STRONG YEN AND DEBT IN JAPAN AFTER THE 2008 FINANCIAL CRISIS

STRONG YEN AFTER THE LEHMAN BROTHER COLLAPSE

The yen continued to strengthen, falling below ¥85 to the dollar in August 2010 to ¥84.72, and reaching a 15-year low in September, falling below ¥83 to ¥82.87. The strong yen continued to be seen as primarily a negative thing and there were calls for the Bank of Japan and the government to do something to reverse the trend.

Conventional thinking had always been that the value of a currency rises when the a country’s economy is strong and declines when the economy is weak. So why has the yen appreciated when Japan’s economy has been far for robust. Osaka University professor Yoshiyasu Ono, an advisor to Prime Minister Naoto Kan, thinks this has occurred as result of improved productivity by Japanese economies.

Junuchi Maruyama wrote in the Yomiuri Shimbun , “When the nation’s exports slow due to a rise in the yen, firms try to improve productivity by cutting production costs and improving competitiveness in the global market. As a result exports do not decline significantly. Instead, imports fall as domestic companies cut jobs to streamline business...The drop in imports is due to a decline in domestic demand. When imports is due to a decline in domestic demand. When imports decline while exports do not, the nations current account surplus will grow, prompting further appreciation of the yen.”

“One believes a vicious cycle occurs, with the yen’s rise causing layoffs that prompt domestic demand to fall, bringing about a further appreciation of yen. Conversely, improving the job market and boosting domestic demand will efficiently break this cycle and stem the rise in the yen. The high value of the yen also has its roots in the economic probes in the United States and he. Major investors consider the yen to be a safer investment than the dollar or the euro.

“Even though Japan’s economy is no great shakes,” Maruyama wrote, investors “purchase the yen because they believe Japan’s currency does not violently fluctuate and its exchange risks are easy to manage compared with the those of the greenback and euro, whose value may suddenly plunge at any time.”

Response to the Appreciation of the Yen

In September 2010, the Japanese government and the Bank of Japan took decisive action to lower the value of the yen, helping Japanese exporters, by selling ¥2.13 trillion in yen and purchasing dollars. It was Japan and the world’s largest single day invention ever and the first time in 6½ that the Japanese government and BOJ had made such an intervention. The intervention seemed to work. Afterwards the value of the yean weakened to the ¥85 to ¥86 range. The Kan government and BOJ said it was prepared to take more action if necessary. Some U.S. lawmakers were critical the move, comparing it to China’s manipulation of the yuan.

Japan made the move unilaterally without support from the Western nations, which had little incentive to intervene on Japan’s behalf because they were having their own economic problems and trying to spur exports, which a lower-valued yen would hurt. Acting unilaterally is usually regarded as a no-no unless economic conditions are highly volatile. In the end the move seemed to have little impact. After the intervention the yen weakened to just above the ¥80 mark, not fare from the postwar low of ¥79.75 in April 1995. In October 2010, the dollar fell against the yen to a new 15½ year low of ¥81.08.

Defiying conventional wisdom exports were strong. In the first half of fiscal 2010 (April to September ) there was the strongest surge in exports in 20 years and Japan’s surplus soared. Gains that Japan has earned from interest earned on foreign currency bonds it bought during exchange intervention’sometimes referred to as “buried treasure”---amounted to between $10 billion and $20 billion in 2010. The government tapped into the fund to cover a shortfall in its budget.

Toyota, Honda and other Japanese companies responded by shifting their assumed exchange rate projection to ¥80 from ¥ 85 and ¥ 90 and tried to move as much production overseas as possible to cut costs. The IMF lowered its growth estimate of Japan from 1.8 percent to 1.5 percent.

The high yen encouraged Japanese manufacturers to move more operations overseas. Carmakers, steelmakers, electronics companies and precision tool makers moved more operation to China and other countries in Asia and bought more goods from producers that had their facilities outside Japan.. This helped the manufacturers survive but was bad news for Japanese workers and towns that depended on the industries being in Japan.

Economy After the Earthquake and Tsunami

See earthquake and tsunami in 2011

Value of Yen Rises After the Earthquake and Tsunami

When the Japanese economy was hit by the powerful earthquake and a nuclear power plant accident in Fukushima Prefecture in March 2011, the yen rose to a postwar record-high of 76.25 yen against the U.S. dollar. In May 2011 the value of the yen rose again to the ¥80 to the dollar, reaching ¥79.57 the rise was mainly due, analysts said, to concerns about the U.S. economy. It also dipped below the ¥80 mark in June.

