Exact predictions of the date may differ, but the general consensus on Japan remains the same. In a matter of just three to 10 years, the world’s third-biggest economy may start running out of the savings needed to fund its massive public debt.
The days of Tokyo’s finance mandarins being admired for their fiscal prudence are long since gone. According to the IMF, Japan’s general government debt first crossed 100 percent of gross domestic product (GDP) in 1997 as the authorities tried hard to pump prime the economy out of its post-bubble scenario.
But, ending the credit binge – and its famous “bridges to nowhere” construction projects – has proved challenging for governments dealing with a deflationary downturn, rising welfare costs and dwindling tax revenues.
Since 1990, public finances have deteriorated significantly. In recent decades, Japanese governments have piled up debts worth some €11 trillion ($14.6 trillion). In 2011, general government gross debt totaled nearly 230 percent of GDP and is projected to reach 245 percent in 2013, with the government’s fiscal deficit currently around 10 percent of GDP. Net public debt, which subtracts from gross debt government assets such as public pension funds, has also increased tenfold over the past two decades to reach more than 125 percent of GDP. The US government has gross and net debt of 107% and 84%. Total gross debt (government, non-financial corporation and consumer) is over 450% of GDP, compared to around 280% for the US.
In the post war period, Japan enjoyed decades of strong economic growth – around 9.5% per annum between 1955 and 1970 and around 3.8% per annum between 1971 and 1990. Since the collapse of the Japanese debt bubble in 1989/ 1990, Japanese growth has been sluggish, averaging around 0.8% per annum. Nominal gross domestic product (“GDP”) has been largely stagnant since 1992. Japan’s economy operates far below capacity, with the output gap (the difference between actual and potential GDP) being around 5- 7%.
The Japanese stock market is around 70-80% below its highs at the end of 1989. The Nikkei Index fell from its peak of 38,957.44 at the end of 1989 to a low of 7,607.88 in 2003. It now trades around 8,000-12,000. Japanese real estate prices are at the same levels as 1981.
Despite the highest public debt to GDP ratio in the industrialized world, Japan remains the world’s biggest creditor with net foreign assets of around US$3.1 trillion, with its 2011 per capita GDP of US$34,294 above Italy, Spain and South Korea and four times the size of China’s. And in comparison with Europe’s indebted economies, Greece reached crisis point with its debt to GDP ratio of just 150 percent, while the Spanish government has faced a storm with a debt ratio below 100 percent. While Greece has recently had to cough up interest at double-digit rates, for example, the comparable figure for Japan has been a mere 0.75 percent. Even Germany, the euro zone’s healthiest economy, has to pay more.
The reason behind this is Japan has maintained a high corporate savings rate and low levels of fixed investment (both residential and nonresidential), making Japan a net exporter of capital. However, its fiscal profligacy is catching up with it: Its fiscal deficit has risen to more than 11% of GDP, where it remains today.
Household assets of an estimated 1,500 trillion yen, surplus funds held by the private sector and the demand from Japanese banks and other financial institutions for low-risk investments have given the government a ready market for its JGBs.
In addition, Japan’s low ratio of taxes to national income provides scope for increasing the burden. According to OECD data, Japan’s 27.6 percent ratio in 2010 compared with the United Kingdom’s 35 percent and was below the average 33.8 percent of tax revenue as a percentage of GDP.
Japan’s current account surplus has also allowed the government to run large budget deficits which can be funded domestically. Since 2007, the Japanese trade account surplus has fallen sharply, turning into a deficit in 2012..
“But Japan is not Greece as it funds its own debt, whereas in Greece 70 to 75 percent of government bonds were owned by non-Greeks. Crises happen when your creditor goes on strike, and the fact is that Japan’s debt is held almost exclusively by the Japanese themselves so any comparison just doesn’t make sense,” Japan economist Jesper Koll, Japan Director of Research at JP Morgan, said.
The reason is simple: Unlike countries in the euro zone, Japan borrows most of its money from its own people. Domestic banks and insurers have purchased more than 90 percent of the country’s sovereign debt using the savings deposits of the general population. What’s more, the Japanese are apparently so convinced that their country will be able to pay off its debts one day that they continue to lend their government a seemingly endless amount of money.
