As Japan sails into the shadows, let’s wish them well and wave good-by

About Japan, excerpt from John Mauldin’s weekly letter of 11 July 2009.  Based on work of Hayman Capital.  I recommend reading this in full, esp to see the fine graphs.

Over the years, I have written about Japan often. Its economy is very important to the world, and its banks have funded and loaned a great deal to companies outside of Japan. Global growth would have been a lot slower without the Japanese. Up until recently, their population has saved a great deal of its disposable income, and those savings have allowed the Japanese government to run massive deficits.

As late as 1999, personal savings plus pensions were running at 12% and had been as high as 16%. And much of those savings went into government debt. The government kept borrowing, and rates stayed in the area of 1%. Today, a ten-year bond yields 1.3% in Japan, so they could run up a very large debt and the interest-rate cost was not a big factor in the budget.

But now things are changing. Demography is starting to change the landscape. Japan is a rapidly aging nation. The population is shrinking, and the birth rate is among the lowest in the world. And the dependency ratio is starting to rise. There are currently 1.2 nonproductive citizens (under 15 years old and over 64) for every productive Japanese; the ratio will reach 2.0 by 2020 and will continue to grow thereafter. (See chart below.)

This also means that the ability to save is dropping, since so many retirees now need to dip into savings to live. Notice in the chart below that savings have dropped from 18% to 1.8%. Also notice that annual net savings is now down to 5 trillion yen.

But this year, the Japanese will want to issue roughly 33 trillion yen in debt! Also note that the national pension fund has informed the government that this year they will for the first time be net sellers of debt. Look at the chart below. Notice that as debt was increasing through 2006, actual interest-rate expense for government debt was decreasing, because rates were dropping, getting to 0.1% in 2001. Yet with no more room to cut rates, interest-rate expenses have started to rise. Total government debt is now close to 900 trillion yen.

Interest-rate expense is now about 18% of the Japanese government budget. What if rates went to a lofty 2%? That would over time double the interest-rate expense. And the Japanese are borrowing between 30-40% of their annual budget. The total debt is rising rapidly.

The remainder of the article discusses the implications, which are all bad.  Japan’s political regime may have passed the point of no return.  The demographics are essentially fixed for a generation or two.  The debt is too large and too short-maturity to inflate away — rising interest expense would bankrupt the government (or force hyper-inflation) before it reduced the real debt.  And its too big to pay — or even sustain.

Tough choices lie ahead for Japan.  It will be interesting to see what they choose to do.

Nothing lives forever, and Japan’s brief experiment with democracy and free markets may be reaching its end.

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Other posts about Japan:

14 thoughts on “As Japan sails into the shadows, let’s wish them well and wave good-by

  1. Japan’s birthrate has fallen so dramatically that their population is shrinking. They are closing MASSIVE numbers of schools; there is no younger generation. This is the price to be paid for lifestyle choices. Europe and the US are not so different EXCEPT for the number of immigrants. Where Japan does not allow immigration (for the most part), Europe and America have grown due to immigrants, NOT from birthing one’s own children. The problem is that these immigrants are generally not providing the tax ‘contributions’ that governmental entitlements require. Interesting times are upon us…

  2. Here’re some public debt/GDP percentages : Zimbabwe – 218%, Japan – 199%, Italy – 100%, USA – 80%, Germany – 77%, India – 58%, Brazil – 45%, Indonesia – 34%, South Korea – 28%, China – 18%.
    THe 80% number for the USA isn’t particularly reliable. It’s hard to estimate the unfunded liabilities of the Federal Government. They took the equivalent of 40% of US GDP from the Social Security Fund and spent it. So officially that’s recorded as “intra governmental holdings of public debt.” Apart from that,the public debt is 40% of GDP. So quacks count only 40% and claim there’s a lot of room for US public debt to grow.
    Japan is the 2nd largest creditor to the US. If and when the Japanese economy goes bust, FM can wave goodbye to the US economy alongside, as they bite the dust together.
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    Fabius Maximus replies: The 80% number for the US is reliable, because debt results from past spending. It does not include future liabilities. These numbers are not comparable because they are gross debt, including intergovernmental loans. These net out, hence only net debt should be used. The IMF and others publish the more useful net ratios. Economist recently ran a table of net debt to GDP.

    “If and when the Japanese economy goes bust, FM can wave goodbye to the US economy”

    Backwards, as usual. Why would Japan going bust hurt the US? They export to us; they loaned money to us. Us going bust would hurt them, not so much the other way.

  3. The Japanese are in worse shape than the US as they already have a value-added tax. (That’s what helped to balance the budget in Canada under Paul Martin). The immigration solution is not available to Japan because of its xenophobia – ask Japanese of Korean descent how they are treated.

