floating-rate payment stream – is negative, implying a real loss for investors.

The US government is now trying to repay old debt by borrowing more; in 2010, average annual debt creation (including debt refinance) moved above $4 trillion, or almost one-quarter of GDP, compared to the pre-crisis average of 8.7% of GDP. As this figure continues to rise, investors will demand a higher risk premium, causing debt-service costs to rise. And, once the US economy shows signs of recovery and the Fed’s targets of 6.5% unemployment and 2.5% annual inflation are reached, the authorities will abandon quantitative easing and force real interest rates higher.

Japan, too, is now facing emerging interest-rate risks, as the proportion of public debt held by foreigners reaches a new high. While the yield on Japan’s ten-year bond has dropped to an all-time low in the last nine years, the biggest risk, as in the US, is a large increase in borrowing costs as investors demand higher risk premia.

Once Japan’s sovereign-debt market becomes unstable, refinancing difficulties will hit domestic financial institutions, which hold a massive volume of public debt on their balance sheets. The result will be chain reactions similar to those seen in Europe’s sovereign-debt crisis, with a vicious circle of sovereign and bank debt leading to credit-rating downgrades and a sharp increase in bond yields. Japan’s own debt crisis will then erupt with full force.

Viewed from creditors’ perspective, the age of cheap finance for the indebted countries is over. To some extent, the over-accumulation of US debt reflects the global perception of zero risk. As a result, the external-surplus countries (including China) essentially contribute to the suppression of long-term US interest rates, with the average US Treasury bond yield dropping 40% between 2000 and 2008. Thus, the more US debt that these countries buy, the more money they lose.

That is especially true of China, the world’s second-largest creditor country (and America’s largest creditor). But this arrangement is quickly becoming unsustainable. China’s far-reaching shift to a new growth model implies major structural and macroeconomic changes in the medium and long term. The renminbi’s unilateral revaluation will end, accompanied by the gradual easing of external liquidity pressure. With risk assets’ long-term valuation falling and pressure to prick price bubbles rising, China’s capital reserves will be insufficient to refinance the developed countries’ debts cheaply.

China is not alone. As a recent report by the international consultancy McKinsey & Company argues, the next decade will witness rising interest rates worldwide amid global economic rebalancing. For the time being, the developed economies remain weak, with central banks attempting to stimulate anemic demand. But the tendency in recent decades – and especially since 2007 – to suppress interest rates will be reversed within the next few years, owing mainly to rising investment from the developing countries.

Moreover, China’s aging population, and its strategy of boosting domestic consumption, will negatively affect global savings. The world may enter a new era in which investment demand exceeds desired savings – which means that real interest rates must rise.