Japan from the inside out

Will Japan’s economy go belly up?

Posted by ampontan on Sunday, November 29, 2009

“As the Japanese certainly realize, both restoring banks and corporations to solvency and implementing significant structural change are necessary for Japan’s long-run economic health. But in the short run, comprehensive economic reform will likely impose large costs on many, for example, in the form of unemployment or bankruptcy. As a natural result, politicians, economists, businesspeople, and the general public in Japan have sharply disagreed about competing proposals for reform. In the resulting political deadlock, strong policy actions are discouraged, and cooperation among policymakers is difficult to achieve. In short, Japan’s deflation problem is real and serious; but, in my view, political constraints, rather than a lack of policy instruments, explain why its deflation has persisted for as long as it has.”
– U.S. Federal Reserve Chairman Ben Bernanke

EITHER THE BUSINESS of following the movement of money for a living attracts those of a saturnine cast, or the business of following money itself makes people that way. Even in the balmiest of economic climes, they scan the skies for storm clouds while issuing dire warnings about the sooty wisps that just float overhead or dissipate before any rain falls.

In today’s economic climate, however, those who put the dismal in the dismal science are reveling in a saturnalia of pessimism so extreme it’s time for the rest of us to pay attention to the racket they’re making instead of shutting the window. It isn’t just the United States that’s causing the analysts to pour themselves another stiff drink; even the layman senses that the Americans are building another house of cards on the lot filled with the debris from last year’s collapse. What has some money watchers reaching for the bottle this time is Japan and China.

Earlier this month, Ambrose Evans-Pritchard wrote this column in Britain’s Telegraph headlined, “It is Japan we should be worrying about, not America.”

The barman sets them up:

Japan is drifting helplessly towards a dramatic fiscal crisis. For 20 years the world’s second-largest economy has been able to borrow cheaply from a captive bond market, feeding its addiction to Keynesian deficit spending – and allowing it to push public debt beyond the point of no return.

And then pours:

Regime-change in Tokyo and the arrival of Yukio Hatoyama’s neophyte Democrats – raising $550bn (£333bn) to help fund their blitz on welfare and the “new social policy” – have concentrated the minds of investors at long last. “Markets are worried that Japan is going to hit a brick wall: the sums are gargantuan,” said Albert Edwards, a Japan-veteran at Société Générale.

Here’s the chaser:

Simon Johnson, former chief economist of the International Monetary Fund (IMF), told the US Congress last week that the debt path was out of control and raised “a real risk that Japan could end up in a major default”.

Care for a double? (My emphasis)

The debt situation is irrecoverable,” said Carl Weinberg from High Frequency Economics. “I don’t see any orderly way out of this. They will not be able to fund their deficit. There will be a fiscal shutdown, a pension haircut, and bank failures that will rock the world. It is criminally negligent that rating agencies are not blowing the whistle on this.”

On second thought, make it a triple:

“This is incredibly dangerous,” said Russell Jones from the RBC Capital Markets. “The rate of deflation is shocking. The debt dynamics are horrible and there is the risk of a downward spiral.”

The author points some fingers:

Japan’s terrible errors are by now well known. It failed to jettison its mercantilist export model in time. It resisted the feminist revolution, leading to a baby strike by young women. It acquiesced in a mad investment bubble (like China now) in the 1980s, stealing growth from the future.

Some of that’s overstated. China and South Korea use the same mercantilist export model, and none of the three could have succeeded unless the U.S., among others, allowed it to succeed. Birth rates are falling throughout Europe and East Asia, so if there’s any “baby strike”, the picket lines aren’t just in Japan. (It also isn’t due to resistance to the feminist revolution, but we’ll be looking at that and the Chinese bubble in some upcoming posts.)

QE was too little, too late, and this is the lesson for the West. We must cut borrowing drastically over the next decade, and offset this with ultra-easy monetary policy.

By QE, he means quantitative easing, or the purchase of national and corporate debt instruments by the Bank of Japan. Finance Minister Fujii Hirohisa is upset with the BOJ for halting their QE, by the way. The central bank’s justification was concern over rising public debt, but Mr. Fujii wants them to resume. He says there’s a limit to what fiscal measures can accomplish. He did not mention structural reforms.