Why was the yen bought up in a time of crisis like? You would think people would be more likely to buy other currencies. According to Kyodo News: “The yen was bought on the back of growing anxiety... Fears over the nuclear power plant accident led to a stock plunge in Japan, pulling down share prices overseas as well. Investors who try to avoid investing in risky assets such as stocks and currencies of emerging economies are fleeing their funds to the Japanese currency, which is considered safe. Speculators have capitalized on such moves, lifting the currency by nearly 5 yen against the dollar.” [Source: Kyodo News, March 17, 2011]

Why was the yen considered ''safe'' even after the earthquake and tsunami in 2011? According to Kyodo News: “The Japanese economy has been suffering from low growth and prolonged deflation since the collapse of the bubble economy in the early 1990s, prompting the Bank of Japan to introduce the monetary easing policy to keep interest rates lower than levels in other countries. Under such circumstances, while it is unlikely the economy will see robust growth, there is little risk of the economy collapsing or the yen falling sharply. In addition, Japan maintains a current account surplus with abundant external assets, making investors feel comfortable buying the yen whenever anxiety grows in the market.

Isn't it strange that the yen is being bought when the Japanese economy itself is a source of concern now? It appears to be a strange phenomenon, but the yen's ''myth of security'' remains persistent, leading yen buying to surpass selling pressure stemming from prospects of deterioration in the Japanese economy. The yen was also bought on speculation that Japanese companies would repatriate overseas assets and convert them into yen to cover disaster-related costs. [Ibid]

How did hedge funds and other speculative funds move? There is a view that they have launched yen buying by capitalizing on speculation that Japanese insurers are repatriating overseas assets to prepare for massive payments of insurance claims resulting from the quake. But insurers have denied that they have sold assets denominated in foreign currencies on a large scale to secure yen funds for insurance payments. [Ibid]

Is the strength of the yen likely to continue? There are many market participants who believe the yen will face buying pressure while the prospects of disaster reconstruction and nuclear power plant troubles remain unclear. But other participants point out that money will be invested in higher-yielding currencies as emerging nations continue to see high growth, reducing the yen's value. Some say overseas investors could start engaging in ''Japan selling'' and bring down the yen if the nuclear power-related troubles deepen further. [Ibid]

Foreign exchanges holding are a measure of economic links with other countries and a manifestation of imports and exports, investment and speculative “hot money” flowing into local markets.

As the cost of raw materials around the globe rose, so too did prices in Japan for things like bread and flour (three to eight percent), eggs (10 percent from the previous year), T-shirts and underwear (10 percent to 30 percent) and towels ( 30 to 50 percent in a eight month period). The price hikes reflected rising prices for raw materials such as wheat, corn and cotton.

High Value of Yen: Two- Edged Sword

Hiroko Tabuchi wrote in the New York Times, “Considered a haven by investors, the yen has been driven to near post-World War II highs amid Europe’s debt problems and doubts about U.S. economic growth. The currency’s climb has wreaked havoc with Japan’s export-led economy and weighed on the stock market. [Source: Hiroko Tabuchi, New York Times, August 18, 2011]

A strong yen hurts Japanese exporters because it makes their goods less competitive and erodes the value of their overseas earnings when repatriated into yen. Every time the dollar loses ¥1 in value, Toyota Motor loses about ¥30 billion in earnings per quarter, according to the automaker. At the same time, the strong yen has bolstered the country’s purchasing power overseas, an advantage most visibly exploited by Japanese corporations that are seeking to expand.

Tsuyoshi Ueno, senior economist at the NLI Research Institute in Tokyo, told the New York Times that Japan needed to concentrate on the positives of a strong currency and deal with the negatives. “Upward pressure on the yen is likely to continue for some time, and even if the yen were to weaken temporarily, there would be no change to the fact that every time the global economy worsens, the yen strengthens,” Mr. Ueno said in a note to clients. “To escape this cycle, Japan needs to build an economy and industry that not only survives a strong yen, but thrives with it.” Japan needs to foster new industries, like care for its elderly, and seek opportunities overseas, he said.

Still, the response in Japan has been characterized more by panic than anticipation of any potential upside. And the prospect of Japanese companies shifting more of their production abroad does little to soothe the anxiety.