Unlike Greece, Spain and other members of the Euro zone’s monetary straightjacket, Japan has its own currency which could prove an important advantage, Koll added.
“If it comes to a point where domestic savings can’t fund the deficit any more, the currency is likely to weaken, making yen assets such as Japanese bonds more attractive. That’s something that is in fact already started.
The story begins with Japan’s post-war economic miracle. In order to rebuild its economy after the devastation of World War II, the Japanese government adopted an export model, like that in Germany, to boost export growth and import know-how. Japan invested heavily in education, research and manufacturing. A key element of the export model is, of course, accommodative monetary policy whereby a country uses credit creation, infrastructure development, and lower-than-market interest rates (known in monetary parlance as “financial repression”) to focus the country on exports. As the original “Asian Tiger,” Japan employed this strategy to great effect over the years, growing GDP sharply on the back of strong exports. As long as GDP and exports are growing, this model works. But when GDP stops growing and exports become slow, the model fails. In the post war period, Japan enjoyed decades of strong economic growth – around 9.5% per annum between 1955 and 1970 and around 3.8% per annum between 1971 and 1990.
The Plaza Accord signed on 22 September 1985 called for France, West Germany, Japan, the United States, and the United Kingdom to devalue the dollar relative to other major currencies (including the yen) by intervening in currency markets with the specific intent of reducing trade imbalances. Between 1985 and 1987, the Yen increased in value by 51% against the dollar.
Japan moved from an era of En’yasu, an inexpensive Yen, to a period of Endaka or Endaka Fukyo, an expensive Yen. The higher Yen adversely affected Japanese exporters. Japanese economic growth fell sharply, from 4.4% in 1985 to 2.9% in 1986.
Desperate to restore growth and offset the stronger Yen, the Japanese authorities eased monetary policy with the BoJ cutting interest rates five times from 5% to 2.5% between January 1986 and February 1987, leaving it finally at 2.5% — which remained in effect until May 1989. The BOJ was ferociously trying to stimulate the economy with aggressive easing. The lower rates led to a rapid increase in debt funded investment, driving real estate and stock prices higher. At the peak of the “bubble” economy, the 3.41 square kilometer (1.32 square miles) area of the Tokyo Imperial Palace had a theoretical value greater than all the real estate in the state of California. The point of failure for Japan was when it’s easy monetary policy stimulated a real estate and stock market bubble instead of fueling exports.
Seeking to reverse the unsustainable asset price inflation, the authorities increased interest rates to 6% between 1989 and 1990 triggering the collapse of the boom. The bubble manifested itself in both real estate and the stock market. It finally popped as the BOJ raised interest rates in 1989–1990(with historic collapses from which — even now, some 22 years later — the country has not recovered).As Japan’s economic problems worsened rapidly, the government responded with large fiscal stimulus programs. The BoJ cut interest rates to zero. But the policy measures failed to revive the economy, which slid into deflation.
Following the collapse of the bubble, policymakers implemented a variety of economic stimulus programs. Japan’s budget surplus of 2.4% in 1991 has become a chronic budget deficit, increasing from 2.5% in 1993 to about 8% by the end of the 1990s. It has remained high during the 2000s. The BoJ has tried unsuccessfully to increase inflation to reduce debt. Japanese inflation has averaged minus 0.2% in the 2000s, a decline from levels of 2.5% in the 1980s and 1.2% in the 1990s. The policies have failed to restore economic growth, trapping Japan in a period of economic stagnation.
Since the collapse of the Japanese debt bubble in 1989/ 1990, Japanese growth has been sluggish, averaging around 0.8% per annum. Nominal gross domestic product (“GDP”) has been largely stagnant since 1992. Japan’s economy operates far below capacity, with the output gap (the difference between actual and potential GDP) being around 5- 7%.
