Home » Economy » What Blows Up First? Part 2: Japan

What Blows Up First? Part 2: Japan

by John Rubino on January 6, 2014 · 24 comments

Of all the crazy financial stories of the past year, Japan’s might be the craziest. To recap:

For two decades, successive Japanese governments have fought the deflationary effects of bursting real estate and stock bubbles with ever-larger public works programs. These prevented the collapse of the country’s zombie banks and construction firms but didn’t produce the kind of growth necessary to bring the zombies back to life. The sustained deficit spending did, however, produce a public debt that as a percentage of GDP dwarfs even those of the US and Europe.

So in 2013 incoming Prime Minister Shinzo Abe demanded that the Bank of Japan inject enough credit into the banking system to produce at least 2% inflation. The bank acquiesced and in the space of less than a year more than doubled the size of its balance sheet by buying bonds on the open market with newly-created currency.

Now here’s where it gets strange. While this massive debt monetization program was ramping up, Abe and company began to worry about their ongoing deficits. So they raised the national sales tax to 10% in order to generate more revenue. But of course higher consumption taxes are deflationary, thus counteracting the Bank of Japan’s inflationary debt monetization.

So the government then decided to aggressively increase public works and military spending, which means it will henceforth take in more money and spend nearly all of it, leaving the country with unsustainably-high deficits and a bigger, more intrusive government. In other words, a lot of effort has been expended to no real purpose, while the debt keeps mounting and government officials keep saying ever-more-senseless things to obscure the above facts. See this, from late December:

Japan Unveils Record 2014 Budget Draft as Debt Burden Mounts

Japan unveiled a record budget for the next fiscal year, as Prime Minister Shinzo Abe boosts spending on social security, defense and public works while trying to contain the growth of the world’s biggest debt burden.

Government ministers and the ruling coalition adopted the 95.88 trillion yen ($921 billion) budget proposal for the fiscal year starting April 1 at a meeting yesterday in Tokyo, Finance Minister Taro Aso told reporters. Japan will issue 41.25 trillion yen of new revenue bonds, Aso said, less than the 42.9 trillion yen earmarked in this year’s initial budget.

Abe aims to pull the country out of a 15-year deflationary malaise and cope with the rising welfare costs of its aging population, while containing public debt that’s more than twice the size of the economy. His government has pledged to halve the primary balance deficit by fiscal 2015 and achieve a surplus by fiscal 2020.

“The government needs to show that it’s moving in the right direction on fiscal discipline but this budget lacks punch,” said Yoshimasa Maruyama, chief economist at Itochu Corp. in Tokyo. “The government must cut spending to reach the planned target of a surplus in 2020.”

Improving Deficit

The government “will simultaneously achieve the revitalization of the economy and fiscal consolidation,” Abe said yesterday at the meeting of government ministers and the ruling coalition, adding that the budget draft will be submitted to Parliament in the new year for debate.

Japan’s growth slowed for a second straight quarter in July-September, as the initial impulse of Abe’s reflationary policies, dubbed Abenomics, started to fade. While an increase in the sales tax in April will boost revenue, enabling the government to check bond issuance, it is forecast to push the economy into contraction, adding headwinds to Abe’s efforts to drive sustained recovery in the world’s third-biggest economy.

Revenue from bond sales will pay for 43 percent of next year’s budget, down from 46.3 percent this year, according to draft budget documents obtained yesterday by Bloomberg News from a government official. Debt-servicing costs — including interest payments for outstanding bond issuance — will rise to 23.3 trillion yen from 22.2 trillion yen this year, the documents show.

Japan’s primary balance deficit will improve by 5.2 trillion yen next year, Aso said, with tax revenue estimated to rise to 50 trillion yen. This compares with 43 trillion yen estimated for this year’s initial budget.

Rising Revenue

In addition to the sales-levy bump, higher company tax payments as corporate profits rise will also help lift revenue. The sales tax will be increased to 8 percent from the current 5 percent from April 1, and the government plans to increase it again to 10 percent in 2015.

Social security spending will rise to 30.5 trillion yen next fiscal year, compared with 29.1 trillion yen this year, the draft budget documents show. The increase comes as the nation’s aging population boosts costs for welfare and pensions.

Public works spending will rise by 680 billion yen to 5.96 trillion yen, and the defense budget will rise by 130 billion yen to 4.88 trillion yen, according to the documents.

Real gross domestic product will grow 1.4% in the year starting in April, according to the documents, which show nominal GDP growing 3.3% to 500.4 trillion yen.

