TOKYO -- Japanese government bonds are less risky than U.S. Treasurys for the first time in seven years -- and the reason appears to be politics.
According to Credit Market Analysis, a U.S.-based research firm, the dollar-denominated spread of credit default swaps, or default-risk premium, on five-year JGBs in January fell below that of their U.S. equivalents for the first time since June 2009.
As of Monday, the credit default swap spread on JGBs was 25 basis points, while that for five-year Treasurys was 27 basis points. A higher figure indicates greater risk.
You may remember credit default swaps from the Lehman shock of 2008. Back then, they were in the news because they allowed speculators to bet against mortgage-backed securities. Think of them as insurance policies that anyone can buy -- multiple times, even -- on a piece of property that the buyers do not even own.
The credit default swap spread is a key gauge of a country's default risk.
But why are speculators now betting that U.S. government finances pose more of a financial risk than those of Japan?
U.S. news agency Bloomberg points to political risks as a possible answer. Since President Donald Trump was inaugurated a month ago, the U.S. has been exposed as a house divided.
Even Trump's tweeting habits are seen as a risk.
Europe, meanwhile, also appears to be rife with divisions. Later this year, France and the Netherlands will hold elections in which far-right populists could end up victorious.
In Japan, Prime Minister Shinzo Abe, a conservative himself, and his Liberal Democratic Party continue to dominate politics, though they are seen doing so with a steadier hand.
When investors see risks ahead, they often buy gold. But the gold market is too small of a haven to accept all investors who seek it as a hedge to the political risks in the U.S. and Europe.
So JGBs and other yen-based assets are being looked at as alternatives.
The higher risk premium of Treasurys could also be attributable to expectations that Trump will ramp up fiscal spending to pay for all the infrastructure projects he keeps talking about. A fall in tax revenue (Trump is also hinting at lower corporate taxes) and an infrastructure credit card binge would almost surely increase U.S. government debt. As a result, Washington will have to issue more bonds.
The U.S. is currently running federal budget and current-account deficits. As a way to mitigate the situation, Trump is trying to halt the dollar's rise with his verbal assaults on governments he sees as currency manipulators.
But his desired path -- aggressive government spending and a tighter monetary policy -- can only lead to a stronger currency.
Given that the U.S.'s twin deficits will not be corrected anytime soon, a simple question arises: Who wants to buy U.S. Treasurys? The answer, my friend, is blowing in the credit default swap premium.
Japan itself is no poster child for fiscal sanity. Its government deficits and debt are also runaway trains. But Japan is running a current-account surplus -- one that is expanding.
And while the U.S. is the largest debtor nation, Japan is the largest creditor, with net foreign assets exceeding 300 trillion yen ($2.64 trillion). These keep paying interest and dividends.
This affluence is largely held by Japanese companies and individuals. The Bank of Japan has tried to encourage corporate and household Japan to use their cash piles on investments ... and to live a little. Go ahead, spend it, the BOJ has been saying for years now with its unprecedented quantitative and qualitative monetary easing. But so far, all the central bank's yen-printing has had little impact on the real economy.
The government appears to be the biggest beneficiary -- it pays next to nothing in interest on all the borrowing it does to cover those budget deficits it keeps racking up.
The government is also happy that Japan's gross domestic product is showing signs of recovery.
In addition, it is encouraging that Japan's debt-to-GDP ratio has decreased ever so slightly despite a primary balance that remains in the red. Sound contradictory? The situation is made possible by all the excess cash in the country.
Japan's economic climate seems to be warming up. Even the credit default swap spread says so.
So listen to the BOJ -- go out and live a little.