The Japanese stock market is around 70-80% below its highs at the end of 1989. The Nikkei Index fell from its peak of 38,957.44 at the end of 1989 to a low of 7,607.88 in 2003. It now trades around 8,000-12,000. Japanese real estate prices are at the same levels as 1981.
There was a parallel deterioration in public finances. At the time of collapse of the bubble economy, Japan’s budget was in surplus and government gross debt was around 20% of GDP. As the Japanese economy stagnated, weak tax revenues and higher government spending to resuscitate growth created substantial budget deficits.
Japan’s total tax revenue is currently at a 24 year low. Corporate tax receipts have fallen to 50 year lows. Japan now spends more than 200 Yen for every 100 Yen of tax revenue received.
The period of Japanese economic decline was known as the Lost Decade or Ushinawareta Jūnen. As the economy failed to recovery and the problems extended beyond 2000, it has come to be referred to as the Lost Two Decades or the Lost 20 Years (Ushinawareta Nijūnen).
Japan’s large pool of savings, low interest rates and a large current account surplus has allowed the build-up of government debt. Japan has a large pool of savings, estimated at around US$19 trillion, built up through legendary frugality and thrift during the nation’s rise to prosperity after World War II. High savings rates also reflected the country’s young age structure especially until the 1980s, the low level of public pension benefits, the growth of income levels through to the late 1980s, the bonus system of compensation, the lack of availability of consumer credit and incentives for saving.
In recent years, household savings were complemented by strong corporate savings, around 8% of GDP. This reflects slow growth, excess capacity, lack of investment opportunities and caution driven by economic uncertainty.
Much of these savings are invested domestically. A significant amount of the savings is held as bank deposits, including large amounts with the Japanese Postal System. In the absence of demand for credit from borrowers, the banks hold large quantities of government bonds to match the deposits, helping finance the government. Japanese banks hold around 65-75% of all Japanese government bonds (“JGBs”) with the Japanese Postal System being the largest holder. Around 90% of all JGBs are held domestically.
The high levels of debt are sustainable because of low interest rates, driven by the BoJ’s ZIRP and successive rounds of JGB bond purchases as part of quantitative easing (“QE”) programs since 2001. The BoJ balance sheet is now around US$2 trillion an increase from around 10% of Japan’s GDP to 30% since the mid-1990s. BoJ holdings of JGBs are around US$1.2 trillion, around 11% of the total outstanding.
Low interest rates perversely have not discouraged investment in bank deposits or government bonds. This reflects the poor performance of other investments, such as equity and property, during this period. The strong Yen has increased the risk of foreign investments. Although nominal returns are low, Japanese investors have received high real rates of return, because of falling prices or deflation.
Over the last 50 years, Japan has also run large current account surpluses, other than in 1973–1975 and 1979–1980 when high oil prices led to large falls in the trade balances. The current account surplus has resulted in Japan accumulating foreign assets of around US$4 trillion or a net foreign investment position of approximately 50 % of GDP. This helped Japan avoid the need to finance its budget deficit overseas and also boosted domestic resources, increasing demand for JGBs.
These foreign currency holdings generate substantial amounts of investment income each year. However, the control of these vast sums is concentrated in a few hands. Likewise, the bond market (and hence, interest rates) is controlled by many of these same hands. And because bonds are priced in a market, if and when the managers of this capital decide to sell, they can cause a stampede for the exit.
Since the global financial crisis and more recent European debt crisis, Japan has been viewed as a “safe haven”. Investors have purchased Yen and JGBs, pushing rates to their lowest levels in almost a decade and increasing foreign ownership of JGBs to around 9%, the highest level since 1979, the first year for which comparable data is available. These factors have assisted Japan to finance its budget deficit.
These factors which allowed Japan to increase its government debt levels are unlikely to continue.
Private consumption is weak, further reducing domestic demand. This reflects weak employment, lack of growth in income and the aging population. Strong exports and a current account surplus have partially offset the lack of domestic demand, as firms focused on overseas markets.
With investment and consumption weak, large budget deficits have supported economic activity, avoiding an even larger downturn in economic activity. In a balance sheet recession, monetary policy is ineffective with limited demand for credit. Government stimulus spending is the primary driver of growth.
