Satyajit Das: Japan's Forgotten Debt Problem
Japan may have no option other than a domestic default to reduce its debt levels.
Japan’s large pool of savings, low interest rates, and large current account surplus has allowed the build-up of government debt.
Japan has a large pool of savings, estimated at around US$19 trillion, built up through legendary frugality and thrift during the nation’s rise to prosperity after World War II. In recent years, household savings were complemented by strong corporate savings, around 8% of GDP.
Much of these savings are invested domestically. A significant amount of the savings is held as bank deposits, including large amounts with the Japanese Postal System. Japanese banks hold around 65-75% of all savings with the Japanese Postal System being the largest holder. Around 90% of all Japanese government bonds (JGBs) are held domestically.
Over the last 50 years, Japan has also run large current account surpluses, other than in 1973–1975 and 1979–1980 when high oil prices led to large falls in the trade balances. The current account surplus has resulted in Japan accumulating foreign assets of around US$4 trillion or a net foreign investment position of approximately 50% of GDP. This helped Japan avoid the need to finance its budget deficit overseas and also boosted domestic resources, increasing demand for JGBs.
Since the global financial crisis and more recent European debt crisis, Japan has been viewed as a “safe haven.” Investors went long yen and JGBs, pushing rates to their lowest levels in almost a decade and increasing foreign ownership of JGBs to around 9%, the highest level since 1979, which is the first year for which comparable data is available. These factors have helped Japan finance its budget deficit.
Airbags designed to protect occupants of a car from injury in a crash only work once. Similarly, the factors that allowed Japan to increase its government debt levels are unlikely to continue.
Following the collapse of the bubble, policymakers implemented a variety of economic stimulus programs.
Japan’s budget surplus of 2.4% in 1991 has become a chronic budget deficit, increasing from 2.5% in 1993 to about 8% by the end of the 1990s. It has remained high during the 2000s. The BoJ has tried unsuccessfully to increase inflation to reduce debt. Japanese inflation has averaged -0.2% in the 2000s, a decline from levels of 2.5% in the 1980s and 1.2% in the 1990s. The policies have failed to restore economic growth, trapping Japan in a period of economic stagnation.
Nomura economist Richard Koo argues that Japan is experiencing a “balance sheet recession,” triggered by the collapse of financial asset prices. Financially insolvent firms are reducing debt -- deleveraging -- despite low interest rates. This is evidenced by a sharp fall in investment (currently around 22% of GDP, down from 32% in 1990) and corporations becoming net savers from net borrowers.
Private consumption is weak, falling to about 57% of GDP, further reducing domestic demand. This reflects weak employment, lack of growth in income, and the aging population. Strong exports and a current account surplus have partially offset the lack of domestic demand as firms focused on overseas markets.
With investment and consumption weak, large budget deficits have supported economic activity, avoiding an even larger downturn in economic activity.
In a balance sheet recession, monetary policy is ineffective with limited demand for credit. GDP tends to decline by the amount of debt repayment and unborrowed individual savings. Government stimulus spending is the primary driver of growth.
Given the strategies that have been tried unsuccessfully before, Prime Minster Shinzo’s policies have a desperate quality. Although the measures will provide a short-term lift in economic activity, it is unlikely to create a sustainable recovery. They will increase the budget deficit and government debt levels.
Continued economic weakness, a decline in savings rates, and a reversal of the current account surplus make the Japanese government debt burden increasingly unsustainable.
Getting Poorer at Home
The Japanese government’s ability to finance spending is increasingly constrained by falling Japanese household savings rates, which have declined from between 15% and 25% in the 1980s and 1990s to under 3%, a level below the US until recently. This decline reflects decreasing income and the aging population.
Wages have fallen with average annual salaries including bonuses falling every year since 1999 and decreasing by around 12% in total. Between 1994 and 2007, labor costs as a percentage of manufacturing output declined from 73% to 49%. Japanese workers' share of GDP fell to 65% in 2007, from a peak of 73% in 1999.
The aging population further reduces the savings rate. Household surveys indicate that around a quarter of households with two people or more have no employment. In aggregate, the amount of money being paid to retirees from savings exceeds the amount of new money that is going into savings funds. This is compounded by low returns on investments, which accelerates the rundown of savings.
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