Satyajit Das: Japan's Forgotten Debt Problem
Japan may have no option other than a domestic default to reduce its debt levels.
Japan’s Nikkei 225 (INDEXNIKKEI:NI225) stock average rose by around 23% in 2012. Much of the increase reflects faith in the reflation strategy of second time Prime Minster Shinzo Abe to increase growth through an additional US$120 billion of public spending, create inflation to reduce the debt to GDP ratio, and devalue the yen. The strategies have all been tried before, with limited success. There is no reason to believe that this time it will different.
In the post-war period, Japan enjoyed decades of strong economic growth – around 9.5% per annum between 1955 and 1970 and around 3.8% per annum between 1971 and 1990. Since the collapse of the Japanese debt bubble in 1989/1990, Japanese growth has been sluggish, averaging around 0.8% per annum. Nominal gross domestic product (GDP) has been largely stagnant since 1992. Japan’s economy operates far below capacity, with the output gap (the difference between actual and potential GDP) being around 5- 7%.
The Japanese stock market trades around 70-80% below its highs at the end of 1989. The Nikkei Index fell from its peak of 38,957.44 at the end of 1989 to a low of 7,607.88 in 2003. Japanese real estate prices are at the same levels as 1981. Short-term interest rates are around zero under the Bank of Japan’s (BoJ) zero interest rate policy (ZIRP), which has been in place for over a decade. 10-year Japanese government bonds yield around 1.00% per annum.
Since 1990, public finances have deteriorated significantly. Government spending to stimulate economic activity has outstripped tax revenues, resulting in a sharp increase in Japanese government gross debt to around 240% of GDP. Net debt (which excludes debt held by the government itself for monetary, pension, and other reasons) is about 135%. The US government has gross and net debt of 107% and 84%. Total gross debt (government, non-financial corporation, and consumer) is over 450% of GDP, compared to around 280% for the US.
Japan’s demographics parallel its economic decline. Japan’s population is forecast to decline from its current level of 128 million to around 90 million by 2050 and 47 million by 2100. A frequently repeated joke states that in 600 years, based on the present rate of decline, there will be 480 Japanese left.
The proportion of Japan’s population above 65 years will rise from 12% of the total population to around 23%. Japan’s workforce is expected to fall from 70% currently by around 15% over the next 20 years. For every two retirees, there will be around three working people, down from six in 1990.
According to one forecast by 2050, Japan will have a median age of 52, the oldest society ever known.
Origins of the Crisis
Japan’s post-war economic success, like that in Germany, was based on an export-driven economic model, using low costs and manufacturing competence. An under-valued yen provided Japanese exporters with a competitive advantage.
The Plaza Accord signed on September 22, 1985 called for France, West Germany, Japan, the United States, and the United Kingdom to devalue the dollar in relation to the Japanese yen and German Deutsche mark by intervening in currency markets. Between 1985 and 1987, the yen increased in value by 51% against the dollar. The higher yen adversely affected Japanese exporters. Japanese economic growth fell sharply, from 4.4% in 1985 to 2.9% in 1986.
Desperate to restore growth and offset the stronger yen, the Japanese authorities eased monetary policy with the BoJ cutting interest rates from 5% to 2.5% between January 1986 and February 1987. The lower rates led to a rapid increase in debt funded investment, driving real estate and stock prices higher. At the peak of the “bubble” economy, the 3.41 square kilometre (1.32 square miles) area of the Tokyo Imperial Palace had a theoretical value greater than all the real estate in the state of California.
Seeking to reverse the unsustainable asset price inflation, the authorities increased interest rates to 6% between 1989 and 1990, triggering the collapse of the boom. As Japan’s economic problems worsened rapidly, the government responded with large fiscal stimulus programs. The BoJ cut interest rates to zero. But the policy measures failed to revive the economy, which slid into deflation.
There was a parallel deterioration in public finances. At the time of the collapse of the bubble economy, Japan’s budget was in surplus and government gross debt was around 20% of GDP. As the Japanese economy stagnated, weak tax revenues and higher government spending to resuscitate growth created substantial budget deficits.
Japan’s total tax revenue is currently at a 24-year low. Corporate tax receipts have fallen to 50-year lows. Japan now spends more than 200 yen for every 100 yen of tax revenue received.
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