High Value of Yen Hurts to Japanese Economy

Exports have suffered from the strong yen. Japanese exports were down 3.3 percent in July 2011 from a year earlier, according to Ministry of Finance data, worse than the 2.4 percent decline expected by economists. [Source: Hiroko Tabuchi, New York Times, August 18, 2011]

The strong currency is threatening to undermine Japan’s economic recovery just as industrial production rebounds following the earthquake and tsunami. Fears of a global economic slowdown are also hurting trade, weighing on the Japanese economy.

Reconstruction demand and a recovery in industrial output are likely to buoy the economy, said Cameron Umetsu, senior economist for Japan at UBS. “But the murky global backdrop still holds the potential to serve up nasty surprises for export-sensitive Japan,” he said.

Yen Intervention in August 2011

In early August 2011, Japan stepped into currency market to stem yen's rise as the Japanese currency neared the ¥75 level. The Mainichi Daily News reported: Japan's monetary authorities intervened in the foreign exchange market in a bid to arrest the yen's appreciation against the U.S. dollar and help boost the flagging Japanese economy, Finance Minister Yoshihiko Noda said.” The intervention, which came amid growing pressure on the profitability of Japanese exporters from the rising yen, was conducted by Japan alone, Noda told reporters, adding it was intended to counter ''one-sided'' movement in the currency market. [Source: Mainichi Daily News, August 4, 2011]

The intervention was Japan's ''response against speculative and disorderly moves'' in the market, Noda said. ''The yen's one-sided strength recently in the foreign exchange market has persisted,'' he told reporters. ''If the trend remains, it would cause negative effects on the stability of the Japanese economy and finance, despite various efforts having been made for the reconstruction of Japan following the earthquake disaster.'' [Ibid]

The minister did not clarify the amount of yen sold in the attempt to manipulate the exchange rates or which currency had been purchased. The intervention came after the dollar changed hands at around the 77 yen line against the yen. The dollar briefly shot up to around 78.70 yen. [Ibid]

It was the first intervention by Tokyo since March 18, when monetary authorities in the Group of Seven leading economies -- including Japan, the United States and some European countries -- jointly stepped into the market to stem the yen's surge after it hit a postwar high of 76.25 against the dollar the previous day. Japan's unilateral intervention was last conducted in September 2010. Noda said Japan had consulted with monetary authorities in some other countries before the latest intervention, but did not say whether Tokyo was able to win their support. [Ibid]

Later it was revealed that the Japanese government spent an estimated ¥4.5 trillion to stage what was a record intervention in currency markets, selling the yen and buying dollars in a bid to weaken the Japanese currency. Though the yen fell slightly against the dollar following that move, it has again edged upward in later sessions. [Source: Tomohiro Ohsumi, Bloomberg News, August 18, 2011]

Bloomberg reported: “Over the past five years, the dollar’s value has fallen 33 percent against the yen. Analysts have questioned whether Japan can hope to keep the yen from rising, as long as global investors treat it as a haven. It may seem counterintuitive that the currency of Japan, a country burdened with sluggish growth and a huge public debt, is seen as a refuge from the debt crisis in Europe. But most of Japan’s debt is held domestically, yields on government bonds remain far lower than other industrialized nations and inflation is nonexistent, all positive factors for the yen. [Ibid]

In mid August “a top currency official at the Japanese Finance Ministry met with his counterpart at the central bank, a signal to markets of government readiness to temper the rise in the yen. Though the officials did not reveal specifics of their discussion, the meeting seemed aimed at showing markets Japan’s determination to try to stare down currency markets. After the meeting, Vice Finance Minister Takehiko Nakao said that talks had covered “the yen and global financial markets over all.” Mr. Nakao met with Hiroshi Nakaso, the executive director of the Bank of Japan, the central bank.” [Ibid]

“Mr. Nakao did not say whether Japan planned another currency intervention, though government officials have said that they are watching market movements closely. Government officials have also urged the Bank of Japan to take measures to increase liquidity in the Japanese financial system, which also has the effect of weakening the yen. Last year, a similar meeting between senior officials of the Finance Ministry and Bank of Japan, also following a spike in the yen, produced a joint statement warning markets against excessive currency volatility.” [Ibid]

Record High Value of Yen

In late August 2011, the dollar briefly hit a record low of 75.95 yen on the New York foreign exchange market, breaking the previous record 76.25 yen set on March 17th after the March 11th disaster in northeastern Japan. The gain occured after a vice finance minister expressed caution on monetary intervention. The dollar was later traded at mid-76 yen, still hovering around historic lows against the yen.