The Japanese government’s ability to finance spending is increasingly constrained by falling Japanese household savings rates, which have declined from between 15% and 25% in the 1980s and 1990s to under 3%, a level below the US until recently. This decline reflects decreasing income and the aging population.
In terms of debt capacity, the net assets of Japanese households reach 1,156 trillion yen; while the national debt is 1,133 trillion yen. The difference is around 23 trillion yen. The increase in assets buyback already hits 10 trillion yen, which means there is not much domestic capacity left for absorbing any newly issued debt, which means there is not much domestic capacity left for absorbing any newly issued debt. In other words, if the Japanese government continues with its current economic policies and has no way out in economic development, it has to go to foreign lenders for funds. Worst still, it is doubtful if the Japanese government can issue debt at such interest rates. With the worsening debt to GDP ratio and an unreasonable debt level, new lenders are likely to ask for a fair premium for the lending.
Wage have fallen with average annual salaries including bonuses falling every year since 1999 and decreasing by around 12% in total. Between 1994 and 2007, labor costs as a percentage of manufacturing output declined from 73% to 49%. Japanese worker’s share of GDP fell to 65% in 2007, from a peak of 73% in 1999.
Compounding matters, Japan’s manufacturing prowess is weakening while the country as a whole is becoming less competitive. They have lost leadership positions in a number of key industries and the rise of the yen is making their exports less competitive as well. Moreover, pressured budgets make it more difficult to engage in the long-range R&D spending that had helped the country become a global leader in manufacturing. As an example, once a stalwart in consumer technology, Sony recently announced the layoff of 10,000 workers.
Since the epic global financial meltdown in 2008, the U.S. Federal Reserve has maintained an aggressive policy of depreciating the U.S. dollar. The yen has appreciated some 30% against its post-bubble average, as well as against the dollar, since the collapse in 2008.
This recent appreciation of the yen is exacerbating all of Japan’s problems — its export products are now 30% more expensive on global markets. Its profile is similar against other major currencies. For the first time since the Japanese bubble collapsed, Japan will now need substantial alternate forms of funding to keep the government afloat.
Japan’s demographics parallel its economic decline. Japan’s population is forecast to decline from its current level of 128 million to around 90 million by 2050 and 47 million by 2100. A frequently repeated joke states that in 600 hundred years based on the present rate of decline there will be 480 Japanese left.
The proportion of Japan’s population above 65 years will rise from 12% of the total population to around 23%. Japan’s work force is expected to fall from 70% currently by around 15% over the next 20 years. For every two retirees there will be around three working people, down from six in 1990. This aging population further reduces the savings rate. Household surveys indicate that around a quarter of households with two people or more have no employment. In aggregate, the amount of money being paid to retirees from savings exceeds the amount of new money that is going into savings funds. This is compounded by low returns on investments which accelerates the rundown of savings.
The secular factors driving the fall include an appreciating Yen and slower global growth, which has reduced demand for Japanese products, such as cars and consumer electronics. In late 2012, territorial disputes with China exacerbated the decline in exports. It also reflects the impact of the Tohoku earthquake and tsunami as well as the subsequent decision to shut down Japanese nuclear power generators, which increased energy imports, especially Liquid Natural Gas.
Deep seated structural factors also underlie changes in the trade account. Since the 1980s, rising costs and the higher Yen have driven Japanese firms to relocate some production facilities overseas, taking advantage of lower labor costs and circumventing trade barriers. More advanced, technologically complex and high value manufacturing was kept in Japan. But post 2007 Japanese firms have increasingly been forced to close these domestic production facilities as they have become uncompetitive.
The combination of falling exports, lower saving rates, declining corporate earnings and cash surpluses is likely to move the Japanese current account into deficit. In turn, this will force Japan to become a net importer of capital to finance government spending, altering the dynamics of its finances.
If Japan continues to run large budget deficits, as is likely, then the falling saving rate and reversal in its current account will make it more difficult for the government to borrow, at least at the current low rates.
