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Japan is one of America’s biggest creditors. It also has an enormous debt crisis of its own. Is this sustainable? And what can the US learn from Tokyo’s profligacy? “Time will tell if the world has enough capital to service U.S. debt.”
(photo by Toru Hanai/REUTERS)
(photo by Toru Hanai/REUTERS)
TOKYO – It’s hardly news that the U.S. government is breaking new records for deficit spending. According to official projections, by the end of fiscal 2010, the government will accrue nearly $3 trillion in new debt, bringing the outstanding federal tab to $14.4 trillion. (You can check out the chilling numbers here.)
That will put the public debt-to-GDP ration at nearly 100 percent – meaning that for every dollar the U.S. economy produces, the government will owe a dollar. This has triggered a heated debate — catalyzed by Beijing, which holds the largest foreign chunk of U.S. debt — about whether the burden hasn’t become overwhelming.
But if you really want overwhelming, take a look at Japan.
According to the OECD, last year Japan overtook Lebanon in debt, leaving only Zimbabwe with a worse public debt-to-GDP ratio. By 2010, the figure is predicted to reach 197 percent of GDP, or about $8.5 trillion. Within ten years, it’s expected to hit 300 percent.
Paying back government bonds this year will cost Tokyo over 20 trillion yen ($200 billion), or nearly a quarter of the regular national budget. That would leave a gaping hole in spending plans, if it weren’t for the fact that the government will issue more than double that amount in new bonds.
That raises the question, how much red ink is too much? As America frets the sustainability of its own debt, what can be learned from Japan, where the figure is already twice as bad? And how has Japan gotten away with borrowing so much?
A tale of two debtors
Aside from the magnitude of the problem, there are important differences between Tokyo and Washington D.C.’s unpaid bills.
For starters, the two countries’ indebtedness has different roots. America’s current problem stems largely from war, tax cuts, and the bailout and stimulus packages over the past decade. Remember, President George W. Bush came to office in 2001 with a projected 2010 surplus of $5 trillion (altough that figure may have been somewhat inflated).
In contrast, Japanese governments have been living beyond their means since the 1960s, through the good times and the bad. Pork-barrel politics at its worst ensured a constant flow of economic aid to the regions. While this provided Japan with some of the world’s finest infrastructure, there was also waste on almost unimaginable scale.
Just a few examples of this are the infamous “bridges to nowhere,” the concreting of many rivers, and bullet-train stations at small sleepy towns. Environmental concerns and the traditional Japanese belief in harmony with nature were no match for the might of construction and concrete companies. These industries became dependent on public spending, perpetuating the problem.
While Japan’s debt dwarf’s America’s as a percentage of GDP, oddly, its cash on hand is far greater as well. While Washington’s reserve holdings — essentially its national savings — hover around $75 billion, Japan has more than $1 trillion in foreign exchange, mainly in U.S. Treasuries. On top of that is the almost mythical maizokin, or buried treasure, a fund for paying off government bonds and protecting the exchange rate. It is held in a multitude of special reserve accounts, and is rumored to total more than $2 trillion, but no one outside the government knows for sure.
Mopping up the debt
In the 1990s, after the bursting of Japan’s bubble economy, the government attempted to lift the nation out of recession with even more public spending — with limited success. With the election of reformist Prime Minister Junichiro Koizumi in 2001, the first serious attempts were made at tackling the problem. As the economy began to grow, the price of borrowing grew with it and so the cost of servicing the debt began to rise.
“In the early 2000s there was more concern because interest rates rose,” suggests Martin Schulz, senior economist at the Fujitsu Research Institute. “But the government has become very complacent again in recent years.”
Although interest rates in Japan have historically been very low, and currently remain close to zero, the national debt is now so large that even a tiny rise will have enormous repercussions.
“If the economy really starts to recover, interest rates may rise and this will then dampen the sectors of the economy that rely on borrowing, such as business expansion and consumer spending,” says Kyohei Morita, chief economist at Barclays Capital, Tokyo. But it is a minor concern; according to Fujitsu’s Schulz, “There is little fear that interest rates are going to rise because nobody expects the economy to start growing strongly.”
