These two
bubble pops, however will pale in comparison to the next one coming: Japanese
Bonds. To set a bit of context, the Japanese government, in order to stimulate
the economy back in the early 90s, had effectively begun printing money
(issuing bonds) at such a frenetic pace (and has continued unabated for the
last two decades) that the amount of government bonds issued far out-stripped
the amount of tax revenue they receive from Japanese citizens. At the moment
Japan’s government gross debt sits at 240% of GDP (More fun if we start talking
though in terms of Yen, Quadrillions of it).
While even
getting to this mark does seem logically-defying for any rational thinking
human being, what made this possible up until now were three key factors: A
large pool of savings, low interest rates, and a postive trade surplus
(earnings from exports are greater than the costs of imports).
At face
level, the following statistics could put one’s mind at ease that there is no
crisis to really worry about: Japanese have $19 trillion dollars in savings and
90% of Japanese Government Bonds are held domestically, so say if China or the
US were to decide to dump their holdings in Japanese Government Bonds, it would
not lead to a collapse in the Japanese economy. In addition overnight cash
interest rates are around 0.1% per annum, which is the lowest rate amongst all
the major central banks in the world. The below link attests this:
All good? Not quite.
Let us start
with the savings rate: During the hey-days of the late 80s and early 90s, Japan
had a savings rate of around 15 to 25%. Today it is under 3%. The two main
causes are: a) declining asset prices (i.e. deflation), and b) an ageing
population. We have effectively touched on the asset price collapse over the
last two decades with the real estate and stock market bubbles, so we will
focus on the impact of the aging population. More than 23% of Japan’s
population are above the retirement age of 65 (compare that to 11.6% in 1989),
and as the chart clearly shows below, there is a direct correlation between the
decline in the working age population and the rate of economic growth (makes
sense - less able workers, less production…).
Apart from having
a lower proportion of the population in the workforce, pension funds and
insurance companies have had to start selling their Japanese Government Bond
(JGB) holdings in order to payout the retirement benefits that are owed. This
leads to the servicability of debt becoming more difficult (seriously who wants
to put their money into savings that would only get you next to nothing in
interest?). To ascertain the degree of desperation of those governing the
finances of the nation, one “remedial” solution proposed by the new (but don’t
know for how long) finance minster Aso Taro was to ask the elderly to “hurry up
and die” http://www.guardian.co.uk/world/2013/jan/22/elderly-hurry-up-die-japanese in order to reduce the cost of social welfare (18% of national income
currently, 27% by 2025) – what is the phone
number to The Hague, please?
Anyway moving
from that slightly morbid blot now is a good time to touch on interest rates, I
mean what interest rates? For about 17 or so years, the overnight cash rate in
Japan has been set by the Bank of Japan (BoJ) to under 1% per annum in order to
help revitalise the economy (see chart below).This has not quite worked out
(check out chart previously).
Now the
latest Prime Minster Shinzo Abe has promised to combat the deflation of asset
prices in Japan by proposing a 2% inflation target. This would imply making
assets, including Japanese Government Bonds more attractive to purchase. Now we
have touched on the fact that the savings rate in Japan is now under 3%, domestic
purchases would have a band-aid effect, so it would be wise to increase sales
to foreign investors, but again with a declining Yen and next to nothing
interest rates, what can make one more interested in purchasing bonds? One
solution is to increase the yield of return on Japanese Governement Bonds, but
this would imply raising interest rates.
There is a
fundamental problem to this however: Even at these low levels of interest,
25-30% of Japanese tax revenue is spent on servicing only the interest payments
for the bonds. It has been calculated that if interest rates go up to as much
as 2.5%-3.5% per annum, the tax revenue generated would not be enough to cover
the interest payments. At the moment the Japanese tax rate is 5%, with plans to
increase it to 10% by 2015, but even if all Japanese held assets were put to
service the debt issued by the Japanese government and taxes were raised to
100%, it has been forecasted that it would be enough to only service the debt
for another 12 years. Things look terminal at best.
The last
major point I want to look at is Japan’s trade surplus. Before the 2011
Earthquake/Fukushima disaster, Japan had maintained a positive trade balance
due to high volume of exports, as well as low dependency to meet the energy
requirements of the nation due to the development of nuclear reac tors.
Post
Fukushima, however, nuclear reactors were shut down leading to significnat
increases in energy imports, making Japan a net importer as oppose to a net
exporter (see chart below).
Combine that
with a weaker yen to boost exports, increased stimulus to revitalize
infrastructure (20 trillion yen promised by Shinzo Abe), falling exports to
China (it’s largest export partner, and territorial disputes brewing again) and
a downbeat global economy, it Is expected that the deficit will get much wider.
So what is it
that needs to be solved in Japan? Increase economic growth and increase the
value of asset prices. What can be done? Government go beserk, print more
money/issue more JGB at super-low interest rates and devalue Yen to increase
exports. That has been the current policy to date, and clearly has not worked..
So what about stopping the money printing, raise interest rates and increase
the value of the Yen? – As we have seen it is a quick step to sovereign
default. How about re-starting the nuclear reactors? – Not sure if one can
stomach 3-eyed fish. How about addressing xenephobic immigration policies or
increasing incentives to have larger families to increase the proportion of the
working age population? – Wishful thinking, but may be too late to implement as
it is.
If we put the
implications in a global context, consider that Japan is the third largest
economy in the world and holds $4 trillion US dollars in foreign assets. Now
mix with that the crisis in the Eurozone and Helicopter Ben Bernanke continuing
to go wild in the US with the never-ending “quantitative-easing” money printing,
we would most likely see a crisis in the Global Financial Markets unprecedented
in anyones’ time sooner rather than later.
Ah0707 - “Guns and Food (Gold and Silver too)”
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