Ignoring foreign borrowing and debt monetization by the central bank, the stock of private sector savings limits the amount of government debt. In the case of Japan, this equates to around 250-300% of GDP. Japan’s gross government debt will reach this level around 2015, although net government debt will not reach this limit until after 2020.
Even before Japan’s government debt exceed household’s financial assets, the declining savings rate and increasing drawing on savings by aging households will reduce inflows into JGBs making domestic funding of the deficit more difficult.
Insurance companies and pension funds are increasingly selling their holdings or reducing purchases to fund the increase in payouts to people eligible for retirement benefits. Institutional investors and to a lesser extent retail investors are also increasingly investing in other assets, including foreign securities, in an effort to increase returns and diversify their portfolios.
Japan’s large portfolio of foreign assets will cushion the effects for some time. Japan has accumulated large foreign assets totaling around US$4 trillion, making it the world’s biggest net international creditor. The BoJ is the largest investor in US Treasury bonds, with holdings of around US$1 trillion.
Unless public finances improve, Japan ultimately will be forced to finance its budget deficit by borrowing overseas. Where the marginal buyers of JGBs are foreign investors rather than domestic Japanese investors, interest rates may increase, perhaps significantly. Even at current low interest rates, Japan spends around 25-30% of its tax revenues on interest payments. At borrowing costs of 2.50% to 3.50% per annum, two to three times current rates, Japan’s interest payments will be an unsustainable proportion of tax receipts.
Higher interest rates will also trigger problems for Japanese banks, Japanese pension funds and insurance companies, which also have large holdings of JGBs.
In fact, the major banks, such as Bank of Tokyo-Mitsubishi UFJ, Sumitomo Mitsui, and Mizuho, regularly buy JGBs — even viewing it as a “public mission” to support Japan. In addition, the Bank of Japan buys lots of JGBs on the open market, trying to drive up prices and drive down yields, thereby manufacturing low rates. While this monetization of debt creates inflationary pressures, it has thus far been offset by the deflationary pressures of a declining workforce and declining population. Looking forward id there happens to be some mild inflation of, perhaps, 2–4% (depending on how much monetization and how much debt issuance occurs), but it would likely be enough to re-calibrate the bond market’s expectations. And if JGB yields rise from 1% to just 2%, Japan’s debt service will explode. Thus, a vicious cycle of higher yields, greater fiscal deficits, greater monetization, and greater inflation will occur.
There are also short-term fluctuations from year to year, but it is clear when looking at the averages decade by decade that funding pressures in Japan have been growing over time. JGBs total around 24% of all bank assets, which is expected to rise to 30% by 2017. An increase in JGB yields would result in immediate mark-to-market large losses on existing holdings, although higher returns would boost income longer term. BoJ estimates that a 1% rise in rates would cause losses of US$43 billion for major banks, equivalent to 10% of Tier 1 Capital for major banks or 20% for regional banks.
This cash flow cycle is how Japan has funded itself over the past 22+ years. Only now, the profile is changing. The Japanese debt crisis is being spawned by a burgeoning fiscal deficit. As the fiscal deficit has expanded, it has placed greater pressure on the Japanese government to sell debt and on the Bank of Japan to purchase it. Of course, the BOJ has been stepping in and buying JGBs when corporate demand has not been strong enough to keep rates low.
To avoid the identified chain of events, Japan must address the core problems. But reductions in the budget deficit are difficult. Spending on social security accounts and interest expense now totals a major part of government spending. Increasing health and aged care costs are expected by 2025 to be around 10-12% of GDP. An aging population and shrinking workforce will continue to drive slower growth and lower tax revenues. Tax increases are politically unpopular. Reductions in the budget deficit are likely to reduce already weak economic activity, compounding the problems.
Prime Minister Ryutaro Hashimoto tied in 1997 to raise the sales tax. Hashimoto’s move cost him his job.
According to the OECD, Japan’s tax revenue in 1991 totaled some 66 trillion yen in individual and corporate income taxes. By 2009, this had fallen to 36 trillion yen, with bond issuance exceeding tax revenues in fiscal 2012 for the third straight year.