Japanese monetary authorities say the rapid rise of the yen will have negative impact on the economic recovery from the March disaster, further damaging Japan’s already-hurting exporters and possibly causing firms to transfer production outside Japan. The prime minister's office was conspicuously silent on the matter. Aides quoted the prime minister as saying he intends to "keep watching the situation" for the time being before deciding whether the government and the Bank of Japan should intervene in the markets again or launch further quantitative monetary easing.

Many officials close to Kan believe there is little Japan can do to rein in the yen, other than a market intervention and quantitative easing, because the yen's climb has been fueled by financial unrest in the United States and Europe, sources said. "The prime minister can't afford to worry about that" because he is tied up with his pending resignation, one aide said. "The fact that investors are gobbling up the yen despite the political situation here shows just what bad shape the economies of the United States and Europe are in." After the credit rating of long-term Japanese government bonds was downgraded in January, Kan caused an uproar when he admitted he was "out of touch with such things." [Source: Yomiuri Shimbun, August 21, 2011]

A few days later the dollar briefly rebounded to ¥77 on hints by government officials there might be some kind of intervention. Finance Minister Yoshihiko Noda said Japan will take decisive action against the yen’s sharp rise. The change in the yen’s value was not much as currency players reasoned that an intervention would not have much of an impact if it were taken.

On how all this relates to the dollar, William Pesek of Bloomberg wrote: “Investors display an obvious preference for yen over dollars. That the IOUs of a debt-ridden, aging, politically adrift nation smarting from a huge earthquake and nuclear crisis seem safer than U.S. Treasuries says it all.

High Value of Yen Hits Companies Hard

Yoichiro Kagawa and Etsuo Kono wrote in the Yomiuri Shimbun, “Companies struggling to recover from the impact of the Great East Japan Earthquake also have been rocked by the strengthening yen, which has risen to the 77 yen level against the U.S. dollar in Tokyo. Many exporters had predicted the exchange rate in fiscal 2011 would be between 80 yen and 83 yen per dollar, so the rise of the yen beyond this level has put them on the ropes.” [Source: Yoichiro Kagawa and Etsuo Kono, Yomiuri Shimbun, August 1 2011]

Additional negative factors such as electricity shortages and the continuing aftereffects of the disaster have prompted economists to voice fears that the nation's industries may be hollowing out. In its consolidated business results for the April-June quarter, released Friday, Mazda Motor Corp. announced an operating loss of 23 billion yen because of the disaster and the rise in the yen's value. In the same quarter last year, Mazda was 6.3 billion yen in the black. Kiyoshi Ozaki, executive vice president of Mazda, said, "We can't overcome the effects of the current rise in the yen's value through our own efforts."

Hitachi Ltd. also released its consolidated operating profits for the same quarter on Friday, which showed a decline of 15 billion yen. Nissan Motor Co.'s operating profits fell by 55 billion yen. In contrast, rivals in other countries, especially South Korea, are upbeat. In its consolidated business results from January to June this year, which were released Thursday, South Korea's Hyundai Motor Co. recorded higher sales and profits. The automaker increased sales partly because it took orders for products normally supplied by Japanese-affiliated makers.

Although the value of South Korean won has recently risen against the dollar, the South Korean currency has been more competitive than the yen. Mazda's Ozaki said, "South Korean and European manufacturers are making significant inroads in the U.S. market for compact cars. Their prices are more attractive [compared to Japanese cars due to the effects of the strong yen]."

However, Japanese companies are doing their best to cope with the strengthening yen. Toyota Motor Corp. has announced it plans to establish a base in the Tohoku region to build compact cars from development to production with the aim of overcoming cost-cutting competition with firms from emerging countries. Nissan was to spin off its plant in Kandamachi, Fukuoka Prefecture, on Monday. The plant will become a production base capable of competing with firms from emerging countries by increasing parts procurement from South Korea and China.

Toshiba Corp. is expanding overseas production of flat-screen TV sets and some other products that it will import into Japan, to circumvent the strengthening yen. Sony Corp. has raised its percentage of overseas production to about 70 percent, so the negative effects of the yen on its profits are virtually zero.