Added Deputy Finance Minister Noda Yoshihiko:

With the rate of price increases expected to be negative for a long period of time, we would like the Bank of Japan to indicate a clear stance on how it will deal with the situation.

Remember that it was fewer than two years ago the Democratic Party of Japan, then in the opposition, tried to create a political crisis by rejecting the Fukuda Administration’s BOJ appointments, claiming Finance Ministry OBs were unacceptable. Their rationale, which has merit and is employed as a general rule of thumb in other countries, is that they wanted to keep fiscal and monetary policy separate.

But opposition parties everywhere have a problem with remembering the things they used to scream about once they’re in charge.

(Incidentally, even when many in the DPJ signaled they were willing to accept some appointees with a Finance Ministry background, the idea was nixed by Big Boss Man Ozawa Ichiro. Mr. Ozawa has always been more interested in politics than in government, and in ruling rather than governing.)

The danger here is that central bank purchases of the debt securities of their own government create money, which is known as monetizing the debt. In addition to putting into circulation specially made pieces of paper with elaborate colored engravings that everyone pretends has value, the process allows politicians to overspend revenues without raising taxes or risking default. Since the Finance Ministry is agitating for tax increases, and there’s a real risk of default anyway, it would seem that Japan has painted itself into a corner. No wonder Mr. Fujii is concerned.

Credit rating downgrade

The following report came out about a week after the preceding article appeared:

Fitch Ratings warned Japan on Tuesday to keep to its borrowing target or risk a credit rating downgrade as the finance minister acknowledged the problem and tried to reassure rattled investors by saying spending had to be cut.

What’s the problem this time?

The government has said it plans to borrow 44 trillion yen ($490 billion) in the 2010/11 fiscal year starting next April, which would be on top of expected record issuance this fiscal year of more than 50 trillion yen. But Fitch Ratings said it’s hard to see how the 2010/11 goal will be achieved and borrowing much more than 44 trillion yen would spark a ratings review.


“It’s not the sole determinant that will drive our assessment but other things being equal, then I think that would prompt us to review Japan’s current double AA-minus rating.”

Just when you think things can’t get any worse, they get worse.

The Government announced that Japan was again officially in a deflationary period. Here’s a passage from a website page explaining deflation, and how the lack of Japanese action in the past was deflationary:

Banks have delayed that decision (to collect on the loans), hoping asset prices would improve. These delays were allowed by national banking regulators. Some banks make even more loans to these companies that are used to service the debt they already have. This continuing process is known as maintaining an “unrealized loss”, and until the assets are completely revalued and/or sold off (and the loss realized), it will continue to be a deflationary force in the economy.

Here’s the suggestion the Deflation page authors passed along for dealing with deflation in Japan:

Improving bankruptcy law, land transfer law, and tax law have been suggested (by the Economist magazine) as methods to speed this process and thus end the deflation.

Those are probably some of the steps Mr. Bernanke had in mind. But what did the government do?

They passed through the lower house—after only eight hours of debate—Financial Services Minister Kamei Shizuka’s plan to encourage a debt moratorium and have the taxpayers guarantee the loans. In other words, instead of making the banks and businesses assume the risk—which is where it belongs—they’re making taxpayers liable for it.

Maintaining unrealized losses is deflationary. Therefore, the Japanese government is implementing a measure that will exacerbate deflation during a deflationary period.

Here’s another straw for the camel’s back: The government’s loan guarantee program has already used up half of its JPY 30 trillion (US$ 340 billion) budget, and the government says it doesn’t plan to allocate any more money. But how long will they keep singing that tune if too many default on those debts? Some default is inevitable, which means the government will be throwing the taxpayers’ money away. But what the heck, it’s only fiat money anyway. That’s the term for the money of the mind created after the debt has been monetized.

Still not worried?

As the old jest goes, if you can keep your head while those about you are losing theirs, perhaps you don’t understand the situation. Now we learn the Financial Services Agency plans to revise its rules for financial institutions to exclude debts suspended by the moratorium from the bad debt classification. In other words, the Government thinks that putting the peg in a different hole will hide the debt for the three-year moratorium period. Then, like Cinderella’s pumpkin, the name changes back and the banks have to write off the bad debts.

