The True Story of Japan

[Wonkish1]

What is their debt-to-GDP ratio again? 250% yet? 300% soon? And how are they ever going to repay it...

'debt-to-GDP ratio' never matters when it is in your own currency, Polico.  

Oh yes. I forgot that in opebo's world you can simply erase debt with the stroke of a button without creating inflation. Did Zimbabwe appreciate your consultation?

Moderate inflation would solve at least some of Japan's short-to-medium-term economic problems, actually.

No it wouldn't, actually. 200 basis pt increase in their debt service and they are bankrupt(i.e. their debt service outstrips all of their government revenue). The reason why Japan has gone through numerous finance ministers in the last few years is because they are caught between a rock and a hard place. Their is no way out except print it all away and take their populations wealth by purchasing power or by default(in which case ~90% of JGBs are owned by the Japanese people which is the single largest store of wealth in Japan by a huge margin--so your talking about huge loss of wealth to the Japanese people).

Oh and you can't do a little bit of either one and hope it gets better. A tiny default(haircut) skyrockets the cost of borrowing facilitating more defaults. A little printing changes their economy from a deflationary to inflationary economy causing that to be priced into their JGB rates and also higher cost of capital.

So quite literally they are f***ed!

[Wonkish1]

And Beet this thread is going to seem remarkably and ironically dumb in the next year or 2(if by some feet of luck they manage to keep things at bay that long), no offense.

I've seen these per capita GDP analysis's years ago on Japan. While technically accurate lets not forget that their entire economy rests on practically one asset class the JGB which today is essentially worthless and all that waits is for the market to assess it as such. Like a set of Bernie Madoff clients just before finding out what the real value of their investments are.

Its Japan that awaits the real human tragedy. Greece, Portugal, Spain, Italy, etc. don't hold a candle. They will make out amazingly well in comparison to the Japanese.

So I would probably refrain from the "how good the Japanese have got it" posts unless you want to eat a lot of foot.

[Wonkish1]

I've seen these per capita GDP analysis's years ago on Japan. While technically accurate lets not forget that their entire economy rests on practically one asset class the JGB which today is essentially worthless and all that waits is for the market to assess it as such.

Yeah, I have wondered for a couple of years why the market has not accepted this yet. Denial can only last so long until reality sets in.

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This I am not so sure about. Italy, in particular, may be in a world of trouble. Funny enough, Italy's saving grace may be their expansive underground economy. I've always admired their distrust of government, at least by European standards.

The answer is quite simple and rather quite unique to Japan. Approximately ~90% of JGBs are owned by the Japanese themselves. Their banks, their pension funds, and Japanese citizens. Starting back many years back the Japanese government went on what you would call a PR campaign to convince the Japanese people to buy JGBs because the rest of the world was increasingly less interested in them. In Japanese culture directions from their government are a lot more, umm, important than most of the world. Plus the Japanese had just gotten destroyed in the Japanese stock and property crash so they were interested. Also(and I'm I have some friends that deal with this on a regular basis so I now how bad this is) Japan is extremely strict on money leaving the country so most markets in the rest of the world are very challenging for the Japanese to invest in so there isn't many options.

So you combine this altogether and as long as the Japanese population continued to rollover their governments debt and buy up the new issuance then the Japanese government could continue to self finance at way low interest rates. Furthermore, as long as the trade surplus that manifested itself into savings at the banks and pension funds(and was invested in JGBs) was larger than the annual deficit than their would be enough money to buy the new issuance each year.

So you have right there the true makings of a real ponzi scheme. You have unwitting investors courtesy of the Japanese PR campaign. You have enough new money coming into fund the growth of the ponzi scheme. And you didn't have net sales(redemptions) to cause it to blow up.

Well that all changed in the last couple years For one the highly xenophobic aging Japanese population featured for the first time more people exiting the scheme than entering(people retiring). When people retire their their pension funds and banks need to sell their JGBs to produce income to the retirees making the Japanese economy net sellers not net buyers. Also around that time the size of the debt got large enough that the trade surplus that shows up isn't enough to handle the entire deficit. So if I were to graph this both of these lines have crossed in the last couple of years and now are progressively getting worse. Its like Bernie Madoff's clients slowly starting to pull money out leaving the remaining balance smaller and smaller.

