I found a very good article in Reuters, so I thought I’d follow up my previous postings on Japan, and their fiscal nightmare. First, to orient you a bit, I will hotlink the following two graphs :
The first graph pretty clearly outlines the case for Japanese collapse. After the real-estate bust in the 90′s, Japan went on a fiscal stimulus binge and never stopped. As of 2010, they spent 90 trillion yen, while getting less than 45 trillion yen in revenue. Not good. Now, publics works projects ARE being wound down, so spending will actually decrease in the coming years. The only question is – will it be enough? It is no small task we are looking at for the Japanese government. The second graph gives us the problem more clearly – welfare spending on an aging population has grown from 10 trillion annually in 1990 to more than 25 trillion last year. So, as I’ve concluded many times before, Japan actually cannot fund the welfare spending and interest on their debt without borrowing (discretional spending is on top of this). If you look at the yellow line, thats the sales tax. It is calculated (according to Reuters) that each percentage point increase in the sales tax would give an additional $2.5 trillion in revenue. To cover the 45 trillion deficit, Japan would need to raise the sales tax between 15-20%. It currently stands at 5%. A quadrupling or a quintupling of the sales tax is no easy thing to swallow politically. But lets assume they cut discretionary spending instead. If they remove ALL spending except welfare and interest on existing debt, they would almost close the deficit. A 2% increase in the sales tax might then be enough to stabilize the debt levels.
But there is a problem, and you can see it in the lower graph. Welfare spending is increasing, because people are getting older. Unless reforms are made (some are being contemplated, but nothing is being done so far), covering this would require and additional 1% sales tax each year. And then there is the unfortunate ticking time-bomb. The reuters article tells us that Japan has an enormous pool of domestic savings, about three times the GDP of the country. This is great, of course, but we need to realize that 2/3 of this “wealth” is invested in Japanese government bonds. And the savings rate is falling, down from 10% a decade ago to just 3% now, so this pool is not likely to increase very fast. And as people get older, they tend to liquidate savings to fund their retirement. It’s all about what sort of lifestyle old people in Japan are expecting, as they retire.
The final problem though, and the single largest threat to Japan, is if interest rates start going up. Rumours tell me that people have been shorting Japanese government bonds for almost two decades, and lost money on it. This means that the idea of constantly lower interest rates is as entrenched in Japan as it is in the United States. And this is a problem, because if interest rates tick up just a couple of points, Japan is in deep shit. The obvious option is to let the Bank of Japan step up purchases, and to start, this is probably going to look like a good idea. The yen will lose some value, but due to the constant trade surplus it won’t collapse immediately, and the deficit spending can continue. The problem is that this has always been the Japanese solution, even if it isn’t admitted. Interest rates have been near zero for a very long time, and by waving the specter of “deflation” (japanese CPI figures are rumoured to be a bit iffy as well), quantative easing has been a constant policy of the Bank of Japan. Yet we all know that this cannot go on forever. The Krugmanites of the world will say that Japan is in a “liquidity trap”. If we define “liquidity trap” as reaching the debt limit of society and ending up with a bunch of Zombie banks that hoard money and slowly leak losses through bad assets, then sure. Liquidity trap it is. But this cannot be solved with low interest rates, or quantative easing, as we’ve seen for 21 years in Japan. It can only be solved by pushing the banking system through bankrupcy, and then setting decent interest rates. The prospects for this are rather bleak.
Conclusion? The Japanese game goes on, and it seems very hard to predict for how long it can do so. I suspect that a “solution” will be patched together by raising some taxes here, and lowering some spending there, but all this will do is pretty much keep the status quo. The fact is that if interest rates go up, Japan will still have to print unbelievable amounts of money. And they can do this – for a while, until the yen starts crashing. And unfortunately, we have a lot of macro-economic uncertainty coming up, and once the world has decided that it is done worrying about the fiscal position of various small European countries, it is the US and Japan up next. I may have been premature calling for the fiscal collapse of Japan (and that of the US), but as things stand I stick to my prediction. It might take a few years more than I expected, but unless things change radically, I don’t know who will save Japan.