Japan’s Debt: Argentina Times One Hundred!
One of the things that has been keeping me awake at night lately is Japan’s horrendous government debt burden. This is already more than 170% of GDP and will only keep rising as the budget deficit surges this year and GDP plummets. I forecast government debt reaching 250% of GDP by the end of 2018, which assumes an average debt increase of 5% per year from 2011 and real GDP growth averaging just below 2.0% over the same period.
Japan's Government Debt (% of GDP). f=BMI forecasts.
If anything, my calculations may be on the conservative side. Deutsche Bank recently forecast debt exceeding 300% by 2020. Yet despite these figures, Japan’s 10-year bond yields remain remarkably low, at 1.3%. These low yields reflect a) Japan’s deflationary pressures (core CPI was a record low of -2.2% in July) and b) the willingness of Japanese financial institutions to keep buying debt.
My question is, how long can this go on for? At some point, something’s got to give on either of these two fronts.
True, commentators have been warning of a debt crisis for a long time now, as evidenced by this article in The Banker magazine of December 1998. Similar warnings were sounded in the early 2000s, but Japan subsequently started reducing its budget deficit, and its debt burden at least started stabilising.
Going forward though, I fear that a full-blown fiscal and debt crisis is looking increasingly likely. The previous government’s massive fiscal outlays to counteract the 2008-09 recession have reversed years of progress on deficit reduction, and the new Democratic Party of Japan (DPJ) administration cannot easily course-correct. Another problem is that Japan’s population is ageing rapidly, meaning that there will be higher expenditures on the elderly, and fewer young people to pay for all this… meaning higher taxes and thus lower private consumption.
Japan's Population Profie
As far as I know, Japan’s debt burden is unprecedented for a country in peacetime. The UK’s debt exceeded 200% of GDP during World War II, but that was exceptional, and Britain had much more favourable demographics, with the population enjoying a post-war boom. Even when one calculates Japan’s net debt, this is still nearing 100% of GDP.
Japan To Default Within A Decade?
All this leads me to utter the word that virtually no-one else does: default.
In theory Japan can avoid default by printing more money to pay back debt. But eventually, this could prove hyperinflationary, causing the yen to collapse and people’s savings to become worthless. If you think Argentina’s sovereign default was bad in 2001, then Japan’s debt load is Argentina times one hundred! Yes, one hundred! Argentina owed about US$100 billion, whereas Japan owes the dollar equivalent of US$10 trillion. The difference of course is that Argentina owed external creditors, whereas Japan owes the money to its own people. However, even so, with around 7% of Japan Government Bonds (JGBs) held by foreigners, external payments would be the equivalent of US$700 billion.
The political implications of a Japanese default are hard to fathom. If this scenario were to play out under the DPJ’s watch, then it would probably be blamed, even though the problems were built up under the (now) opposition Liberal Democratic Party (LDP)’s 55-year rule. On the plus side, neither Russia’s 1998 default nor Argentina’s crisis led to revolution or anarchy.
Nonetheless, I cannot see a happy ending to this story.