A global fiasco is brewing in Japan by Ambrose Evans-Pritchard
(Telegraph January 12, 2010)
I have felt rather lonely after
suggesting in my New Year Predictions that
Japan is dangerously close to blowing up on its sovereign debts, with
consequences that will be felt across the world.
My intended point — overly condensed — was that 2010
will prove to be the year that Japan flips from deflation to something very
different: the beginnings of debt monetization by a terrified central bank
that will ultimately spin out of control, perhaps crossing into hyperinflation
by the middle of the decade.
So it is nice to have some company: first from PIMCO’s Paul
McCulley, who said that the Bank of Japan should buy “unlimited amounts” of
long-term government debt (JGBs) to lift the country out of a “deflationary
liquidity trap” and raise the souffle again.
His point is different from mine, in that he discerns
deflation “as far as the eye can see”. But in a sense it is the same point. Once
a country embarks on such policies, the game is nearly up. The IMF says
Japan’s gross public debt will reach 227pc of GDP this year. This is
compounding at ever faster speeds towards 250pc by mid-decade.
The only reason why this has not yet blown up is because
investors (mostly Japanese) have not yet had the leap in imagination required to
understand their predicament, and act on it. That roughly is the
argument of Dylan Grice from Societe Generale in his latest Popular Delusions
note released today. “A global fiasco is brewing in Japan.”
Japan’s deficits are already
within the hyperinflation “red flag” zone identified by historian
Peter Bernholz (”Monetary Regimes and Inflation” .. the Bible on this
subject). As you can see from the charts below, prices start to spiral
into the stratosphere once the deficits as a share of government expenditure
rises above a third and stays there for several years.
The Bernholz range for the five hyperinflations of
France, Germany, Poland, Brazil, and Bolivia over the centuries is surprisingly
wide, from 33pc to 91pc. Japan has been in the that range almost continuously
for the last eight years. The US joined
the party in 2009. Japan’s Bernholz index will rise above 50pc this year
for the first time, meaning that it will have to borrow more from the bond
markets than raises in tax revenue. You see the problem.
We all know that Japan has been racking up debt for Two Lost
Decades, yet the sky has refused to fall. Borrowing costs have slithered down to
1.36pc on 10-year JGBs and under 1pc on shorter debt, though they are not as low
as they were .. nota bene. This seeming defiance of gravity has emboldened the
Krugmanites and Keynesian prime-pumpers to call for a repeat in the US, UK, and
Europe. There lies a great danger.
Mr Grice said Japan was able to pull off this feat only
because its captive saving pool was large enough to cover the short-fall, and
because the Japanese people continued to be reassured by the conjurer’s illusion
that all was well. This cannot continue.
The country tipped into outright demographic decline in 2005.
Households have already stopped adding to their stock of JGBs. As the aging
crisis accelerates, the elderly are running down their assets. The savings rate
will soon crash below zero.
Japan can turn to foreign investors to plug the gap, or
course, but at what price? If yields reached UK or US levels of 4pc, debt costs
would soak up nearly all the budget, leaving nothing for schools, roads, the
police, or salaries for the Ministry of Finance. “I doubt there is any yield
that international capital markets can find acceptable that will not bankrupt
the Japanese state,” he said.
Note too that the Japanese will also have to run down their
holdings of US Treasuries, currently $750bn or 10pc of the entire stock of US
Treasury debt, as well as selling a lot of Gilts and Belgian bonds.
“This might very well precipitate other government funding
crises. At the very least I’d expect it to trigger an international bond market
rout scary enough to spook all other asset classes. So maybe we should all be
concerned that Japan is in the hyperinflationary range. And if so, maybe we
should think a little more carefully about how Western governments consider
their debt burdens. Maybe Japan’s will be the crisis that wakes up the
rest of the world,” he said.
Will it happen, this week, this month, this year, or
will Tokyo keep the illusion of solvency going for years longer? Who knows.
Japan is an endlessly mystifying society. But as Mr Grice puts it, if you are
sitting on a tectonic fault line, expect an earthquake.
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