Most people who have paid attention to the economy (instead of following the Japanese government’s lead and sticking their collective heads in the sand) are aware that the government has created an unsustainable debt situation. Taxes can not be raised high enough to pay off this historic debt, nor even to forestall the day when the debt will collapse the economy via the bursting of the JGB market and the economy is simply not able to grow at a level sufficient to overcome the inevitable demise. For one analyst, that time is approaching…fast.
It is a fact that when it comes to the oddly resilient Japanese hyperlevered economic model, the bodies of those screaming for the end of the JGB bubble litter the sides of central planning’s tungsten brick road. Yet in the aftermath of last month’s stunning surge in the country’s trade deficit, this, and much more may soon be finally ending. Because as Caixin’s Andy Xie writes “The day of reckoning for the yen is not distant. Japanese companies are struggling with profitability. It only gets worse from here. When a major company goes bankrupt, this may change the prevailing psychology. A weak yen consensus will emerge then.“
As for the bubble pop, it will be a sudden pop, not the 30 year deflationary whimper Mrs. Watanabe has gotten so used to: “Yen devaluation is likely to unfold quickly. A financial bubble doesn’t burst slowly. When it occurs, it just pops. The odds are that yen devaluation will occur over days. Only a large and sudden devaluation can keep the JGB yield low. Otherwise, the devaluation expectation will trigger a sharp rise in the JGB yield. The resulting worries over the government’s solvency could lead to a collapse of the JGB market.”
It gets worse: “Of course, the government will collapse with the JGB market.”
We will not mourn the collapse of the Japanese government which has been ineffective, corrupt, and elitist, choosing to prop up itself and various corporations and special interests at the wholesale sacrifice of the nation. And while the government will boast that it kept the nation from experiencing the pain of deleveraging from the excesses of the 1990′s asset bubble burst, in reality, it has only delayed, a delay that will cause the pain to be much worse this time.
Why has Japan been able to sustain its deflationary collapse for over 3 decades? Simply – an ever rising currency.
A strong yen, deflation and rising government debt form a short-term equilibrium that lasts as long as the market believes it is sustainable. The yen has seen a relentless upward trend since it depegged from the dollar in 1971, up to 83.4 from 360 again to the dollar. When wages and asset prices rise, a strong currency can be justified. When wages and asset prices fall, a strong currency is suicide. Japan’s nominal GDP peaked in 1997 and its nominal wages did too. Its property prices have declined every year since. The Nikkei rose in only four out of the last fifteen years and is still close to a three-decade low.
Japanese policymakers, businesses, academics, currency traders and the average Mrs. Watanabe all believe in a strong yen. This belief is wrong but self-fulfilling. It has lasted so long because the Japanese government adopts policies to offset the destabilizing effects of deflation due to a strong yen. Hence, Japan’s national debt has marched upwards along with the value of yen. It is expected to top yen 1,000 trillion in 2012, 215 percent of GDP, 7.8 million yen (or roughly US$ 94,000) per person, and about half of net household wealth per capita.
The government has been living off the savings of Japanese working families for 2 decades. The upcoming collapse will make that apparent as the government either defaults on its debt to the Japanese families or devalues the yen. Either way, the value of those saving will be largely eliminated.
The sustainability of Japan’s deflationary path depends on the market’s confidence in Japan’s debt market. As Japanese institutions and households hold almost all of the government’s debts, their faith in the government’s creditworthiness is the mojo for Japan’s seemingly harmless deflationary spiral.
There’s that. And also that it is nothing but a ponzi. In Xie’s words.
The justification for the low JGB yield is deflation. The real interest rate (the nominal rate plus deflation) is comparable to that in other countries. This rationale requires deflation to persist. But, deflation shrinks the nominal GDP or tax base. How could the government pay back its escalating debt by taxing a shrinking economy? It can only sustain its debt by borrowing more. This fits the definition of a particular type of Ponzi scheme.
The article continues with discussion of trade deficits (a trend despite a recent return to surplus) and the declining competitiveness among Japanese corporations, particularly the auto and electronics industries (which is why the government is now funneling taxpayer money into Thailand, India, Indonesia, and Vietnam in support of these industries, a policy which further drains the domestic economy and, despite assurances for the government to the contrary, return few measurable benefits to the Japanese taxpayers).
The article continues…
There is only one controlled way out for Japan: take the pain now, or let a veritable epic econoic collapse sweep everything that Japanese society stands for. Recent overtures by the BOJ show it understands what has to be done. It is, alas, not doing it fast enough.
Japan has only one way out – a massive devaluation. If the stable national debt is 120 percent of GDP, the yen needs to be devalued by 40 percent because devaluation is ultimately equal to the nominal GDP increase. The devaluation is likely to sustain 2 percent to 3 percent of nominal GDP growth for Japan beyond the repricing induced increase, which is necessary to restore Japan’s tax revenue. Deflation has caused Japan’s tax revenue to decline as a share of GDP. It can be only reversed through restoring nominal GDP. A devaluation of 40 percent can restore Japan’s competitiveness against Germany and South Korea, which will lay the foundation for Japan’s industrial recovery.
The Bank of Japan is trying to weaken the yen through expanding its balance sheet. It has an asset purchase program of 65 trillion yen and a lending program of 5.5 trillion yen. The two are equivalent to 15 percent of GDP, comparable to what the Fed or European Central Bank have done. The effectiveness is limited so far. Because Japanese businesses, households and investors believe in a strong yen, the printed yen largely stays in the country and just slows down money velocity. The U.S. dollar has risen 10 percent against the yen from last year’s bottom. This is probably due to the financial market upgrading its view of the U.S. economy rather than the BoJ’s action.
Yen devaluation is likely to unfold quickly. A financial bubble doesn’t burst slowly. When it occurs, it just pops. The odds are that yen devaluation will occur over days. Only a large and sudden devaluation can keep the JGB yield low. Otherwise, the devaluation expectation will trigger a sharp rise in the JGB yield. The resulting worries over the government’s solvency could lead to a collapse of the JGB market. Of course, the government will collapse with the JGB market.
The day of reckoning for the yen is not distant. Japanese companies are struggling with profitability. It only gets worse from here. When a major company goes bankrupt, this may change the prevailing psychology. A weak yen consensus will emerge then.
Even though the yield on 10-year Japanese Government Bonds (JGB) is only 1 percent, the interest expense is expected to top 22.3 trillion yen in the fiscal year that begins next month. This is one-quarter of the general account budget. If the bond yield rises to 2 percent, the interest expense would surpass the total expected tax revenue of 42.3 trillion yen.
The fiscal and monetary malfeasance of the Japanese government, born from hubris and maintained on the backs of the Japanese people, is coming to an end. There is little doubt that the people will suffer. One can only hope that the end to the government scam will be the end of the corrupt government as well on all levels.
For those who can prepare for this, we advise that you do so now. For those who will have to simply live through this the best they can, we urge you all to be wary of what kind of government arises from the ashes of this collapse. For all Japanese…good luck.