The IMF has warned that the increase in consumption tax goes only halfway toward achieving a desired fiscal adjustment of 10 percent of GDP over the next decade to put the debt ratio on a downward path. With some fiscal adjustments, the public debt to GDP ratio is forecast at 300 percent of GDP by 2030, with further cuts deemed necessary to stabilize and then start reducing the ratio.
The government has forecast a primary deficit of between 1.9 and 3.1 percent of GDP by fiscal 2020, compared with the fiscal 2011 deficit of 7.4 percent.
Bringing the primary balance, where fiscal expenditures can be covered without borrowing, into equilibrium is estimated to require an additional 5 to 6 percent hike in the consumption tax.
But, some have argued that Japan can ameliorate its budget shortfall by raising tax rates. In economics, there are no grand solutions, only trade-offs. So, it is a fallacy to think that increasing tax rates necessarily increases tax revenues to the government. Many governments and countries have tried raising tax rates and failed to increase tax revenues either due to tax avoidance or damage to economic growth (or both).
Other analysts have compared Japan’s relatively low tax revenue/GDP ratio with that of other countries, claiming that there is ample room to raise taxes. However, this belies the welfare society construct that Japan has developed in the past 75 years. In contrast to the welfare state, the welfare society provides social benefits through private employers. Japan’s welfare society attempts to maintain near-total employment via liberal government loans to private companies, often circumventing the need for unemployment benefits. Also, retirement pensions come largely from personal savings and company compensation rather than as benefits from the state. So, the state has intentionally shifted the cost of its social programs to companies. Should it raise taxes on the private sector, additional pressure would be placed on corporate budgets, and thereby weakening the economy.
When Hashimoto increased the rate by just two percentage points to its current level, the economy plunged into a 20-month recession, albeit worsened by the Asian financial crisis.
Proposed solutions to Japan’s economic woes have included measures to deregulate the agricultural, electricity and service sectors, along with the politically sensitive measures of joining the Trans-Pacific Partnership and increasing immigration.
The IMF has suggested the fiscal consolidation include raising the consumption tax rate to 15 percent – closer to the OECD average – while reducing corporate taxes, broadening the personal income tax base and increasing the pension retirement age to 67.
In its August 2012 report, the IMF warned that “even a moderate rise in yields would leave the fiscal position extremely vulnerable…Failure to implement a credible fiscal consolidation plan could lead to sovereign downgrades and trigger similar actions for financial institutions, which could eventually erode confidence in the JGB [Japanese government bond] market.”
Higher JGB yields would further damage public finances, with the government’s budget already at a point where bond issuance exceeds taxation revenues. The IMF calculates that a spike in bond yields would slash output by 6 to 10 percent over 10 years, potentially harming not only other Asian economies but also the United States and Euro-zone.
In 2012, for example, the Japanese government needs to issue debt amounting to 59.1 percent of GDP; that is, for every $10 that Japan’s economy generates this year, the government will need to borrow $6. It will probably be able to do so at very low interest rates—currently well below 1 percent.
The fact that government debt is held mostly by Japanese citizens is not sufficiently reassuring. The same was true in Germany during the 1920s and Russia during the 1990s, yet in both cases the elderly lost their savings to high inflation.
Japan’s problems have been compounded by two major natural disasters – the 1994 Kobe earthquake and the 2011 Tohoku earthquake and tsunami.
In the face of the nation’s long term decline, Japanese politics has become increasingly fractious. Frequent changes of leadership, often driven by arcane internal factional politics, have created an unstable environment and a lack of policy continuity. Japan has had seven prime ministers in six years and six finance ministers in three years. Former Brazilian President Luiz Inácio Lula da Silva once joked that in Japan you say good morning to one prime minister and good afternoon to another.
What makes the problem so serious in Japan is the country’s refusal to do what other countries have done: admit massive immigration of younger people from overseas. It is very difficult to immigrate to Japan, and (having immigrated) even harder to obtain citizenship. Japan is the world’s most homogeneous large country.