Takahide Kiuchi, chief economist of Nomura Securities Co.'s Financial & Economic Research Center, said, "There is a spreading view that the government will take no action to deal with the strengthening yen or help affected companies, so there is definitely a risk industries will hollow out."

Noda Government Response to High Yen Values

In September 2011, according to Kyodo news, the Japanese government under then new Prime Minister Noda released a report that detailed how it would deal with the high value of the yen, under conditions in which domestic manufacturers are already hurting from the March earthquake and tsunami. Measures include financial assistance to smaller businesses and measures to encourage major firms to remain in Japan at a time when the stronger yen makes it more likely they will accelerate their shift abroad in pursuit of cheaper labor costs. [Source: Kyodo, September 21, 2011]

The report also mentioned some employment-boosting measures, including easing conditions for companies to apply for a government subsidy program and implementing more job training for the unemployed. "We are focusing on transforming the structure of the economy in order to make it less dependent on (the yen's) foreign exchange (rates)," economic and fiscal policy minister Motohisa Furukawa told reporters after the meeting. [Ibid]

The report said the government wants the Bank of Japan to "underpin the economy with appropriate and decisive monetary policy," suggesting the central bank should further ease monetary conditions in the country and boost the economy. To make the best use of the rising yen, the government will encourage large firms to seek an interest in developing overseas energy resources. [Ibid]

The report said the government will introduce numerical goals to measure its achievement under the policies. The emergency measures will be financed by a planned third extra budget for fiscal 2011, which will also finance reconstruction following the March 11 disaster.

In August while still acting as finance minister, Noda announced the creation of a $100 billion fund to stem yen’s rise. The Yomiuri Shimbun reported, “Under the program, set to run for one year, the government intends to support mergers and acquisitions by Japanese companies, and support exports by small and midsize companies. The government expects domestic companies to invest abroad, taking advantage of the strong yen. The up to 100 billion dollars (about 7.6 trillion yen) emergency program aims to encourage domestic companies to sell their yen for foreign currencies, resulting in a correction of the yen's appreciation. [Source: Yomiuri Shimbun, August 25, 2011]

Under the program, the government will loan up to 100 billion dollars to the Japan Bank for International Cooperation from a special budget account for foreign exchange funds. JBIC and Japanese banks will provide funds to domestic companies at low interest rates. The government will also step up its supervision of dealings at foreign exchange markets, asking major financial institutions to report their trading positions about twice a day until the end of September to put a brake on speculative yen buying. Many critic scoffed at the plan, calling a last ditch effort that little chance of succeeding.

High Value of Yen and Mergers and Acquisitions

Hiroko Tabuchi wrote in the New York Times, “Despite the disruption caused by the devastating earthquake and tsunami in March, Japanese companies spent $26.6 billion on mergers and acquisitions overseas in the three months through June, the highest quarterly volume in almost three years, according to Dealogic. “When the yen is on an upward trend, it creates a favorable environment for M.&A.’s,” Kotaro Masuda of the Institute for International Trade and Investment told the New York Times, referring to mergers and acquisitions. “It also becomes possible for companies to buffer against currency risks by producing more overseas.” [Source: Hiroko Tabuchi, New York Times, August 18, 2011]

The Asahi Group has used the strong yen to expand overseas. In August 2011 the beer company said it was buying Independent Liquor of New Zealand for ¥97.6 billion, or $1.3 billion, as the Tokyo-based beverage maker looked to increase its sales overseas to make up for a shrinking market at home. Asahi, the maker of Japan’s top-selling beer, Super Dry, and soft drinks, said that it would buy all outstanding shares of Flavoured Beverages Group, the parent company of Independent Liquor, from the private equity firms Unitas and Pacific Equity Partners, adding the Woodstock Bourbon and Vodka Cruiser labels to its family of drinks.

Asahi’s purchase followed a bigger overseas acquisition by its rival Kirin, which said this month that it would buy a controlling stake in Schincariol, a Brazilian beverage maker, for $2.6 billion.

