Tuesday, February 2, 2016

Japan Is Falling Into An Economic Abyss

Japan Is A Failing Economy
The writing is on the wall. Japan is facing a mountain 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 industrial world.  While Japan's economy comprises 6.18 percent of the world's GDP it makes up a whopping 19.99 percent of the world's total sovereign debt. Often because of its geographical size people forget that little Japan is the world's third-largest economy making it a huge economic power with a big shadow.

I have written several articles about Japan over the years and how growing debt was poisoning its options, two years ago I voiced the opinion the country would continue to slide into an economic abyss. Now regional weakness and credit issues in China have begun spilling over to undercut Japanese growth, this is a force that will last for some time. It must be noted that Japan would be sitting in far worse shape if it were not for the wealth currently shifted each year from America to the small island nation. America spends billions each year defending Japan and puts much of this money directly into their economy. Another way we support Japan is that American consumers purchase many of the goods the country produces, in 2015 America's trade deficit was over 62 billion dollars. Through this massive trade deficit, America feeds large amounts of money into Japan, without this money the massively indebted nation would be in even more trouble.

It has been pointed out time and time again that Japan is faced with sour demographics that bode poorly going forward. The country is stuck with an aging and shrinking population that with each day becomes more expensive for the government to provide for. The budgetary impact of rising social welfare costs linked to an aging population has taken its toll. Adding to its woes the Fukushima nuclear disaster has shuttered its nuclear power plants and forced the country to import more expensive energy alternatives. All this means that neither monetary nor fiscal policy will adequately solve Japan's problems. Year after year Japan faces fiscal deficits and this 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.

For years even decades the conventional wisdom has been that Japan is, or was in the unique situation of controlling its own fate because its debt was owned internally. Unlike America that sold its bonds to foreigners who at any time might pull out or demand payment this was considered a source of strength. It is important to recognize that over the years many new pathways have opened that now allows individuals to protect their wealth by moving it offshore. Back in June with little fan fair Japan Post said that it will significantly alter its investment strategy and invest more money outside the country. Because of the mere size of Japan Post Holdings, this is a signal of major importance and has far-reaching implications. Traditionally, with close ties to the government, the investment strategy of Japan Post has been very conservative with low-yielding JGBs making up more than half of its portfolio. This may someday be looked on as a watershed event as to how the Japanese began shifting  away from a falling yen to protect their wealth.
Yen Falling-It Takes More To Buy A Dollar

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 a response, Japan has undertaken a policy to weaken its currency and to strengthen its exports. America and 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 has unfolded investors and the megabanks have quietly and drastically reduced their Japan Government Bond (JGB) holdings. The risk of who gets hurt in the case of a default has been shifting from the private sector to the public as the BOJ splurges on JGBs.

As Japan continues down this path it is only a matter of time before the credibility of the BOJ is lost and the yen will plunge. The financial markets have seen time and time again it is far easier for a country to weaken its currency than support it. 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 Japanese 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 when the end becomes apparent to all, events will pick up speed and the situation spiral out of control. When Japan crumbles the shock waves will reverberate around the world.  

1 comment:

  1. Only the Keynesian imbeciles could have brought Japan to this end. What a tragedy. This is one of Mr. Krugman's "triumphs." A teenager could see that, if the BOJ is the only buyer of Japanese bonds, the game will soon be over. And it will.