JAPAN'S MASSIVE DEBT: WHAT IT MEANS AND HOW IT IS MANAGED

JAPAN'S HUGE NATIONAL DEBT

The Japanese government is the world’s largest debtor. Japan’s government debt is more than twice the size of its $5 trillion economy---and rated more risky than that of Italy and Spain. Even before the disasters, Japan’s debt was expected to soar to almost 220 percent of its gross domestic product next year, according to the Organization for Economic Cooperation and Development, which would rank it as the largest debt-to-G.D.P. ratio in the world.

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Japan had a $6.3 trillion debt in December 2005, compared to $4 trillion in the United States. In November 2009, government debt reached ¥864 trillion (about $9.5 trillion). It reached a record ¥838 trillion at the beginning of 2008. By some calculations the debt continues to rise by about $100,000 every minute. The last time the Japanese government ran a budget surplus was in 1992, almost two decades ago. Tax income now covers less than half of Japan’s annual budget.

As of 2009 national debt equaled 217 percent of its GDP, compared with 81.2 percent in the United States and the largest by far of any developed nation. In the 1990s, Japan’s gross government debt stood at 63 percent of the country’s G.D.P. One reason it is so high is that much of the debt is double counted because government and quasi-government entities hold Japanese government bonds in their portfolios?just as the Social Security trust fund owns U.S. debt. On a net basis Japanese debt is about 100 percent of GDP, still high but not astronomically high [Source: Barrons]

Deflation and sluggish growth has long weighed on Japan’s economy, eroding the country’s tax base and forcing the government to issue debt to finance its budget. Meanwhile, spending on pensions and social welfare has soared as the country’s population ages. The global economic crisis further darkened Japan’s economic outlook, as has the recent tsunami and nuclear accident. Global market turmoil in recent weeks has also wreaked havoc with the Japanese economy, driving up the value of the yen and hurting its export-led economy. Because Japan is so in debt and faces problems in the future with its pension system it is going to be hard to use government spending to prod the economy.
[Source: Hiroko Tabuchi, New York Times, September 1, 2011]

Japan’s Debt Reaches $12 Trillion in 2011, More Than 2.3 Times Its GDP

According to the International Monetary Fund, Japan's debt-to-GDP ratio was about 230 percent in 2011, the worst among developed countries and much greater that the 161 percent chalked up by Greece. In addition, Japan's social security burden is increasing annually as the population grays.

Japan's debt burden is about $12 trillion, more than twice the size of its $5 trillion economy. This is by far the worst among industrialised countries. It has been built up as the government tried to stimulate the economy during two decades of sluggish growth and deflation. [Source: Reuters, May 22, 2012]

“Japan's national debt hit 960 trillion yen ($12 trillion), a record, at the end of fiscal 2011 (April 2011 to March 2012), the Finance Ministry said. The ministry forecasts that Japan's outstanding debts will top 1 quadrillion yen at the end of fiscal 2012. It said the government's total outstanding debt reached 959.95 trillion yen, up 35.59 trillion yen from a year earlier. [Source: Asahi Shimbun, May 11, 2012]

“Bonds made up the largest portion of debt at 789.34 trillion yen, a year-on-year increase of 30.77 trillion yen. Finance bills to provide cash for foreign exchange interventions came to 116.87 trillion yen, up by 6.08 trillion yen. Borrowing came to 53.74 trillion yen, down by 1.26 trillion yen. [Ibid]

“In May 2012, Fitch said Japan's gross general government debt is projected to rise to 239 percent of GDP by the end of 2012. Based on that projection, the ratio would have risen 61 percentage points since the global financial crisis, compared with a median of 39 percentage points for countries in the Organisation for Economic Co-operation. The government's own plan to reduce its debt burden doesn't foresee the debt/GDP ratio coming down until 2020/21. "Fitch regards this as a slow pace of consolidation given the scale of Japan's debt," it said. Ratings agencies have repeatedly warned Japan that its pace of fiscal consolidation is too slow to lower its debt burden and budget deficit. [Source: Reuters, May 22, 2012]

Why Japan’s Huge Debt Isn’t As Bad As It Seems

Comparing Japan’s debt problem with that of Greece or the United States isn’t totally apt. There is one key difference: Athens depends on foreigners to purchase government bonds, where as Japan has personal financial assets with an estimated ¥1,450 trillion and government bonds are purchased mostly by domestic buyers.

