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In December I wrote "Setting Up the Japan Panic Trade," and this article updates the situation. The Japanese have conjured a true end game that should implode the country in a manner of a few months. In the prior article, I reviewed the fundamentals of Japan's Hari Kari-style fiscal and economic policy. Although it plans on doubling the monetary base ($80 bn per month) by the end of 2014, the game won't go on that long. This will play out around both the currency and the JGB, as any one with half a brain will pull their wealth out of the country. It's an invitation for cascading capital flight.

Indeed, the very night that the BoJ launched its new money printing program, the JGB 10-year spiked to a 35 bps yield then reversed down to 65 bps, reversed again to recover to 45 and ended up around 55. Then Sunday night as I prepared to post, the range was 144.24-145.30 with the yield spiking up and down again, recovering no doubt on BoJ intervention while the Yen swooned hard again.

This market looks like an out of control kamikaze. That's a lot of daily volatility for a vehicle that yields around 50 bps per year. A new and very different risk-reward Keynesian end-game regime is at hand. I've been "warm-up trading" the JGB with some initial and mostly lucky success. But the bottom line is I think the trend will be much higher yields.

This trade is also bound to attract the interests of speculative pools, that would likely facilitate an attack on the both the currency and the JGB, but especially the JGB. Japanese institutions and individuals can then do the absurd exercise of determining if their exposure is really worth the risk.

With the Yen rout on, the question is where does the money go? I say it flees Japan in the form of capital flight. Unfortunately, the average Japanese citizen without substantial assets will be poorer, as the cost of living will be rising while their incomes continue to lag. Meanwhile, as Kyle Bass states, bad price signals will further erode their real economy and spook the population. Kyle Bass weighs in on the risk and seems to be emphasizing that the moment is near when Japan loses control of its rates.

The path of this Japanese money will be bizarre and might initially be more race-to-the-bottom activity. There was a purchasing frenzy of Italian bonds last week emanating out of Japan, which of course is nutty behavior. Elsewhere in the Potemkin Village, South African bonds also got a nice bid. Read "South Africa Heading for Collapse" and I think you'll get the picture. In other words, the Japanese Hari Kari multitude will enter the financial history books as the biggest bagholders of all time.

The question now is what will happen when and if Japanese households panic? At the end of last year, Japanese households held 1,515 trillion yen in assets (now equal to $15.5 trillion and dropping like a stone). Even if they don't panic, will Japanese investors be quite so keen on a 0.50% yield in a 2% or 3% inflationary environment? The trend on this was poor even before Abe's experiment.

Beyond inflation, another question is where will Mrs. Watanabe run to if there's an inflation panic and growing concern about banks in that country. If Japanese banks, which are heavily exposed to JGB, get even more shaky, it could accelerate into a bank run.

(click to enlarge)

Unless the fictitious capital represented by 14 trillion in JGB is quickly destroyed and goes to money heaven, the Japanese investor class will be running all over looking for a safety valve. Therefore, the JGB yield should be carefully monitored because once rates start spiking, Japan's government will be overwhelmed by a fully sprung debt trap - fiscally, Japan already spends a third of its tax revenues on interest payments - and huge losses in JGB assets will be incurred. If the bond yield rises to 2%, the interest expense alone will surpass the total expected tax revenue of 42.3 trillion yen. This will have game-changing ramifications globally.

For those wishing to try the Japanese Hari-Kari trade, the sequence to playing the end-game is to consider to what degree Mrs. Watanabe can get out of the burning house before the wealth, held in fictitiously priced Japanese assets, is destroyed. The process will likely occur simultaneously, as the capital flight becomes the causa proxima of the JGB-Yen bust. But as financial institutions collapse, a large portion of these assets will go to money heaven. The various trades to utilize would be in three sets.

The first set is to short Yen, but this is now very crowded. The second is to short JGB. I think the second trade is now the timely one. These actually trade with good liquidity, but mostly at night via mini-futures on the Singapore Exchange. I trade them with my Options Express account with Charles Schwab. The third, perhaps, would be gold.

Gold has been a sideshow for Japanese retail. But there are signs that interest is increasing from an almost non-existent level ("Gold Lures Japanese Pension Funds"). Still, the change is halting so far as there is something fundamentally wrong with the Japanese thinking and sistema, and, yes, Hari Kari describes it.

In the past, Mrs. Watanabe has been a carry trader, borrowing in yen to purchase higher-yielding currencies, such as the Brazilian Reis, Aussie Dollar and Turkish Lira. But getting involved in the Japanese renting of bonds of other insolvent countries doesn't really interest me, so my fundamental trades here are gold and short JGB.

Source: Japan's Excessive Money Printing Self Destructive