The Japanese title translates to “delaying bankruptcy”. Japan is know for its huge amount of government debt. Everyone seems to be baffled by the fact that the Japanese government is still alive, even though its debt share surpasses 200% of GDP by now.
I have written before that I expect Japan to reach a tipping point sooner or later. Inflation or bankruptcy, or both, may become unavoidable. But, for us Europeans and Americans, the important question is, how was Japan able to shoulder such an amount of debt without having runaway inflation in the first place?
This chart shows (HT @ZeroHedge) who helds how much government debt in Japan. Most debt is actually held by the government itself or by institutions that have close relations with, or are even influenced, by the government. These are the Bank of Japan, the public pension funds, and the famous (government-controlled) behemoth named ‘Japan Post’.
I divide the Japanese “debt miracle” into three stages:
1) 1990-1997: In the aftermath of the stock market and real estate collapse of 1990, government bonds (‘JGBs’) rallied as interest rates of 10-year bonds went down from around 7% to 2%. I would interpret this as the logical result of years of overinvestments. When there is too much capital around, returns on capital go down. Besides, from an investor’s point of view, in a world in which both stocks and houses are vastly overvalued, what would you buy?
2) 1998-2010(?): Japan’s economy changed from being ‘disinflationary’ to becoming outright ‘deflationary’ after the Asian Crisis in 1998, when Japanese banks finally had to realize some of the huge losses that were hiding in their books. They started hoarding cash, as bonds were now so expensive that they also couldn’t promise good returns anymore. Stocks and real estate were still pretty expensive on a fundamental valuation basis. The Bank of Japan (‘BOJ’) did let deflationary expectations took hold of the economy. This made cash an attractive investment with a promised return equal to the rate of deflation, i.e., around 1%.
In 2001, the BOJ started ‘quantitative easing’, i.e., buying government debt. However, they did it the same way as Bernanke does it now. They only bought intermittently, at the same time promising to unwind ‘QE’ if necessary in order to control inflation. As some economists have already pointed out, the BOJ acted as if they were an ‘price level targeter’, i.e., they were trying to allow neither inflation nor deflation in the longer term. This strong anti-inflationary stance made cash even more attractive as an long-term investment, complementary, or even as a substitute, to government bonds. But government bonds were still attractive, too. Stocks and real estate have never fully recovered yet, even though economic growth was pretty impressive during 2004-07.
3) 2011(?)- : The final phase will bring about the end of the debt miracle. There are already signs that private investors are neither willing, nor able, to buy more government bonds. The same goes for the pension funds. And I wonder how many more bonds the several local and central governments can sell to each other. The BOJ and the government will probably aim for a continuation of the slightly deflationary monetary policy, as it allows them to conduct more ‘QE’ purchases of bonds without igniting fears of hyperinflation. However, at some point in the future there will be no other buyer left other than the BOJ. Then, people will realize that ‘QE’ would have to become permanent in order to finance government deficits. This will be the point when people start to get out of cash and pour their savings into either foreign investments, or stocks and real estate, something that is protected against inflation. Stocks are now so cheap in Japan that the lure to buy them becomes ever larger, even with slightly deflationary monetary policies.
Another option for the government would be to default on its debt, but I think that is rather unrealistic. Firstly, the financing deficit and the debt burden are so large that the central and local governments would have to conduct such a harsh austerity package that Greece’s reforms would look like a walk in the park. Secondly, the savings of the Japanese people are so large that an ‘inflation tax’ on them would be the easiest way to finance the redemption of the debt. Further, it would provide for a relatively fair distribution of the redemption burden onto all citizens. I know, I know, how can inflation be fair! Of course, I mean the democratic meaning of the word ‘fair’. In other words, the majority of the voters will demand inflation.