Some thoughts
The above article tosses around a lot of alarming numbers. But the two that stand out are:

“Revenue from bond sales will pay for 43 percent of next year’s budget, down from 46.3 percent this year…” This means that, far from reining in its excesses, the government will again borrow nearly half of its budget. This would be the equivalent of the US borrowing $1.5 trillion, something that would not be considered progress by most observers outside of the New York Times’ editorial department.

“Debt-servicing costs — including interest payments for outstanding bond issuance — will rise to 23.3 trillion yen from 22.2 trillion yen this year…” That comes to about a fourth of Japan’s federal budget, and is rising.

The dilemma is clear: Japan has to keep spending to satisfy its growing population of retirees, offset the effects of higher taxes and counter China’s military build-up. And a big part of that spending has to be borrowed. But government debt of 220% of GDP and interest expense at 24% of the budget is already way too much, so the systemic implosion is just a matter of people figuring this out. And that could be triggered in 2014 by lots of things, including a slight uptick in interest rates that sends interest expense above the psychologically-important level of 25% of the budget, a confrontation with China over the islands they both claim, or a slowdown in a major export market like Europe.

The result: a sudden loss of confidence in the yen and/or the Nikkei that raises Japanese borrowing costs and forces the government to sell some of its Treasury bonds, thus exporting its crisis to the rest of the world.

  • David Reischer

    第四の愚痴を回す!= Fourth Turning Bitches !!!

    • Jo

      How enlightening…

      • David Reischer

        Thanks ! :)

  • Bill Johns

    And yet for as long as I can remember from years ago folks have been predicting the collapse of the Japanese economy “any quarter now.” Don’t get me wrong, I don’t question any of the numbers or logic or thinking above. I just don’t understand how it is that Japanese can get away with debt numbers like that given the quality of the country’s leadership. Simply amazing. If they could bottle that and sell it to other countries and economies, we could have the whole world with debt levels north of 200+% of GDP and apparently get away with it.
    And with that thought…..Happy New Year?

    • esqualido

      They have been losing market share in a number of industries, notably automotive and e consumer electronics, and have decided that since the galley slaves are not working hard enough, the solution is to reduce their rations- because that is exactly what devaluing the yen amounts to. Abe may have just paid his respect to the war dead, but he has also moved senior citizens a step closer to the grave

      • Wim Lammens

        What I find difficult to understand is that when abe devalued the yen with 15 % with his abenomics, how come regular Japanese people should experience high inflation in imported products like food and oil.
        Is there somebody cleverer then me?

        • Bruce C

          Because they have to spend more yen to buy the same imports.

  • tom

    No mention of Fukushima?

    • Tony D

      Hi Tom,

      Interesting point. How do you see Fukushima causing an economic collapse in Japan ? I;m not looking to argue but to understand.

      • Agent P

        Not ‘causing’ per say, but ~Related~ in a Big way. The common denominator? Fear, followed by panic. Followed by – well, let your imagination run with it. At the point of realization that something very wrong is afoot, Fear does discriminate between economic or ecologic – it’s all Fear the same, and the reactions will be as well. Good luck –

  • Bruce C

    One of the reasons I started getting into all of these financial and economic issues is because the people who claimed to know the system and what they were doing (e.g., financial advisors, investment managers, mutual and hedge fund managers, etc.) turned out to be appalling ignorant. I don’t think things have changed much. I think that a lot of readers of sites like this are much more informed and enlightened than the professionals. So when J.R. says, “[Japan’s] systemic implosion is just a matter of people figuring this out,” he isn’t kidding, “people” being a proxy for institutional investors. But who knows when that will happen.

    • Wim Lammens

      I was in the stock market from 1995 till 2000 and sold real estate before the bubble bursts here in Belgium (still at the highest level). Bought silver with the proceeds and am now on half the price I paid in rising euros. I totally agree that newspapers and tv totally lost my confidence in them and bank advisors are hardly scolared in financial history or austrian economics. Reliable people luckily can be found in other writings. I wonder who is really still invested in the stock market and who will be buying thes stocks when the sell off starts. It won’t be me for a whole lot of years.

  • Digby Green

    With their high wages Japanese corporations have been shifting production off shore. You cant keep doing that and have a productive working economy.
    I think that is the bigger problem rather than any deflation.

  • boatman10

    we all stand around, waiting for the next big middle east blowup to send oil to 180$+, riding the current bubble, the DOW.
    envision this west+Japan debt/credit/derivatives house of cards and toothpicks, when Isreal sees the rest of the world is really going to let Iran point nukes at Tel-Aviv.

    • bingbingwa

      THis is an article about Japan. Does EVERYTHING have to be about Israel?