As the Japanese are forced to sell more internationally they will be increasingly at risk of a spike interest rates. Either A) because its just so large and that next margninal investor may just say, "Hey for 200%+ dept to GDP I'm going to want a little more than a couple hundred basis pts" or B) A hard default in Europe causes investors to be spooked around the world about buying government bonds from heavily indebted nations. So that is where they sit.


Sorry for the book.




And in regards to Italy vs. Japan not even close in my mind. Japan's *on balance sheet* debt is the better part of near double Italy's, but the real issue is that Japan's debt is about 90% internally owned and is the principal asset everybody relies on in Japan. Italy has a lot of its debt internationally owned. So if each country stiff's their creditors the Italian people lose a lot of wealth and the Japanese lose the vast majority of their wealth. The math says the Japanese are going to get it far, far, far worse than anybody in Europe. To put it in human terms. When this comes to a head the pictures of average Greeks and Italians will have the faces of those that watched their house burn down, but they have the optimism to build and start again. The pictures of the faces of the average Japanese will look just like after WWII where behind their calm conservative demeanor is a look of utter despair(the look of people in the US during the Great Depression would likely be an improvement for the Japanese when you compare it to what they're heading into) and the scary part is they don't even see it coming.

So when I say real human tragedy, I'm not talking about no more Lexus's and BMWs. I'm actually quite serious. I'm talking about multiple families living in an apartment. I'm talking about 80 year olds returning to work because otherwise the retirement they thought they had might not even be able afford food for the rest of their lives. I'm talking about people taking the furniture out of their homes to trade or sell for the equivalent of a weeks worth of meals. So yes *real* human tragedy not the oh woe is me I can't take my annual vacation this year or go out to dinner a couple times a week.

[Wonkish1]

I'm coming around to the Wonkish view on this... I don't have access to the inside and professional information he does, but just looking at some pure headline numbers. The Japanese debt is increasingly composed of government JGB as that is the sector of their economy that by far leverages up the most.

While the financial crisis of 2008 stopped the crazy mad leveraging in the US and Western Europe, JGB leveraging has just continued and even accelerated as Japan has run a larger government budget deficit to make up for the 2009 recession, and the Tsunami recession. During the 1990's and 2000's it appears that some of this was counter-balanced by deleveraging in the Japanese private and corporate sectors, as described by Richard Koo in his book 'The Holy Grail of Macroeconomics'. However, in recent years it has reached a point where private sector deleveraging can no longer make up for JGB leveraging because JGB have taken up the lion's share of the total debt market.

Further, now you have that the trade surplus has essentially disappeared, part of which due to global recession, part of due to the Fukushima disaster necessitating a ramp-up of energy imports (although I'm not sure what share this pulls in Japan's total import), and part of due to the strong yen.

So Japan must fall back on its existing net creditor position within the world. You saw this happening at the Fukushima disaster. The yen spiked as there was a sudden repatriation of foreign assets to cope with the disaster. In other words, they may still have one more wind in their sails, which may last who knows how long. But like the cat with nine lives, eventually it will run out.

Wonkish, I know we tend to strongly disagree on this, but what do you think of the possibility of monetary easing and Japan 'inflating' their way out of the situation? It seems that this could happen either to forestall a crisis, or to reflate after a crisis, in a Keynesian style. Hyperinflation is not a concern in my mind because generally, that is the result of a lack of real resources (supply is crushed, as in Zimbabwe and Weimar Germany, the most notorious and extreme historical examples), or in the more likely variant of hyperinflation, as in Latin America (demand and spending exceeds productive capacity) or any country in the wake of a currency crisis, the result of large and sudden foriegn withdrawals of hot money. It does not seem to me that Japan faces these particular problems, and a significantly weaker yen may be just what it needs to regain competitiveness.

The larger problem in Japan has nothing to do with any of this though, it is a general malaise in their society, a sort of fatalistic acceptance of permanent decline, which is quite sad. From that perspective, a total collapse or 'cleansing' of society, WWII-style, might be a good thing.