If the banks struggle to survive while writing off this debt, there will be inevitable calls for more taxpayer money to bail them out. Where will the government find the money to pay for all that?

Wasn’t “monetizing the debt” where we came in?

Yet another problem with Mr. Kamei’s economic demagoguery is the moral hazard. Some of the businesses freed from the responsibility of repaying their debt will either be unable to restructure their finances, or, considering human nature, may not do it at all. That would mean they go bankrupt anyway in three years, while all that fiat money backing the government’s guarantees evaporates with their business.

Still more to come

The banks are also getting the shaft from another direction. As this report notes:

“The Basel Committee on Banking Supervision is expected to raise the level at which financial institutions are required to maintain their core Tier 1 capital as early as 2012. Core Tier 1 capital includes the sum of common shares and internal reserves.”

The response of the Japanese banks:

“Mitsubishi UFJ Financial Group, Japan’s largest bank, is planning to issue a whopping 1 trillion yen ($11.2 billion) in new shares — the biggest-ever share sale by a Japanese financial institution. Investors are wondering if Sumitomo Mitsui Financial Group Inc. might be next.”

In still more other words: They’re going to dilute their stock, which has already taken a beating since Mr. Kamei announced his moratorium scheme.

It’s well past time for some people to take Mr. Bernanke’s observations seriously and make a choice: Risk losses in the next election, or risk losing the nation’s shirt.

Which one do you think the Ozawa-led DPJ chooses?

14 Responses to “Will Japan’s economy go belly up?”

  1. Ken said

    If at all Japan declares default, most of countries including the US would be involved because Japan is the largest creditor country in the world.
    I do not worry about it so much because Japanese debt is almost from own people but it is sure Hatoyama administration is jeopadizing Japanese economy as I predicted before.
    Minister Fujii’s restraint to foreign exchange market is obsolete method and no effective in current global economy that non-governmental money is significant unlike Fujii’s time.
    Japan may intervene exchange market because Japanese interest rate is higher than other countries by deflation and there will not be exchange war because Jaspan is not exporting to advanced countries so much unlike Great Depression era.
    The biggest problem is Hatoyama administration has no strategy beginning with Ministry of Strategy judging from rejections of a few science & technology projects which made many scientists upset at business assessment.
    It even seems to me that they are redistributing wealth as socialistic policy by cutting down the profit of export companies (mainly large scale) and enabling consumers to buy imported goods cheeper.

  2. M-Bone said

    Apparently, the Japanese gov/state organs holds half (!?) of its own debt –

    So considering the 4-5 trillion left, the Japanese gov. is owed more than 1 trillion of that by foreign creditors who pay considerably more interest than the Japanese gov. offers on its own bonds. This paints a very different picture.

  3. bender said

    It even seems to me that they are redistributing wealth as socialistic policy by cutting down the profit of export companies (mainly large scale) and enabling consumers to buy imported goods cheeper.

    How can the Japanese gov’t save export companies? Buy US dollars? Why should the government bail out export companies using tax money? I want to see charts and calculations demonstrating why currency intervention is justified.

    Regarding import goods, the most basic import, food, is still expensive because of farm subsidies and high tariffs. I’m wondering why people almost blindly agree with sustaining farming by eating up huge amounts of tax money- even with the global food crisis, it’s still cheaper to import rice. I want to see charts and calculations demonstrating why the “food security” policy is justified, too.

  4. bender said

    The WSJ opinion M-Bone introduced is interesting, because I thought guys at the WSJ flatly denied Keynesian (fiscal) policies. BTW, I think the belief that it does not work is dubious, and for Japan, premature withdrawal of government funds is probably a bad idea- kind of like how Mr. Obuchi (was it?) killed recovery back in the late 1990s, which in the end probably caused more deficit rather than reduced it.

    Corruption is one thing to tackle, but it shouldn’t be mixed up with recession economics. But I don’t hear anyone in Japan preaching this. People are entangled into politics too much!

  5. […] raises the alarm. that “What has some money watchers reaching for the bottle this time is Japan…“ But what did the government […]

  6. ampontan said

    Keynesian stimulus policies are like a sugar high. Since they’re not based on real economic activity, once they stop, the effects stop too. Witness the plummeting auto sales in the US once Cash for Clunkers ended.