Japanese policy makers have other options. Financial repression forcing investment in low interest JGBs is one alternative. The BoJ can maintain its zero rate policy and monetize debt to finance the government. Japan can try to inflate away their debt. But ultimately, Japan may have no option other than a domestic default to reduce its debt levels.
Rising inflation helped the United States nearly halve its debt burden from World War II over the period from 1946 to 1955, but Japan’s policymakers, including the Bank of Japan (BOJ), have struggled in recent years to overcome persistent deflationary expectations.
Older Japanese, especially retirees who are major holders of JGBs, would suffer large losses. Younger Japanese would benefit from the reduction in debt and reduced claims on future tax revenues. Such a drastic alternative, with its massive economic and social costs, is difficult to conceive other than as the last option.
However, the status quo in Japan — if left unchanged — will see to it that the funding deficit widens materially. As debt continues climbing and GDP continues falling, the growth in the debt-to-GDP ratio accelerates. The combination of a rising yen and stagnating corporations will result in the structural trade surplus deteriorating over time (which is why the BOJ is trying to get the yen to decline somewhat). Additionally, debt service and social security spending will continue growing as percentages of the federal budget — all without any increase in interest rates. So there is a widening funding deficit that must be made up for with some combination of debt issuance and/or monetization. The combination of large fiscal deficits, funding shortfalls, and private sector not able to save will ensure that Japan must seek investors on the international markets. Consequently, the (natural) domestic demand base for JGBs will fall, while the government’s need for foreign investors is rising. Although some have suggested that the Bank of Japan could devalue the yen. (Remember that Japan imports virtually all of its raw materials, such as energy and hard commodities.) If it chopped the yen in half and many of its input costs doubled, could its export companies be competitive? What would happen to the balance of trade (all else being equal)?
While the underlying economics will change gradually over time, the crisis will erupt when the bond market breaks from the past. When the market realizes that the status quo has changed, rates will rise and force the government’s fiscal budget to explode, creating a sequence of cascading events. Watch closely to see what the major Japanese banks do with their JGB holdings. In addition, watch pension fund managers. The stewards of capital changing their policy allocations will determine when the status quo shifts.
Moreover, Japan has an average debt maturity of 6 years, shorter than Spain, Italy and France. Around 60% of its debt must be refinanced in the next 5 years. This will expose Japan to the discipline of market investors at a vulnerable moment.
Venture capitalist Hitoshi Suga suggested a “debt-equity swap” where the government converted JGBs into 100-year debts, similar to Britain’s “perpetual bonds” issued after the First World War, as well as more fiscal prudence.
Ironically, despite its recent crises, Europe offers an example to Japan of managing fiscal reconstruction while also raising growth. Both the Netherlands and Sweden achieved this feat in the 1980s and 1990s through persistent public finance reforms along with greater labor market mobility and other market opening measures.
The Bank of Japan’s 63-year-old governor, Masaaki Shirakawa — a thin man with neatly parted hair — no longer adheres to the disciplined monetary policies his Western counterparts preach. Instead, Shirakawa keeps the money printers going to stimulate the economy. Since 2011, his bank has launched emergency programs with a total volume of around €900 billion. In comparison, the euro bailout funds jointly financed by the euro zone’s 17 member states only add up to €700 billion.
So far, though, his strategy has done little to help. “At the moment,” Shirakawa admits, “the effect of our monetary policy in stimulating economic growth is very limited.” The cheap money is stuck in the banks rather than flowing into the real economy. “The money is there, liquidity is abundant, interest rates are very low — and, still, firms do not make use of accommodative financial conditions,” Shirakawa adds. “The return on investment is too low.”
Money is only a means with which “to buy time,” he says. “It can alleviate the pain. But the government has to implement reforms too.”One thing is sure, warns central banker Shirakawa, “If we don’t deliver fiscal reform, then the yield on Japanese government bonds will rise.”
At any rate, one thing is clear: change is coming to Japan.
Once the problems emerge, they will be difficult to contain. As Economist Rudiger Dornbush once observed: “The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought”.
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