Thursday, May 1, 2014

Japan Sliding Towards The Abyss

Japan continues to slide towards an economic abyss with each passing day. The writing is on the wall. Japan is facing a wall of debt that can only be addressed by printing more money and debasing their currency. This means paying off their debt with worthless yen where possible and in many cases defaulting on promises made. Japan's public debt, which stands at around 230% of its gross domestic product (GDP), is the highest in the industrialized world. Often because of its size people forget that little Japan is the worlds third largest economy making it a huge economic power with a big shadow.

It should be noted that Japan would be sitting in far worse shape if it were not for the wealth currently shifted from America to the small island nation each year. America spends billions each year defending Japan and puts much of this money directly into the economy. Another way America supports Japan is by purchasing so many of the goods the country produces. The massive trade deficit America has with Japan feeds large amounts of money into Japan, without this money the massively indebted nation would be in even more trouble.

When you introduce demographics into the picture we see that Japan is stuck with an aging and shrinking population that is evermore expensive for the government to provide for. Adding to its woes the Fukushima nuclear disaster has shuttered its nuclear power plants and forced the country to import more expensive energy alternatives. Neither monetary nor fiscal policy will adequately solve Japan's problems. Continuing to run fiscal deficits only means that government debt is pushed onward and upwards leading to a variety of possible scenarios as to the what the end game will be. Simply put, the fundamentals for Japan are lousy.

Japan raised its sales tax, also known as consumption tax, to 8% from 5% recently this is the first hike in seventeen years. The hike comes as Japan has been looking to rein in public debt, while facing rising social welfare costs linked to an aging population. The rise in sales tax is also seen by many as helping Japan achieve its 2% target for inflation. Unlike many other leading economies, Japan has been battling deflation or falling prices for the best part of the past two decades expect this to change as reality takes hold.

As Japan has undertaken a policy to weaken its currency and to strengthen its exports other countries have remained mute in sympathy of the problems Japan is facing. Thus far the current BOJ policy has quietly and systematically distorted financial markets across the planet. As this unfolds investors and the megabanks are drastically reducing their Japan Government Bond (JGB) holdings. The risk of who gets hurt in the case of a default is shifting from the private sector to the public as the BOJ splurges on JGBs. As they continue down this path it is only a matter of time before the credibility of the BOJ is lost and the yen will plunge.

As investors in Japan's government bonds begin to believe that Abenomics will be successful in bringing back inflation it would be logical for owners of  JGBs to move out of low yielding securities and buy foreign bonds or equities. The moment the Japaneses stock market fails to rise enough to offset inflation this will turn into a tsunami of  money fleeing Japan and constitute the end of the line for those left holding both JGBs and the yen. This has been a long time coming and I contend the cross-border flow of money leaving Japan is why some stock markets have remained so resilient . When Japan crumbles it will be felt across the world.

 Footnote; This post dovetails with many of my recent writings. Other related articles may be found in my blog archive, thanks for reading, your comments are encouraged.

1 comment:

  1. Thanks. '

    I dont see Abe turning this around but I do see him making it a lot worse.
    Thanks for the great writing you should be on FT!