1st February 2010 by Shaun Richards
The last week has shown several sides to Japan’s economic position. Some of the data and information simply reinforced long-term trends but others were genuinely new and some had elements of both. With her extremely high level of fiscal deficits and her national debt expected to surge above 200% of her Gross Domestic Product she appears to be a counterpoint to Greece. After all isn’t Greece being punished for high fiscal deficits and high relative national debt levels? Yet Japan on the surface appears calm and her 10 year government bond yield is 1.33% as compared with Greece’s which closed on Friday night at 6.79%. So using German bund yields as a benchmark then Japan is at -1.89% whereas Greece is at +3.72%. Extraordinary isn’t it? Even Switzerland is only at -1.20% when compared on such a basis.
Essentially the main cause is quite simple. The Japanese are a nation of savers and exporters in generic terms. So they finance their own government bond market. They are also large overseas investors and help to finance other countries national debts by buying their bonds. So they can price their own bond market to a degree and in their domestic situation which often has disinflation (negative inflation) they seem happy to accept these yield levels. The Greeks have not been savers their public sector has run high deficits and they are unable to finance their own national debt from domestic savings. Overseas investors have started to demand higher yields on Greek government bonds to compensate them for the risks inherent in Greece’s financial situation and because of her reliance on them yields have had to rise. Exports are another example because as Japan is a net exporter it is perceived that she can repay her debts, if you like in MP3 players, TVs and cars. Greece however has run a current account deficit so again she needs foreign finance.
Implications of her Quantitative Easing experience
As an aside Japan’s situation in the respects described above is why she has been able to run a Quantitative Easing (QE) programme over some years and why the UK will have problems if we try to do so. We rely on overseas investors and she does not. Sooner or later they will demand higher yields on UK government bonds as a result of reduced credibility in UK economic policy. We could find the UK in 2/3 years time with higher bond yields because of QE (it is supposed to reduce them). It is not impossible that in future years the effect may turn negative and of course will also mean that it makes a loss. I notice that more and more supporters of QE are starting to claim that the Bank of England can hold the government bonds to maturity. It appears to have escaped them that this is worse not better and is an example of putting things off into a distant future perhaps in the hope it will be forgotten. This is an interesting tactic as £200,000 million is quite hard to forget you might think.
Japan’s Gathering Problems
As described above Japan has managed something of a conjuring trick in spite of her difficulties over the last 20 years. Sadly there have now been two “lost decades” but she has avoided being punished in the way Greece is being for the reasons described above. However she has an aging population which is becoming a drag on her economic performance (I have written on this before and her position is worse than other western countries, her population is projected to actually fall) and her budget deficits are driving up her national debt to around 200% of her GDP. My contention is that her problems are beginning to gang up on her.
There is a new type of economic analysis which goes as follows. Countries need to finance their national debt. So their economic growth rate needs to be compared with their national debt as a percentage of their GDP to see if they can “afford” to pay their debt. This analysis is a way of measuring the affordability of the national debt in the long-term by comparing interest payments with the ability to pay which is measured by economic growth.
So economic growth needs to be higher than national debt as a % of GDP multiplied by the interest yield under this measure. For Japan using 10-year yields this comes to 2.66%. Is she growing fast enough for this?No? Is her national debt growing?Yes. So the situation is in fact getting worse. There is a lot of analysis on Japan which explains her lack of economic growth in the last decade with the change in her population structure. Looked at as a chart the correlation looks convincing. I am aware that correlation does not prove causation but feel that there is something in this. If so Japan’s economic growth rate will be more constrained as time goes by. Also remember the only reason the situation looks containable now is her extraordinarily low yields.
What also bothers me about Japan is the behaviour of consumer prices. Before the update last week she had nine months in 2009 that showed outright price falls and this is a problem which has persisted in Japan in the recent past. In December 2009 prices fell again with the core index falling on a year on year basis by 1.3%. Even the Bank of Japan is forecasting that consumer prices will fall until March 2011 and it has no incentive at all to forecast this as it has been trying (and failing) to stop it! Preliminary estimates for January 2010 also show falling prices. This is in danger of becoming a spiral downwards. There are signs of recovery in Japan as her exports grew on a year on year basis for the first time in 15 months and industrial output rose by 2.2% in December but the disinflation problem will not go away.
The Bank of Japan appears to be out of ideas and policy measures. If we go back to 2001 then similar examples of falling prices led to it starting a Quantitative Easing programme but as of its statement on the 26th January 2010 there was little of note. Perhaps it is concerned by the new administration in Japan the DPJ which came into power promising change and now looks likely to spend even more than its predecessor. The announcement by Standard and Poors that it would put Japan’s long-term credit rating on negative watch is perhaps not going far enough in my view. Pressures are building and even Japan’s favourable savings situation is looking like it will change as her population structure deteriorates.
Japan has been able to survive her twenty years of economic problems because of her savings culture and her exporting power. However this has hidden changes in Japan which slowly have eroded these advantages and will I believe continue to do so. The worldwide credit crunch hit her at a bad time and her fiscal stimulus responses are leading to her national debt growing alarmingly. The disinflation problem will make the national debt problem worse. Confidence is a tenuous subjective factor and it is hard to be precise about it but in the end if these trends continue then Japan’s large overseas savings and her net exports may not be enough…