    I suspect that the Japanese will be forced to raise taxes and further cut spending and probably allow the elderly to further fall into poverty. Maybe the yen will go back to 360 to a US dollar as in the ’50s. Then the country will flourish as a tourist destination – like France.

  4. FM: They export to us; they loaned money to us. Us going bust would hurt them, not so much the other way.

    Me: Surely you’re joking, Mr. Fabius? If the perception builds up in the market that the Japanese regime is financially unsustainable, a typical currency crisis will ensue. The Bank of Japan is the 2nd largest official holder of Treasuries in the world, and they will offload massively to defend the Yen, and call Washington for help at the same time.Overnight, the sirens will go off loudly, insistently. The Bank of Japan retreating from Treasuries is a great opportunity for the rest of the market to press the eject button on Treasuries. Washington, already beleaguered with multitudinous credit obligations will not be able to enter the fray and effectively stem the tide. It’ll be a Hobson’s choice for them, because when the Bank of Japan retreats from Treasuries, they will come under attack anyway. The inevitable Federal Reserve checkmate, and the long awaited Collapse of the US Dollar will rapidly ensue. The combination of massive Dollar and Yen shorts, combined with the End of the World Trade – long in CDS against US Treasuries – will result in a complete pandemonium. It will be all over in less than three weeks.
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    Fabius Maximus replies: The BoJ would love nothing more than for the Yen to drop vs. the currencies of its export markets, restoring the competitiveness of its exports. Second, why would a long slow demographic collapse force currency flight from Japan? Unlike us, they are a creditor nation. Deflation is very bullish for a currency, unlike inflation (an option no longer open to Japan).

  5. Why does everyone assume that an aging population stops working? In this situation why wouldn’t more and more Japanese delay retirement? An economy with very experienced workers might work better. If Japan is going to borrow a ton of money they should invest it in increasing the health of older people, allowing them to stay in the workforce longer. Either that or giant robots with laser swords.

    OOT, FM, you expressed interest in the reboot of Full Metal Alchemist. It’s been up on Hulu, with a two episode delay after the Japanese release. Better than nothing! Hopefully they won’t go extinct before they finish the show.
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    Fabius Maximus replies: It’s not that the elderly will not want jobs. But rather that an elderly economy doesn’t generate the jobs they need.

  6. The low birth rate in Japan was the result of government policy. The Japanese government did everything it could to have one child families.
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    Fabius Maximus replies: Do you have any evidence for this? Are you thinking of China?

  7. In addition to the domestic dangers looming in Japan’s future, consider some of the overseas events that we can reasonably expect to happen over the next thirty-ish years: the reunification of Korea, peaceful or violent, possibly as a nuclear state but definitely as a strong and antagonistic competitor. A strong and nationalistic China dominating the Pacific. The majority of wealth and population heavily centralized in Tokyo, which is overdue for a devastating earthquake any day now (which the gov is, of course, woefully unprepared for). Predicting the future is a fool’s game, but I’m seeing a lot of dark clouds in Japan’s future and not a lot of silver lining.

  8. The Gods of the Copybook Headings

    AS I PASS through my incarnations in every age and race,
    I make my proper prostrations to the Gods of the Market Place.
    Peering through reverent fingers I watch them flourish and fall,
    And the Gods of the Copybook Headings, I notice, outlast them all.

    We were living in trees when they met us. They showed us each in turn
    That Water would certainly wet us, as Fire would certainly burn:
    But we found them lacking in Uplift, Vision and Breadth of Mind,
    So we left them to teach the Gorillas while we followed the March of Mankind.

    We moved as the Spirit listed. They never altered their pace,
    Being neither cloud nor wind-borne like the Gods of the Market Place,
    But they always caught up with our progress, and presently word would come
    That a tribe had been wiped off its icefield, or the lights had gone out in Rome.

    With the Hopes that our World is built on they were utterly out of touch,
    They denied that the Moon was Stilton; they denied she was even Dutch;
    They denied that Wishes were Horses; they denied that a Pig had Wings;
    So we worshipped the Gods of the Market Who promised these beautiful things.

    When the Cambrian measures were forming, They promised perpetual peace.
    They swore, if we gave them our weapons, that the wars of the tribes would cease.
    But when we disarmed They sold us and delivered us bound to our foe,
    And the Gods of the Copybook Headings said: “Stick to the Devil you know.”

    On the first Feminian Sandstones we were promised the Fuller Life
    (Which started by loving our neighbour and ended by loving his wife)
    Till our women had no more children and the men lost reason and faith,
    And the Gods of the Copybook Headings said: “The Wages of Sin is Death.”

    In the Carboniferous Epoch we were promised abundance for all,
    By robbing selected Peter to pay for collective Paul;
    But, though we had plenty of money, there was nothing our money could buy,
    And the Gods of the Copybook Headings said: “If you don’t work you die.”

