Why America Should Fear Japan's Higher Interest Rates
The US will undoubtedly have to raise rates to be competitive.
- Over 90% of Japanese debt is financed internally
- Japanese debt-to-GDP is 170%, probably even higher than that after you factor in $200 billion plus in stimulus, second only to Zimbabwe.
- Japan has the oldest population in the developed world. Its savings rate has been on the decline since the early 1990s. At its height it was in the mid-teens, now it's in the low single digits. As people get older they make less money and have higher medical expenses, thus they save less. Also, the Japanese are xenophobic -- no immigration; population is shrinking.
- At the same time, as the consumer savings rate declines, there's less demand for government debt.
- It's really an issue of supply and demand: To attract investors, Japan will have to raise interest rates.
Japan is the second-largest foreign holder of US debt (holdings as of July: China $800 billion; Japan $720 billion; and the UK a distant third at $200 billion). However, a year ago, Japan was the largest holder of US debt. Japan is an export-based economy. As exports collapse, it has fewer sales and less money to park in US dollars. This issue will get resolved if the global economy starts growing again, but the next issue won't.
Higher Japanese rates will have significant consequences: They'll attract capital away from US debt, and the US will have to raise rates to be competitive. The US Treasury won't be competing against 0.5% interest rates anymore.
In addition, it will put the end to the giant carry trade. Japanese corporations will have little incentive to park their money in the US dollar, as their borrowing costs in Japan will exceed or equal the interest rate they're getting in US dollars.
Higher interest rates will puncture a huge hole in the Japanese fiscal budget. A 1% increase in rates will cost Japan $60 billion (my guesstimate is that the country as has about $6 trillion in debt) -- about 4% of the Japanese budget.
If the US consumer stays a net saver, this would offset these trends at least partially. But before consumers start buying government debt, they have to chew through a huge pile of higher-interest consumer debt (credit cards, home equity, car loans, and so forth).
How Much, and for How Long?
How much will Japanese rates rise? I don't know -- it will depend, in large part, what the new Japanese government does about their deficits.
And how long? This is likely to be a drawn-out process. The Japanese consumer savings rate has been in decline for a long, long time. In addition, a large portion of Japanese government debt has long-term maturities.
After I wrote the above, a reader forwarded the following note from Dennis Gartman, which somehow leaves me feeling this whole discussion about China, Japan, and our debt becomes meaningless (sorry for wasting your time):
"And the number-one holders of US treasury securities, more than six times as large as are China's holdings, and more than the total of Brazil, the Caribbean banking centers, OPEC, the UK, US Pension funds, States and local entities, 'other investors,' Japan, China, and US Mutual funds combined, is none other than the US Federal Reserve Bank system. So, when we become too egregiously concerned about the concentration of Treasury debt held by the Chinese, or the Japanese or the Russians et al, we should remember that it is the Fed who trumps 'em all and trumps 'em hard. We thought ya'll'd find this interesting; certainly we did."
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