Yes, Japan has a huge debt-to-GDP ration but much of it is financed internally through its huge residual savings while the United States must get help from abroad, namely from China and Japan. The Japanese government has borrowed mostly from Japanese while Japan has continued accumulating foreign assets, behavior that arguably makes more sense that borrowing excessively from foreigners as is the case with the United States.

The debt market is helped by government policies that keep interest rates relatively low. The Japanese government bond market is the world’s largest. It is also one of the least international. Roughly 96 percent of government securities are domestically held so there is little worry about capital flight.

Much of Japan’s government debt is held publicly and financed by the country’s once-ample private savings. Ninety-five percent of Japan’s debt is owned by its citizens, not foreign hedge funds; it’s unlikely that those citizens would dump their bond holdings. But a slow drop in the savings rate has raised fears about the long-run sustainability of public finances, especially given the country’s lackluster economic outlook, the Fitch report said.

Naohisa Ishida, deputy economic news editor with Yomiuri Shimbun, wrote: “The net financial assets of households comes to ¥1,086 trillion when debts such as housing and are excluded. The amount will start to drop as elderly households dip into heir savings to get by....On the other hand, outstanding long-tern debts of the central and local governments with reach ¥862 trillion at the end of fiscal 2010. If nothing is done to reduce these debts, they will eventually exceed the net personal financial assets. The nation’s capacity to purchase government bonds is being rapidly eroded.”

Furthermore Japanese financial institution possess about 40 percent of government bonds. If bonds prices suddenly fell, the value of these institutions; assets would nose-die and the financial system could plunge into turmoil. This would push up interest rates, making fiscal rehabilitation all the more difficult.

How Japan Has Managed Its Debt

Hiroko Tabuchi wrote in the New York Times, Japan “has long been able to borrow at low nominal rates because of unwavering appetite by domestic investors for government debt. For years, Japan has managed its gargantuan debt load, and bond buyers have been willing to lend the government money at some of the world’s lowest interest rates.[Source: Hiroko Tabuchi, New York Times, September 1, 2011]

Throw in individual investors, and 95 percent of Japan’s debt is held domestically. That makes the country less vulnerable to outside pressures that might cause it to default. And in theory, it gives the government plenty of leeway to print money---a spendthrift’s prerogative it holds in common with the United States.

“Unlike the peripheral euro zone countries, where bond yields can easily spike without official support, Japan still boasts the luxury of being able to issue debt in a market full of willing buyers,” said Cameron Umetsu, Tokyo-based economist at UBS Securities. “This is one luxury the government should exploit while it can.”

How the Market Views Japan’s Debt

Hiroko Tabuchi wrote in the New York Times, “Why does Japan’s debt burden matter” After all, despite Japan’s highest debt-to-gross-domestic- product ratio, and less-than-stellar debt ratings---a couple rungs below even the downgraded United States---Japanese bond yields remain the lowest among advanced economies. This signals that bond buyers, far from seeing Japan on the fiscal brink, regard the Japanese government as exceptionally creditworthy. [Source: Hiroko Tabuchi, New York Times, September 1, 2011]

“Japan is not Greece, or even the United States,” Akira Kojima, a senior fellow at a Tokyo-based private policy research organization, the Japan Center for Economic Research, said in a research note. “Japan can finance its deficit on its own.”Mr. Kojima referred to the current-account surplus Japan has run for most of the last three decades, selling and investing more overseas than the other way round. And Japan’s notably thrifty households sit on 1,500 trillion yen ($20 trillion) in savings. The Japanese government is in deep debt, but the rest of Japan has ample money to spare.

