Global Agenda: The Japanese conundrum

How is it that the Japanese economy continues to function in the face of persistent deflation and huge and ever-growing government debt?

By PINCHAS LANDAU
Japanese Prime Minister Yoshihiko Noda 311 R (photo credit: REUTERS/Kim Kyung)
Japanese Prime Minister Yoshihiko Noda 311 R
(photo credit: REUTERS/Kim Kyung)
The world is full of conundra (that’s the plural form of conundrum; people unschooled in Latin will prefer conundrums). The most glaring, in the financial sphere, is that this week the Dow Jones Industrial Average crossed the 13,000-point level and the Nasdaq index the 3,000 level – in both cases the highest in several years – while US government 10-year bonds trade at or below a yield of 2 percent per annum.
At any time prior to the post-crash present, this combination would have been not merely impossible in practice, but unthinkable even in theory. Such high levels for equities must reflect a strong economy, with high employment and rising real wages, as well as excellent corporate profit levels.
On the other hand, sub-2% yields on 10-year bonds must reflect an economy in deep recession, if not outright depression, with no inflation and perhaps outright deflation under way. Any intelligent and well-informed person could have told you that the two states of affairs could not possibly coexist.
Yet here we are in 2011 and 2012, and they do indeed coexist, albeit not necessarily happily. How they do so is a conundrum – defined by the free Webster-Merriam online dictionary (an Encyclopedia Britannica company, so it proclaims!) as “a question having only a conjectural answer” or, alternatively, “an intricate and difficult problem.” Those two definitions are quite different, but either can apply to the conundrum noted above, regarding the state of the American economy and financial markets.
Yet the American conundrum is simple compared to the mega-conundrum of the economic world, today and for the last 20 years. This is simply put: How is it that the Japanese economy continues to function, neither collapsing nor recovering, in the face of persistent deflation and huge and ever-growing government debt? On the one hand, the general price level of goods goes down year after year, which is the very epitome of deflation (it’s even worse in Japanese real assets such as land and homes). Yet on the other, the government runs a massive deficit, year after year – and finances the deficits by issuing ever more debt. This debt is sold at very low yields – the 10- year government bond has offered for between 1% and 1.5% for many years – and no one seems concerned that the government might have a problem paying it off.
The Greek syndrome, the European disease, or however the crisis in government-bond markets in Europe is termed, is nowhere to be seen in Japan – although statistically speaking, the Japanese government is in worse financial trouble than any of its European peers, including even Greece.
Thus the entire structure being put into place to save Greece – the latest bailout plan now being implemented – is designed to get the ratio of Greek government debt to GDP down from its present level of about 160% to 120% in 2020.
Never mind that this is arrant nonsense and everyone involved knows this. The point is that Japan’s ratio is well in excess of 200% and keeps rising. How could it do otherwise, when the government is so hooked on borrowing that the budget for the next Japanese fiscal year, which begins on April 1, will be the fourth in a row in which receipts from borrowing are planned to exceed tax revenues. Think about that, in the context of your household – you borrow more than you earn! Who is the idiot still lending money to the Japanese government? That is a good question, but not a conundrum, because the answer is clear: It is the Japanese public, which has always been characterized by a high level of saving and a very conservative bent. The willingness of the local population to fund the government explains how it has been able to run deficits for so long and accumulate so very much debt. It doesn’t explain why this process has neither revived the Japanese economy or brought about its total collapse – although both outcomes have been confidently predicted for many years.
But what is for sure is that this tenuous stability is unsustainable.
The Japanese people may, in principle, be ready to fund their government for ever, but Japan’s appalling demographic situation will prevent them doing so. More and more Japanese are getting older and older, and these pensioners and aged people are obliged to run down their savings.
The balance between pensioners (who are dis-saving) and workers (who are still saving) is tilting steadily toward more pensioners and fewer workers. That means the pool of lenders is shrinking, and the borrower – the Japanese government – will have to look elsewhere – i.e., overseas. But foreign lenders, if they are prepared to give Japan any money, will demand much higher interest rates, which the Japanese government is no longer able to afford.
At some point in the next few years, quite possibly this year or next, the tipping point will be reached in Japan and the extraordinary stability of the Japanese government-bond market will collapse, along with the value of the yen. Japan may be a weird and distant place, but it is still the third-largest economy in the world. When it crumbles, there will no longer be any need to try and explain the Japanese conundrum.
landaup@netvision.net.il