    Then the Gods of the Market tumbled, and their smooth-tongued wizards withdrew
    And the hearts of the meanest were humbled and began to believe it was true
    That All is not Gold that Glitters, and Two and Two make Four
    And the Gods of the Copybook Headings limped up to explain it once more.

    As it will be in the future, it was at the birth of Man
    There are only four things certain since Social Progress began.
    That the Dog returns to his Vomit and the Sow returns to her Mire,
    And the burnt Fool’s bandaged finger goes wabbling back to the Fire;

    And that after this is accomplished, and the brave new world begins
    When all men are paid for existing and no man must pay for his sins,
    As surely as Water will wet us, as surely as Fire will burn,
    The Gods of the Copybook Headings with terror and slaughter return!

  9. Firstly ,Ramen has a point : we infantalise the elders . An alternative to breeding /importing babies would be to extend people’s working lives. The planet , after all , is getting over populated , doesnt need more and more mouths to feed .
    The best way to extend working lives , I think , would be to reintroduce food and fuel rationing .
    Secondly , this idea that we dont have enough babies ( unless we are teenagers , when it seems we have too many ) and we need immigrants to supply us with future workers .
    I dont know much about the individual US states .Does immigration explain the 2004 stats I googled , where Maine and Vermont had the lowest birth rates per woman, and Idaho and Utah the highest ? There was a 36 % difference.

  10. Although I agree that retirement is actually a BAD idea (and people who continue with productive work live longer and more fulfilling lives), the baby shortage is abundantly clear. The assertion that there are too many people has little REAL basis. This is part of the “mankind is bad” attitude of the tree-huggers. Efficiencies of food production & distribution, as well as other manufacturing, makes us capable of supporting plenty of humanity.

    The problem is we are dealing with a change in attitude. Instead of children being valued by adults, there is more consideration for one’s own comfort and convenience. Comparing statistics of abortions and the gap in the younger population (filled by legal AND MOSTLY illegal immigrants) points out that there is a desire for ‘someone’ to do some work, but not at the cost of actually raising children. Japan certainly bought into the myth, and their culture is dying. Look at America and Europe: the changing demographics show which ethnic groups are on the rise and which are on the wane.
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    Fabius Maximus replies: Whether Retirement is good or bad is irrelevant to the subject under discussion, which is economics. An aging society means less job creation. Intertemporal transfers of wealth being inpossible, that means slower growth. (This is a gross oversimplification, but conveys the basics)

    Also, I suspect ApoloDoc has a white collar job. People who do hard manual work for a living often find retirement easier or even necessary.

  11. In my little planet , my veg patch , I have found three limits on production . One is what you can grow with sunlight ,rainfall , compost etc. One is what you can afford to grow with heating , extra artificial lighting , irrigation , pesticides and fertilisers bought in . The third is the amount of footprint space available.

  12. Update: more folks see dark times ahead for Japan

    Out with the old“, the Economist, 20 August 2009 — “The Liberal Democratic Party is on the brink of electoral defeat. About time too”

    Japan’s economy in valley of tears with record debt“, Deutsche Bank, 19 August 2009

    Japan Is Fading“, Newsweek, 15 August 2009 — “One thing the nation’s next leaders don’t talk about is growth.”

    Can Japan Avoid Another Lost Decade?“, Nouriel Roubini, Forbes, 23 July 2009

    Note: oddly, Roubini’s article appears on his site under the same title but another byline: “Can Japan Avoid Another Lost Decade?“, Mikka Pineda, RGE Monitor, 22 July 2009

  13. As Japan strains to care for elderly, sacrifices begin“, Washington Post, 28 April 2012 — Opening:

    The ominous demographics of this aging nation have long been seen by Japanese as a distant concern, not a present-day one. But that mind-set is being called into question by a prime minister who says that a crisis requiring immediate sacrifices has already begun. In recent months, Prime Minister Yoshihiko Noda has staked his job and bet his support on a tax increase designed to fund Japan’s soaring social security costs.

    And the potential tax hike is only a sneak preview of the burdens to come as Japan grows into the world’s grayest society, a nation where two decades from now seniors will outnumber children 15 and younger by nearly 4 to 1. Economists and government officials say that Japan, in the coming years, will probably raise the retirement age, again increase taxes and trim spending on everything from education to defense, all to care for its elderly.

    Young Japanese — those entering the workforce amid two decades of stagnation — will face the greatest burden: They will earn less in real terms than their parents, pay higher pension premiums, receive fewer social services and, eventually, retire with a less-generous pension package.

    And that’s the best-case scenario, experts say, possible only if a notoriously fractious government succeeds in pushing through a series of unpopular measures.

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