And Japanese investors have long been happy to buy up government bonds. In contrast to Greece and other afflicted economies in the euro zone that are heavily indebted to foreign creditors, 60 percent of Japan’s government bonds are held by Japanese banks, insurance companies and pension funds. An additional 20 percent or so is owned by governmental organizations and the Bank of Japan.

Unsustainability of Japan’s Debt

Hiroko Tabuchi wrote in the New York Times, But for various reasons---including that low tax rate and Japan’s aging, shrinking population---the borrowing binge is looking unsustainable. After the collapse of its boom of the 1970s and “80s, Japan has since the 1990s poured yen after yen into stimulus programs trying to revive the economy, while letting tax revenue atrophy. [Source: Hiroko Tabuchi, New York Times, September 1, 2011] And now, demographics are taking a toll. Social security and pension costs have soared as

Japan’s baby boomers reach retirement, while the birth rate is so slow that the population is actually shrinking. Not only are there going to be fewer taxpayers, but Japan’s savings rate is falling, as more pensioners start dipping into their nest eggs, shrinking the pool of money available for government bond purchases.

And it is unclear, analysts say, how much longer Japanese banks and pension funds will keep up their appetite for government bonds that bring in little interest. The Bank of Japan could buy up more government bonds to make up for a slack in demand, but within the bank there is strong opposition to such moves, which many fear could fuel inflation.

All of which is why analysts see little chance of any bold fiscal moves from Mr. Noda’s new government. “It’s as if the crisis that faces Japan’s finances has been completely forgotten,” Masataka Nakajima, a special researcher at the Japan Securities Research Institute wrote in a recent report. Mr. Noda, as evident from his “sieve” speech, hasn’t forgotten. But he had a big distraction right now: putting together yet another emergency budget for Japan’s crippled economy.

What to Do About Japan’s Massive Debt

Some feel that a Japanese debt default is likely, William Overholt of Harvard’s Kennedy School told Barrons the debt is “destined to keep rising because of unfunded pension liabilities of the aging population and contingent liabilities that the central government bears as a result of functionally insolvent local government.”

Many analysts say that Japan must slash wasteful spending and start cutting its public debt to avert the interest rate and refinancing risks that have wreaked havoc in Greece. Former Treasury Secretary James Baker said that Japan’s debt is a “ticking debt bomb”--- a problem that needs to be brought under control quickly with strong leadership if Japan is going to move forward.

In the eyes of many the only solution is a consumption tax that not only will relieve debt it will also provide a stable source of income for the social security system. “We expect that, unless economic uncertainty is wiped out completely, a tax rate increase will be quite difficult next year to finance reconstruction projects,” Masaaki Kanno, an economist for JPMorgan Securities, told the New York Times

“The IMF recommends a gradual increase of the consumption tax from 5 percent to 15 percent. In June 2012, the House of Representatives passed tax and social security reform bills that are chiefly designed to double the consumption tax rate. The legislation paves the way for an increase in the consumption tax rate from the current 5 percent to 8 percent in April 2014 and to 10 percent in October 2015. One poll found that 64 percent of Japanese supported the sales tax hike. Among the goals of the tax hiker were to aquire money to pay of the national debt and to fund social security. [Source: Jiji Press, June 27, 2012]

Lower Credit Rating for Japan Because of Its High Debts

In January 2011, the New York Times reported, “Standard & Poors, the credit ratings agency, lowered its sovereign credit rating for Japan to AA- from AA. That was three levels below the highest possible rating, and S.& P.’s first downgrade of Japanese government debt since 2002. With the lower grade, the country's debt rating was on par with China’s, which in 2010 overtook Japan as the world’s second-largest economy, after the United States. Moody’s affirmed its Aa2 rank for Japan, the third-highest grade.”

“S.& P., in downgrading Japan, warned that the Japanese government had no “coherent strategy” to address its ballooning deficit, and that its already high debt burden was likely to continue to rise further than it had anticipated before the financial crisis. A rapidly aging population is adding to the country’s woes, raising the likelihood of increasing social security and pension obligations in the future. The news came just over two weeks after the credit ratings agency Standard & Poor’s downgraded Japan’s long-term sovereign debt, to AA- from AA, three levels below the highest possible rating. It was the first time S.& P. had downgraded Japanese government debt since 2002. A rival ratings agency, Moody’s, kept its Aa2 rating for Japan, its third-highest rating, though it later warned that the assessment might be downgraded if the nation failed to carry out fiscal reforms.” In February it changed its Aa2 rating from stable to negative.