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  • Tony D

    A consideration for readers is how an economic failure in Japan will affect them, assuming, in this case that Japan “goes” first, which on exposed evidence is quite possible. The key is to understand that if there is a dislocative event in Japan that they only have (a) day(s) until the effects reach them, wherever they live. If Japan does “collapse” economically it will be worth immediately withdrawing large amounts of cash from bank accounts, transmission of bank failures will be almost instant and could result in frozen accounts and Bail Ins, depending on where you are.
    It will also be worth immediately prepping for a short term break down in our “just in time” commercial logistics system by purchasing necessary items in large amounts. I’d call this “small scale, instant prepping” rather than the “doomsday prepping” prevalent on the net. I guess people should prepare to their own beliefs of what will happen but knowing that “something” will happen. It is worth having a list prepared for this event and storing it on your phone for instant access. Sorry if this sounds a little screwy but an economic dislocation will occur, eventually, and the slow and unprepared will be at risk of being unable to support themselves for a period of time and in some places there will be no guarantee of government support.
    Gold and Silver ? A possible whipsaw in prices as world assets liquidate and PM prices collapse for a VERY brief time before exploding. Just one possibility. Owning PM’s as insurance now is a good idea, even with the opportunity cost involved.

    I believe people will look back in history at what is happening in Japan now with it’s Abenomics combined with a demographic timebomb and wonder how the people of these times couldn’t see a collapse coming.

    Mainstream economic commentary now requires willful blindness.

    We live in “interesting times”

    • HD

      We do indeed live in interesting times. Sometimes, I still cannot grasp that our global financial system has become a mere confidence game and that all this cannot possibly end well. It really feels as if we have arrived at a crossroads on a global scale in so many ways: economic, societal, ecological, you name it, nothing can be taken for granted any longer.

      And the most akward thing is that so few people seem to be aware of how serious our predicament is, especially in the advanced, highly sophisticated and therefore extremely vulnerable western democracies. I don’t get that and I shudder to think what will happen if control is unexpectedly lost.

  • Agent P

    Japan, like China – has been on the ‘verge of collapse’ (any day now), since long about 2008. That’s not to say it can’t or won’t happen soon, perhaps even before supper tonight, but we’ll have to wait & see… It’s a ‘rotating’ theme in a cast of global characters routinely hauled up for a good spanking and then let to be quiet for a spell before the next round…

    JR, give us some dope on the gold buying goings on in China, the TPP (Trans-Pacific-Partnership) and the ‘Pivot-to-Asia’ happenings of late, what with all the nice, new military hardware being sent to South Korea & all that. The more we ‘poke’ around over there, me thinks the sooner the Chinese peg their currency to Gold – the two are related. The only thing that stands in the way now is actual tonnage and how that stacks up against the fairy-tale supply held at Fort Knox and New York, and a premier-event where China opens its vaults for the global media to view its actual gold holdings.

  • Bruce C

    It’s been said – postulated, really – that the reason central banks have not simply given (newly printed) currency to individuals (instead of the banking system) to stimulate the economy is because then “people” would realize that currency is baseless and the system would breakdown. It’s a pretty ridiculous argument when you think about it because if “people” haven’t figured that out by now then they probably never will, or they may understand it perfectly and don’t care (as long as nobody else does, which seems to include all the “smart” money.)

    Either way, since the Japanese seem to have a knack for cutting edge, over-the-top policies (e.g., kamikaze warfare, the invention of QE itself, etc.) if Japan’s government debts become too onerous then the BOJ may be the first central bank to stop out-thinking itself and just literally eliminate/delete/forgive a large portion of all those government bonds it’s been buying by a mere accounting entry (no more bond “assets” for no more fictitious currency “liabilities”), and thus instantly reduce Japan’s total debt, it’s debt-to-GDP, and its debt servicing costs in one fell swoop. In fact, it could potentially be a two-bagger because if by chance “people” suddenly get confused then the yen might finally get truly pancaked and cause the significant price inflation that Abe wants.

    Just a thought.

    • pipefit9

      I don’t know about that, Bruce C. I suppose you could argue that as astronomically high as is the debt level in Japan, there isn’t much to lose, regardless of the apparent craziness of the plan.

      Pretty much the same boat here in the USA as well. Unfunded liabilities at the federal level are approaching $200 trillion, so something presumably has to give here too. Yet you tell people that the actual federal ANNUAL budget deficit is about $7 trillion, using honest, GAAP accounting, and they either don’t have a clue what you’re talking about or don’t care.

      Since you presumably cannot run annual budget deficits of almost 40% of GDP for very long, the shiit has pretty much gotta hit the fan within a year I figure.

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