Tokyo, Japan – The ongoing crisis in Greece has focused global attention on sovereign debt, with many eyes inevitably drawn to Japan, the public finances of which — at least on paper — make those of Athens look almost healthy.
Sovereign debt now amounts to about 200 percent of Japan’s GDP, while the figure for Greece is 115 percent. A report released by Switzerland’s IMD business school on Wednesday estimates it will take Japan until 2084 to bring its debt down to a manageable 60 percent of GDP level; Greece will need until 2031, and the U.S. until 2033.
Meanwhile, the International Monetary Fund (IMF) has once again urged Japan to take steps to tackle its sovereign debt problem, this time from fiscal 2011. All this of course assumes the country is willing and able to take meaningful action in that direction.
As of now, the signs aren’t hopeful.
Figures released this month by the Ministry of Finance show that total outstanding debt in the fiscal year to March was 883 trillion yen ($9.55 trillion). This amounts to $75,000 per person. In comparison, the level in Greece is less than half that at $32,500 per capita.
Last year, about a quarter of Japan’s entire government budget was spent on just servicing existing debt. This year’s budget is the first where more than half of the money has been raised by issuing new debt — in the form of government bonds — to make up the shortfall in tax revenue.
Although there are differences from the Greek situation, the question of this becoming a crisis for Japan is one of when rather than if, according to a growing number of economists, investors and observers.
Professor Yukio Noguchi of Tokyo’s elite Waseda University is renowned as an expert on Japan’s bubble economy, and one of the few Japanese economists to have predicted its bursting.
His current reading of the situation is equally bleak. He now believes that the current debt situation can only end with the Japanese economy spiraling into hyperinflation.
“Inflation is the only answer, the only question is when,” Noguchi said. With Japan stuck in a long deflationary cycle, the danger of hyperinflation is a difficult one for the public and politicians alike to imagine.
Although Noguchi doesn’t believe it will happen anytime soon, when inflation does hit, “the situation will change very quickly.”
“Another sovereign debt crisis, in say, the U.K., the U.S. or an Asian country could be the trigger,” said Martin Schulz, senior economist at the Fujitsu Research Institute in Tokyo.
Almost 95 percent of Japanese government bonds are held domestically — by banks, pensions and other institutions — with yields being very low, in line with the near-zero interest rates and price deflation.
However, because of the huge size of the debt, even a small increase in interest rates could leave the government unable to meet its obligations.
“If interest rates hit 1.6 percent on 10-year benchmark bonds, people would start to get more cautious and the press would be full of stories asking if Japan was the next Greece,” Schulz said. The current rate on U.S. bonds is twice that.
If panic did take hold and the Japanese public lost confidence in the government’s ability to pay back the vast sums it owes them, capital flight from the country could ensue as people looked for stable homes for their savings.
The government would then have to look abroad for buyers for its bonds, who would demand far higher interest rates than it has been able to get away with paying domestically, leaving it unable even to service its debt, let alone meet spending commitments. With no European Union white knight to bail it out, printing vast amounts of money would be almost its only option.
The result: hyperinflation.
If this is anything more than a scare-mongering doomsday scenario, then it begs several questions: How is the yen currently regarded as a safe haven currency and why are Japanese government bonds (JGB) are not rated as junk?
A spokesperson for Moody’s in Tokyo confirmed the AA2 rating on JGBs and described the “outlook as stable, despite some concerns.” The other two agencies, Fitch and S&P, have lowered their ratings, and threatened to do so again, but both have maintained AA investment-grade levels. (Although it should be remembered that these are the same agencies who rated U.S. subprime mortgage bundles as AAA.)
There are though some huge reserves of money that give Japan at least the appearance of security and stability.
The vast pool of household assets, at 1.4 trillion yen ($15.88 trillion), is often said to be a kind of guarantee against the huge government debt. Noguchi described this argument as “nonsense,” pointing out that much of the money is already invested various ways, including much of it in the very same government bonds it is supposed to guarantee.
The government holds more than a trillion dollars in reserves, mostly in U.S. government bonds, and the country’s overseas assets total 225.5 trillion yen ($2.46 trillion), the largest amount in the world.
It may be that these huge reserves, most of which the government does not have access to, are the cause of the complacency that seems to have gripped Japan’s political class on the issue.
However, if Japan’s borrowing costs were to reach even half of what Greece’s did before the recent crisis, the reserves simply wouldn’t be enough.