Strong Yen Pushes Japan's Per-Capita GDP Higher

Japan's per-capita gross domestic product in 2010 stood at $42,983, advancing to 14th in the rank of developed economies from 16th the previous year, helped by the sharp rise of the yen against the U.S. dollar, the government said. The list of 34 OECD countries by per-capita GDP was topped by Luxembourg, which logged $105,313, while Norway ranked second with $84,473. The United States was eighth with $46,588. The per-capita GDP of China, not a member of the OECD, was $4,430. [Source: Kyodo, December 27 2011]

“Total nominal GDP stood at $5.50 trillion, taking up a global share of 8.7 percent and staying flat from 2009. China, at 9.4 percent, replaced Japan as the world's second-biggest economy after the United States, at 22.9 percent, the Japanese Cabinet Office said. Japan's per-capita GDP has grown only about 11 percent since 1994, when it ranked second in the list of the Organization for Economic Cooperation and Development, as the country's economy has been mired in chronic deflation. In 2010, though, the amount was the biggest ever for the country because it was stated in dollars. [Ibid]

Some Advocate Japan Selling U.S. Treasurys

The idea that Japan would ever dump its $900 billion holdings of U.S. Treasurys, the second largest foreign ownership after China, has long been just that---an idea never seriously entertained. The long-standing argument paints a horrific picture of the consequences: The dollar would crash, world markets would be sent into a tailspin and the post-World War II military and political alliance between the U.S. and Japan would be shaken. [Source: Yuri Kageyama, AP, August 15, 2011]

But after Washington's credit rating was downgraded for the first time ever earlier this month---from AAA to AA+ by Standard & Poor's---some daring advocates are voicing that taboo idea: Why not sell Treasurys? "The holdings translate to 1 million yen ($13,000) per Japanese taking this risk in shouldering U.S. debt, all without their fully being aware of it," said Kenji Nakanishi, a lawmaker in a new opposition party that made significant gains in the last election.

Nakanishi told The Associated Press that Japan shouldn't sell all its holdings at once, but should reduce them by about 10 trillion yen ($130 billion) each year, and earmark some of that money for recovery spending in northeastern Japan, which was devastated by the March 11 earthquake and tsunami. A simple explanation to Washington that the move won't change the U.S.-Japan political and defense alliance should be enough, according to Nakanishi. It alarms Nakanishi that the government is trying to raise taxes to fix its deficit and finance the earthquake recovery, a move he fears would further squeeze the Japanese economy.

Views like Nakanishi's may be winning some acceptance. No one expects them to be acted upon immediately. The Japanese government and ruling party officials have repeatedly said Japan won't sell U.S. bonds, and instead will keep buying them. The common wisdom is that a weak dollar would prove devastating to the Japanese economy by making it more difficult for Toyota Motor Corp., Sony Corp. and other pillars of corporate Japan to sell their goods overseas.

Japan would be venturing into untested territory if it decided to reduce Treasury holdings. In 1997, mere musing by then Prime Minister Ryutaro Hashimoto about selling Treasurys set off a Wall Street plunge until Japanese officials quickly jumped in for damage control and promised Japan had no such plans. But Naoto Amaki, a writer and former government bureaucrat, thinks the time is ripe to start thinking the unthinkable. Amaki has long advocated reducing Treasury holdings, but is only recently growing optimistic that others may finally see how his view may be good for Japan.Japan, with its towering public debt, is in no position to help finance America's deficit, especially after the March 11 earthquake and tsunami, he said in a recent blog."Japan's finances were already in serious trouble. Now, we are literally being backed into a crisis of no return," Amaki said.

Around the same time people were talking about this the Japanese government said it might purchase euro rescue bonds to help address the fiscal problems of Greece and other debt-ridden European countries.

Pessimism Over the Future of the Japanese Economy

For many the future of Japan looks even bleaker than things are now, as Japan faces the world’s largest government debt---around 200 percent of gross domestic product---a shrinking population and rising rates of poverty and suicide. Ian Bremmer wrote in the New York Times, “In Japan, anxiety over a lost decade has given way to fear that economic growth is never coming back. Japanese pundits warn that the country has “lost its animal spirits.” A business leader I spoke with during a recent visit talked of relocating his company’s operations to Singapore. Another asked if I thought Japan “would still be around” in 20 years. I’m not sure what he meant, but I know it isn’t good. [Source: Ian Bremmer, New York Times, November 16, 2010, Ian Bremmer is president of Eurasia Group and author of The End of the Free Market: Who Wins the War Between States and Corporations? ]

“Two decades ago, Japan’s gross government debt stood at 63 percent of the country’s G.D.P. Today, it’s at nearly 200 percent. Consumer prices have fallen in 9 of the past 20 years, depressing production. A third of Japanese between the ages of 20 and 30 don’t have jobs. Falling birthrates suggest there may soon be just two workers to support each retiree, yet there is little prospect of immigration reform to give the work force new dynamism.” [Ibid]