Japan’s liabilities will hit 204 percent of its gross domestic product this year, outstripping the 137 percent for debt-ridden Greece, according to figures from the Organization for Economic Cooperation and Development. S.& P. said then that it expected Japan’s debt to continue rising until the middle of this decade, and “We do not forecast the government achieving a primary balance before 2020, unless a significant fiscal consolidation program is implemented beforehand.”

Moody’s Cuts Japan’s Rating One Notch, Citing Its Giant Debt

In August 2011, Moody’s Investors Service lowered Japan’s credit rating by one notch, to a level two grades below the top rating, saying weak prospects for economic growth, as well as its recent disasters, made it difficult for the government to tackle its debt. Moody’s lowered Japan’s grade by one step to Aa3, the fourth-highest rating. [Source: Hiroko Tabuchi, New York Times, August 23, 2011]

The downgrade brings Moody’s rating for Japan in line with Standard & Poor’s, which lowered the country’s grade by one notch to AA-minus in January, the fourth highest on its scale.The action comes after a round of downgrades by major ratings agencies of sovereign debt, and amid concern that the debt crisis in Europe could escalate. On Aug. 5, S.& P. cut the sovereign debt rating of the United States for the first time in the country’s history.

Markets in Tokyo largely shrugged off the downgrade, the latest in a line of many. Trust in Japanese government debt “remains unwavering,” Noda, told reporters after the downgrade.

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Moody’s said that it was worried by large budget deficits and the buildup of government debt. Frequent change in leadership had prevented the government from pursuing long-term fiscal reform, the agency said, while the recent disasters had delayed recovery. Meanwhile, weak prospects for economic growth were also hampering efforts to curb the country’s debt burden, the agency said.

Unlike the severe reaction to the lower of the U.S.’s credit rating, Japan’s rating cut caused relatively minor reactions among investors and global markets.

Public Works and Economics in Japan

Japan has sometimes been referred to as the world’s most successful socialist economy.

Since the 1990, government stimulus packages have generated huge budget deficits rather than solid, self-sustaining growth.

Over $2 trillion was spent on infrastructure projects in the 1990s, which some credit with staving off economic collapse. Richard Koo, an economic advisor to the LDP at the Nomura Research Institute, told the Washington Post, “You can bash public works all you want, but in this type of recession where companies and individuals have stopped spending, government expenditures become absolutely essential. We need speed more than anything in responding to this crisis...Our unemployment never went above 5.5 percent. Public works was an extremely effective fiscal stimulus even though a few projects were really stupid.”

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Banks and the Economy in Japan

Japanese banks play a much bigger role in the Japanese economy than their counterparts do in the West. Banks are among the biggest holders of Japanese stock. Japanese companies have traditionally financed themselves through bank loans rather than money from investors. The financial system is reliant on big banks and long term lending relationships.

Banks traditionally haven’t acted totally like banks. Lending wasn’t based on economics or concepts of risk management but was based on promoting a broader national good. Weak companies were carried by stronger one and the economy was kept rolling with a cheap supply of yen.

In May 2009, the head of the Bank of Japan urged banks to reduced their stocks and holdings in Japanese companies and said their failure to do so could undermine the domestic economy, citing the risks and hardships caused when stocks fall in value.

Image Sources: 1) coins and old banknotes markun.cs.shinshu-u.ac.jp 2) new banknotes Big Globe net and zentech.com

Text Sources: New York Times, Washington Post, Los Angeles Times, Daily Yomiuri, Times of London, Japan National Tourist Organization (JNTO), National Geographic, The New Yorker, Time, Newsweek, Reuters, AP, Lonely Planet Guides, Compton’s Encyclopedia and various books and other publications.

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© 2009 Jeffrey Hays

Last updated October 2012

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