Therein lies the challenge ahead for the U.S.: while the government has spent a fortune to stimulate the economy, as growth begins again the debt burden could raise interest rates, crimping the recovery. “This is the big debate taking place in the U.S. But I think it’s premature. Although optimism is returning to the markets, there is a lot more pain to come for the real economy, if you look back to Japan’s experience after its bubble burst,” says Schulz. “And the Fed won’t be raising rates very quickly. For now there’s more deflationary pressure than inflationary,”
In Japan, with falling tax revenues due to the recession and an extra stimulus package, the ledger looks grim. “Every year Japan issues more bonds. This year it’s going to be 44 trillion yen ($450bn), a new record,” notes Morita. The U.S. will issue a far larger amount to fund its stimulus package this year, but Japan’s economy is a third of the size.
Schulz points out that in 2009, less than half of Japanese public spending is financed by taxes and that the government is essentially “printing money like crazy” by issuing bonds.
What enables the Japanese government get away with this is the huge domestic appetite for government bonds. About 93% of Japanese debt is held by its citizens and businesses — a crucial difference with the situation in the U.S. “The risk is lower when the debt is domestically held,” says Schulz, “for one thing you are unaffected by exchange rate fluctuations.”
U.S. in the mix
With most U.S. debt held overseas, including over $1 trillion each by Japan and China, the situation is less stable for American borrowing. If Japan and China were to get spooked enough about the value of the dollar — or even the possibility of U.S. default — they might try unloading some of it. The Catch 22 is that any attempt to do so would likely send the greenback into freefall, meaning that Japan and China would lose even more.
Schulz adds that for Japan, “The negative side, when compared to the U.S., for example, is that it must be paid back by the citizens of Japan — these are essentially delayed taxes. With so much of American debt held overseas, printing more dollars and devaluing the currency is an option.”
Moreover, the current scenario involves the seemingly bizarre situation of massively-indebted Japan lending vast amounts to an increasingly debt-laden America. For Japan, this has the dual benefits of keeping the yen cheap and lending the U.S. money to spend on Japanese goods. Asian savings have been bankrolling U.S. debt, and ultimately consumerism and trade, for decades now. Japanese households alone hold around $14 trillion in financial assets. The balance may begin to shift if the financial crisis makes Americans more prudent.
“The household savings rate has fallen in Japan and it’s possible we could see a role reversal with the U.S. if Americans start saving more,” points out Morita. “If Japan’s rate became lower than the U.S.’s, then we could see Japan start to carry a current account deficit. In which case, Japan would no longer be a safe haven.”
So is the U.S. worrying too much about a national debt approaching 100 percent of GDP, and could it get into serious financial trouble if interest rates rise? Economists, unsurprisingly, say maybe. “The U.S. needs a rise in the savings ratio,” answers Schulz. “It depends on the net financial assets held by the private sector. The Japanese private sector still has enough capital left after servicing the national debt.” Time will tell if the world, including Japan, has enough capital left to service the U.S. debt, on top of increasing domestic debt around the globe.
The endgame for Japan
Japan’s foreign-currency debt rating was cut last month by Moody’s to Aa2, almost an irrelevance given its minimal overseas borrowings, though symbolically, that was its last triple A rating. Japan’s local-currency debt rating meanwhile was somewhat incredibly, raised to the same Aa2 level.
The opposition Democratic Party of Japan (DPJ), which appears likely to win the election later this year, has proposed addressing the problem by ushering in a new era of fiscal transparency, and tapping into the maizokin, or buried treasure. “Our first priority would be to ensure that all government agencies and ministries fully disclose their budgets, including the maizokin. Only then will we be able to accurately assess the situation and draft a workable, and balanced, budget,” said a DPJ spokesperson. Many worry that if the maizokin turns out to be fool’s gold, a DPJ victory could lead to a greater debt burden to fund their election promises.
There are other options open to Japan, though neither is popular with the electorate: more immigration and more taxes.
“Put simply, we need immigration,” insists Barclays Capital’s Morita. “For four reasons: labor force, consumers, taxpayers, and contributors to the pension system.”
“Japan has very low taxes by international standards. Japan also has one of the lowest tax bases – the number of people paying tax – in the industrialized world,” says Schulz, “Only around 30% of companies pay tax, and I can’t remember the last time the banks paid tax, and we have some big banks in Tokyo.”
Schulz is not optimistic that any politician will make the hard choices required, “The terrifying part is that there is no forward plan for structural reform. There is no exit strategy.”
The ability to endure is one that has traditionally been highly-regarded in Japanese culture. And the older generations feel that today’s young people no longer have the endurance to stomach the hardships they did. But it is upon those youngsters, and perhaps their children, that this generation’s fiscal folly looks sure to rest.