Much as been written about Japan but I haven’t read one convincing story so far as to why a country approaching 250% Debt / GDP ratio is still not technically bankrupt. I decided to pick this topic because I believe it will have huge consequences for the world. Japan is in many ways ahead of the curve 20 years, so the rest of the world is going to get down the same road. Let’s throw in a few numbers to set the stage (JPY trillions):
Total debt: 1,196
Debt / GDP: 230%
Tax revenues: 50
Government expenditure: 100
Debt servicing expense: 23
Social security costs: 31
10 year yield: 0.23%
Budget deficit: 7.6% of GDP
Now stop for a minute to analyse those numbers: They spend 23trn servicing debt, which is around 46% of tax revenues. Did you get that? For every 100 JPY they collect in taxes, they spend 46 to pay interest on their debt!! As comparison, US & other developed countries spend ~15%, which is already a huge number but perhaps still manageable. If you now add social security costs, they are already under water at 110% of tax revenues. So for only these 2 sectors alone they already need to issue new debt to stay afloat. Let’s not even mention the traditional government spending items, which in my grandmother’s days used to be education, security, defence, health, infrastructure, etc. To fill in this gap they need to spend another 40trn JPY. So in short, they need to NET borrow 50trn a year (which is 100% of yearly tax revenues) to stay afloat and pay for all their promises. Again, stop a minute to absorb this. How could they get this point? And is there anything they can do to reverse course? Well, perhaps the fact they’ve had 11 finance ministers in 6 years (between 2006-2012) explains how desperate the situation is. They got appointed, spent 3-6 months analysing the numbers and pretty much resigned… It’s so insane what is happening right now in Japan that only something more insane could be seen as a solution. And that’s what Abe / Kuroda are now doing. Printing money like the world has never seen before. It’s as if you want to cure a Sunday’s hangover by drinking whisky the next few days so as not to feel the pain. If only life was that easy!
To make matters worse, Japan’s demography is the worst in the world. Their total population is shrinking (127million now but likely to shrink to 108mio by 2055, see link below). Their population over 65 now stands at 25% and increasing fast (by far the largest proportion in the world, followed by Germany at 21%), which is only going to worsen their social spending. Their current account is now turning negative – as consequence of obsolete/zombie companies completely overtaken by their Asian counterparts in the technological race. Think how many items you have in your house coming from Japan? Not many frankly, I remember growing up as a kid in the 80’s surrounded by products from Panasonic, Sony, JVC, Sharp, Hitachi, where have these companies gone? So if GDP growth can only be achieved by either population growth or productivity gains – and both these elements are declining in Japan – how can they ever grow out of this mess? Bank of Japan (BOJ) has been trying to keep the system running by monetising debt, but there’s only little they can do. They can buy time, but unless the Japanese people face up to the challenge, they are going to hit the wall pretty soon. BOJ now holds around 20% of all Japanese government debt (and they take 100% of all newly issued debt), so you can make the case that 20% of the 23trn JPY spent on servicing debt actually comes back to the government via the back door. Also, an argument many people use is that most debt is internally held, but this was only possible because they ran a positive current account surplus for decades, which filtered through the economy and helped finance this new debt, but they’re now running a current account deficit, so they’re no longer a net saver country. As a consequence, only BOJ can come to the rescue and that’s precisely what they did. But still, the structural problems are simply too big to overcome with mimics & financial engineering. According to research, Japan would need to collect taxes around 45% of GDP to get into a sustainable path (they currently collect around 10%). My Japanese friends, prepare yourselves for gigantic tax raises in the coming decades, and that’s if you want the system not to collapse. Either that or massive inflation generated by the trillions of JPY injected in the economy by BOJ. Unfortunately I think they got past the point of no return and a financial tsunami will hit them soon. It’s hard to define “soon” as these things take time to play out, but I have no doubt in my mind that the game is over for Japan, it’s now a question of time. Let’s not forget the stock bubble in Japan reached a P/E ratio of 78 in 1989 (for those not familiar a level >20 already signals bubble territory), so irrationality can take a LONG time to unfold and maybe we will see the same here. My hope is that the world can learn from the inevitable catastrophe and that Japan will be seen by the history books as the catalyst for a so needed reset button.
A final note: For those that read the previous post on Switzerland, yields on 2 years have now dropped further into the “unknown” to -1.2%, so you pay the Swiss government 1.2% as fees to keep your money for 2 years. I’m pretty sure anyone predicting this 5 years ago would lose their job and be labelled lunatic. I’m just stunned with why would anyone rational give 100 to Swiss government to receive 98.8 in 2 years. Why wouldn’t corporations/pension funds rent a safe somewhere and keep it there? Why wouldn’t individual people withdraw the cash and keep it home? Well, it may be because this money doesn’t really exist, it’s all electronically created – so we have no real alternative.