♠ Posted by Emmanuel in Japan
at 2/24/2012 09:23:00 AM
The main reason why Japan's economy has not keeled over despite such an onerous burden are well-understood (except to the aforementioned cultists): Persistent deflation makes it actually attractive for Japanese savers to buy its sovereign debt yielding next to nothing, coupled with a sense of duty to help the country out during these trying times. Unlike the United States where nearly half of all lenders are foreign, Japan has to be more concerned about appeasing domestic audiences to curtail such doomsday scenarios from coming true.
That said, solving this issue will involve probing deep-seated structural problems with their economy. It's like Japan's own series of nested dolls: How can you address deflationary pressures in the absence of significant economic growth? How do you generate economic growth with a shrinking population? How do you generate more revenues to not have to issue so many IOUs without economic growth? It's not an isolated issue of, say, raising the VAT rate but goes into why Japan Inc. no longer works as it did in its 70s and 80s heyday.
And now to a more realistic disaster scenario over national superindebtedness:
Capital flight, soaring borrowing costs, tanking currency and stocks and a central bank forced to pump vast amounts of cash into local banks -- that is what Japan may have to contend with if it fails to tackle its snowballing debt.Not long ago such doomsday scenarios would be dismissed in Tokyo as fantasies of ill-informed foreigners sitting on loss-making bets "shorting Japan"...It costs Japan half of the country's tax income just to service its debt.Hardest hit will be Japanese banks who hold a lot of JGBs, potentially posing "moral hazard" issues that would make the West's response to the global financial crisis look like small beer:
Each year, Japan's debt level increases by more than the combined gross domestic product of Greece and Portugal. Yet Prime Minister Yoshihiko Noda's plan to double the 5 percent sales tax to 10 percent over the next three years is seen as far too timid to stop debts from piling up. The fact that bureaucrats openly discuss such disaster scenarios shows their concern that the public, politicians and even some people in financial markets do not take the situation seriously enough, and that the debt blowout will become a self-fulfilling prophecy if necessary steps, such as raising taxes, keep getting pushed back.
But to some economists who have followed Japan for years, the frustration is that the country has yet to solve its underlying problems of slow economic growth and stubborn deflation. As long as those conditions persist, it will be difficult to crawl out from under the debt burden.
While officials stress it is too early for a definite contingency plan, there seems to be an agreement that financial institutions will be the hardest hit because of their big government bond holdings, and that the Bank of Japan will play a key role in shoring up the sector. "The most important thing, in the event of a crisis, is perhaps not trying to affect fund flows by buying government bonds in huge amounts, but to make sure Japanese banks aren't forced to sell en masse to meet day-to-day funding," one of the officials familiar with BOJ thinking said. "Once it becomes a banking sector problem, it's very hard to contain the damage."It all hinges on the continuing willingness of Japanese citizens to buy JGBs despite growing awareness of the risks involved:
In an event of a surge in yields, the Bank of Japan could flood money markets with cash the way it did after the March 11 earthquake and act as a market-maker for the bond market, matching bids and offers if they fail to meet, officials say. The finance ministry could also be forced to redeem bonds ahead of maturity to calm investors, says Yoichi Miyazawa, former vice finance minister and upper house lawmaker for the opposition Liberal Democratic Party. Miyazawa, who led work on the party's crisis plan, says the worst case scenario could involve bank bailouts and Greek-style austerity if debt servicing costs soared, threatening to eat up a big portions of revenues. "The government should show a concrete roadmap for rebuilding public finances, including the kind of reforms adopted by Greece, which involve painful belt-tightening, slashing welfare spending and boosting sales and other tax rates," he said.
Finance Ministry data confirms that banks, rather than the budget, would take the hardest, most direct hit. First, the 2012/13 budget plan is based on 10-year yields of 2 percent, giving the government some cushion considering those bonds are currently yielding less than half of that. Secondly, its simulations show adding 1 percentage point to borrowing costs would add 1 trillion yen to about 22 trillion in borrowing costs over the course of one year, rather than double them as some commentators warn, because the spike would only affect newly issued and rolled over debt.
What sets Japan apart from Europe's crisis-hit nations is that it borrows almost exclusively at home and with domestic savings of some 1,500 trillion yen ($19 trillion) it can do it paying less than 1 percent for 10-year bonds. Deflation and the yen's long bull run foster a "patriotic" home bias among households and institutions, turning private savings into quasi public money, always there and easily accessible. In addition, the central bank acts as a buyer of last resort for the market, taking up large amounts of government bonds both as part of its annual quota of more than 20 trillion yen and an asset-buying plan launched in 2010.Still, inertia favors this odd and ultimately unwelcome situation to continue in the absence of alternatives, or more specifically, attractive alternatives to domestic participants:
That explains how a nation with one of the lowest tax burdens in the OECD and a stagnant economy never seemed to have trouble rolling out hefty stimulus packages or subsidising social security. In fact, the system got so entrenched that bond sales are often reported as budget "revenue," not borrowing.
Budget arithmetic and demographics suggest that it will take another decade before Japan's swelling ranks of retirees will begin to run down their vast savings to the point where Tokyo will need to start borrowing more from overseas lenders. The $10 trillion question is when that money or local investors' patience will run out.Also recall that in addition to having a sizable reserve pile of over $1 trillion, Japan has accumulated among the world's stashes of overseas investment holdings as a consequence of running current account surpluses for so long:
"There's a very strong system in place where all the stakeholders benefit from how things operate now," says one official. The optimistic view is that until then the government can keep rolling over the snowballing debt with ease. "Japanese banks don't have anywhere else to invest, so park their funds in the JGB market. The BOJ supports this by accepting JGBs as collateral. The only thing that could trigger a bond sell-off would be a huge pull-out of deposits from banks, which is hard to imagine."
But soaring fuel imports since the Fukushima nuclear crisis drove the trade balance into deficit in 2011 for the first time in three decades and probably brought closer the moment when the current account will also fall into the red. Hefty surpluses have allowed Japan to accumulate foreign assets exceeding 300 trillion yen, making a nation with the most indebted government also the world's biggest international creditor.It may still be quite some while till this whole economic sideshow comes to a grinding halt. On to Japan's national debt being 300% of GDP!
