On the Road to a Japanese Debt Crisis
May 29th, 2013Via: The Exchange:
The initial results of the Abenomic program would be cause for true celebration if they did not also have the unintended consequence of drawing the market’s attention to the appalling state of Japan’s public finances. However, seemingly this is now occurring as markets have begun to question the logic of holding Japan’s very low yielding government bonds knowing full well that the Japanese government is intent on cheapening the country’s currency and on reigniting domestic inflation through an unprecedented policy of massive money printing. The incipient loss of market confidence has been reflected in a more than doubling in the 10-year interest rate on Japanese government bonds from a low of 0.4 percent in April to its present rate of over 0.9 percent.
The prospect of a further loss of investor appetite for Japanese government bonds would not be so serious were Japan’s public finances in reasonable shape. In truth, however, it is difficult to conceive of a worse state of public finances for the country. Japan’s government still has to finance a budget deficit of around 10 percent of GDP at at time that its gross public debt amounts to close to 240 percent of GDP, or almost 2 1/2 times the corresponding public debt ratio for the United States.
Compounding the dire state of Japan’s public finances is the fact that Japan’s population is now aging at by far the most rapid rate among the industrialized countries. As a result of this aging, Japan’s domestic saving rate is already now declining at a rapid rate, which will make it increasingly challenging for the government to continue financing itself at very low interest rates.
The Bank of Japan could very well soon find itself faced with a terrible dilemma. If it does nothing about rising government long-term interest rates, Japan’s government finances would appear to markets to be all the more unsustainable and Japanese banks would suffer increasing losses on their large portfolio of Japanese government bonds. If, on the other hand, the Bank of Japan were to step up its policy of bond purchases to keep the government’s long-term borrowing costs low, it would very likely accelerate the pace of Japanese yen depreciation and increase inflationary expectations. Such a course would make investors even less willing to hold those bonds which would require yet another round of Bank of Japan buying.
Needless to say, being the world’s third largest economy means that developments in Japan have very important implications for both the global and the US economic outlook. This is yet another reason that one has to hope that Japanese government bond holders do not lose confidence in Japan’s very compromised public finances anytime soon.