    In fact, it was the 10 lost years in Japan that made Anti-Keynesians of some economists around the world.

    Also, the resources being used for the stimuluses are taken from some of the people to whom they’re being given.

    If it works roughly like this:

    1. We take 40% of what you got.
    2. You aren’t spending anything? OK, we’ll give some back.
    3. Now go spend.

    Then it would make sense that the problem lies in #1.

  7. M-Bone said

    “The WSJ opinion M-Bone introduced is interesting, because I thought guys at the WSJ flatly denied Keynesian (fiscal) policies.”

    That one is by Richard Katz who wrote it for the Oriental Economist. The WSJ just picked it up. For the record, I’m on the fence about stimulus spending. Good cases can be made for and against. Katz’ article mainly interests me for the points that he makes about Japan’s debt not being such a serious problem, which is relevant whether the stimulus strategy is followed or not.

  8. All this alarmed chatter defers til ‘later’ the point, ignores it for the US, ignores it for the world: Japan’s birth rate. Our US birth rate, for example, is at bare reproduction of the population levels, yet is celebrated as Europe approaches the same social/economic crisis Japan has created. Yet we have just elected an administration dedicated to the ‘freedom’ of abortion and gay rights at home and around the globe, without a clue, without a care, at the possible effect on our own birthrate–which is, upon examination, based on the births still ‘suffered’ by those ignorant unfeminist Mexicans. Now that Mexico has legalized abortions and the mentality will spread among them, we can kiss it goodbye, too. It’s all about lifestyle, not about economics. Economics comes second.

    I am sure the pundits contributing so impressively to this post will continue to count as idiots those lonely Catholics praying around abortion clinics, will never raise a voice in defense of motherhood, will not even get up to give a woman a seat on the train. They will continue to support ‘feminism'(although the most outrageous, expensive, feminist initiatives have not been successful in raising the birthrates in Sweden and Norway)reflexively. Could it be their own lifestyles depends on continuing the party?

    Here’s what happened in Japan. It’s not about economics at all. On top of an unromantic (read non-Christian) cultural approach to love, they legalized pornography in the last century, and are now so addicted to masturbation they no longer have intercourse. That’s what a condom manufacturer found, when they took the time to investigate falling sales. We don’t want to hear that. ‘Cider House Rules,’ meaning no rules at all, no contraints, no commandments, that’s what we like to hear.

    Go on back to chattering.

  9. M-Bone said

    I’ve done my part to increase Japan’s birth rate.

  10. Ken said

    “How can the Japanese gov’t save export companies? Buy US dollars? Why should the government bail out export companies using tax money? I want to see charts and calculations demonstrating why currency intervention is justified.”

    What is your opinion? How do you cope with current deflation, declining stock price and rising Yen?

  11. lonely Catholics praying around abortion clinics

    Well, they can’t let the priests run out of children to rape, now can they?

  12. RMilner said

    If Japan’s economy is about to fall off a cliff, the Yen should not be rising.
    Think of it as the dollar fallling.

    – A.

  13. St John said

    After reading the comment by Thewhitelillyblog I had to check I was still on the correct website!

  14. The Overthinker said

    “Yet we have just elected an administration dedicated to the ‘freedom’ of abortion and gay rights at home and around the globe, without a clue, without a care, at the possible effect on our own birthrate”

    Not sure how many kids gay people will contribute with or without rights. Unless you want to force people to procreate. And abortion is nowhere near the limiting factor that contraceptives are.

    “….will not even get up to give a woman a seat on the train.”

    Women fought for years to get equal rights. With the key word being “equal.” My standard retort for that sort of “chivalry” idea is, “I’ll give up my seat when you give your vote.”

    “…those lonely Catholics praying around abortion clinics”
    Matthew 17:20:
    For truly, I say to you, if you have faith as a grain of mustard seed, you will say to this mountain, ‘Move from here to there,’ and it will move; and nothing will be impossible to you.
    Nevertheless, despite the Bible’s own word on the subject, many modern apologists like to say, “Yes, God answers all prayers. Sometimes the answer is NO.”
    Therefore, one of three things is possible here.
    1. There is no God and the Catholics are wasting their time.
    2. Their faith is not even as a grain of mustard seed.
    3. God said NO. Therefore God wants abortion clinics to survive.

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