“Add projections for several more years of flat growth, frustration with the country’s deeply dysfunctional political system, and worries that Japan has no place in the emerging world order and you begin to see the depth of the country’s malaise. Japan’s alliance with the United States has been stuck in the mud for some time, and the country is ever more reliant for growth on an increasingly unfriendly China.” [Ibid]

“Japan’s business community seems the most disillusioned segment of society. Senior executives I spoke with acknowledge that Prime Minister Naoto Kan is more competent than his hopeless predecessor, Yukio Hatoyama, but they have little else positive to say about his government. In part, that’s because the Democratic Party of Japan arrived in power just 15 months ago after a half century of nearly uninterrupted Liberal Democratic Party rule. Only since August 2009 have the DPJ and the country’s business community begun to build working relationships.” [Ibid]

“But there is also a philosophical divide between the two sides. The DPJ’s traditional ties with trade unions, and the anti-corporate rhetoric of many of its leaders, make mutual suspicion difficult to overcome. Recent party efforts to build bridges with the Keidanren, Japan’s lead industrial organization, have produced little. In addition, many of Japan’s business leaders have been in place for a long time, and some are resistant to change.” [Ibid]

Optimism Over the Future of the Japanese Economy

Ian Bremmer wrote in the New York Times “Yet, there are three reasons to believe that all this pessimism is overdone. First, the DPJ and the business elite now appear to see that they are stuck with one another. The DPJ will remain in power for awhile, and the industrial elite knows it can’t simply wait for the moribund LDP to stage a comeback. In fact, finance and economic officials say work is moving forward on a proposal for a substantial reduction in the corporate tax rate, one they said enjoyed support at the highest levels of government. It’s a modest accomplishment, and the devil may yet be in the details, but it’s clearly a positive signal that Japan’s political and business elites can work together more effectively. [Source: Ian Bremmer, New York Times, November 16, 2010,Ian Bremmer is president of Eurasia Group and author of The End of the Free Market: Who Wins the War Between States and Corporations? ]

“In addition, Japan was a one-party system for several decades, and there was little incentive for the bureaucracy to share vital information on the operation of government with leaders of the seemingly eternal opposition. Yet, DPJ officials and the army of bureaucrats tasked with day-to-day operation of government finally appear to be communicating with one another more effectively.” [Ibid]

“Second, anxiety over China’s recently more aggressive foreign policy has helped put troubled U.S.-Japanese relations back on track. Much work remains to be done to restore damaged trust. These days, U.S. and Chinese officials negotiate questions of trade, currency policy and security while American and Japanese officials bicker over the length of runways at U.S. military bases.” [Ibid]

“But real progress has been made on an extraordinarily important project: The Trans-Pacific Partnership, a multilateral free trade pact that might one day integrate the Pacific Rim’s largest economies. Singapore, Chile, New Zealand and Brunei are already members. The United States, Australia, Malaysia, Vietnam and Peru are negotiating to join. Tokyo has finally begun to show interest. Under the LDP, Japan would not consider membership, since the country’s farmers, a key segment of the LDP’s base, stand to lose the protections of tariffs on imported staples. Prime Minister Kan has expressed interest in joining the pact, and his support will come at a much lower political cost. That’s good news for those in Washington and Tokyo who see advantage in hedging their bets on China via closer ties with one another.” [Ibid]

“The third reason for a more optimistic view of Japan’s future is that the country’s elected leaders do not face the outraged opposition of citizens and interest groups eager to make trouble in the streets. Following two decades of economic stagnation, there are no Tea Partiers, fuming French transport workers or rock-throwing South Korean students. In China, despite three decades of go-go growth, officials warn that continued growth of 7 to 8 percent is necessary to create enough new jobs to safeguard “social stability.” Japan, by contrast, will continue to enjoy relative domestic tranquility despite yet another year of growth at less than 2 percent. In that sense, at least, Japan’s leaders are the envy of the world. [Ibid]

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.

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.

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.

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]

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.

Image Sources: 1) Shugin House of Representatives site 2) Wikipedia 3) China Labor Watch 4) Kantei, Office of Prime Minister 5) Tokyo Stock Market 6) markun.cs.shinshu-u.ac.

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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