First, I'll say that I wouldn't count on their being that much money outside of Japan to repatriate. In a normal economy, sure. Japan isn't normal though. Do you have any idea how hard it is for Japanese money to get out of their country? I've actually been involved in conversations about this topic for the last several weeks because a small client has a business that sells from the US to Japan and they need to get the money back here. Japan has approved lists for wire or ACH transfers. They have to be initiated at the bank in Japan in person while going through an inquisition of questions that sometimes takes hours(for every single transfer). They don't have checks so you can't mail them. They don't have money orders so you can't mail them. With the exception of things like paypall or a few other creative mechanisms the fact is that you can't get the money out. So with the exception of a handful of large Japanese companies that have given permission to move money freely I doubt there is as much money to repatriate nor the desire to repatriate(given the challenges to get it back out again) in Japan relative to average country.


In regards to your question, I must first establish that me and you see a little bit differently as to where inflation comes from. You can get into demand pull, cost push, real resources, etc. and any other idea that modern Keynesians try to use to justify the complete and utter failure and embarrassment the Philips Curve was(a failure so big that it came close to killing the school in its entirety and the reason why most Keynesians today now refer to themselves as "neo-Keynesians"). For us monetarists our rationale for inflation just makes so much more sense:

Lets say you have 1,000,000 widgets in an economy and you have a money supply of $1,000,000 at that given time. Simple math will tell you that those 1,000,000 widgets will have an average price around $1 a widget. I mean there is a reason why the economy is currently sitting at around $16 trillion and M3 currently is about $15 trillion(keep in mind that their additional near moneys that aren't computed into M3 and so its never an exact calculation). Now if you increase the money supply from $1,000,000 to $2,000,000 and the same number of widgets exist before and after that change then the price will eventually reflect that change and you will see prices at approximately $2 a widget($2,000,000/1,000,000=$2). Now I completely will admit that is definitely an oversimplified explanation because the money supply is affected by fractional reserve banking, to some extent shadow banking, the velocity of money is a key in determining the above, that you can technically export some of your inflation when another country is trying to peg on your, and that temporarily prices can be sticky or spike, but in general over time prices have to approach the fundamentals in the money supply just like a stock price has to eventually reflect the fundamentals of its earnings and balance sheet. Now you can disagree with this if you want, but I would be surprised if you disagreed with the next paragraph.

The principal issue with the question of Japan trying to inflate through monetization is that once they start doing at all in earnest they can't just do it a little bit. Capital markets wont allow it with their current situation they have to print almost all of it. So allow me to play this out for you:
1) Japan's cost of capital rises 50 basis pts and Japan is now worried that if they don't do something the cost of capital could rise another 150 and their debt service will outstrip their revenues forcing a default. So here we have Japanese officials going into crisis mode here and lets say they are going to monetize a chunk of debt to try to keep things under control.
2) So keep in mind they are about 220% of gdp in debt so if they actually want to come close to actually even putting a dent into their debt service they are going to monetize a pretty large chunk. So from a debt service perspective monetizing 20% of gdp in debt probably wont even make up for the 50 basis point move that just happened. Its also only 1/11th of their total debt. But from a money supply perspective printing 20% of your GDP is huge. Its at least going to end their deflationary state overnight. So here lets say they do it and print 20% and lower their debt service a bit.
3) I can guarantee you a quick printing of 20% of your GDP is going to cause foreign exchange losses immediately for foreign any foreign owners and discourage any foreign buyers. That happens day 1. That alone should result in another 50 basis pt rise in their cost of capital making this entire amount of printing meaningless to their debt service. The inflationary affect will be pretty quick. If it only erased the deflation and created 1% inflation(I mean just that little) their cost of capital has to rise because of that as well. Because their whole GJB market rests on deflation to have long term interest rates at only 2%. You eliminate the deflation and market participants aren't accepting below normal interest rates so they'll spike Japan's cost of capital on that as well.
4) So they see this and go owe $hit we need to monetize another 40%. This announcement causes an even bigger firestorm than the first and JGB prices just start crashing and the implied yields just start reaching out of control. So here is guaranteed where you have to end up relatively quickly if you are Japan trying to monetize....
5) Where your going to end up is the amount of monetization necessary to produce budgetary surplus because of lowering of the debt burden because they will not be able issue new debt without extremely punitive interest rates. So their current average cost of capital is lets say 2%. At that percentage they probably can monetize 180% of gdp of debt and produce a large enough surplus(plus maybe some help from the IMF if it still exists) to be able to retire the remaining debt without being able to roll it. Now if you think a 180% increase in the broad money supply(that hasn't even been relevered yet through their banking system which it will eventually) isn't going to produce hyper inflation I think your living out of reality. It doesn't matter if you have all of the resources of the world you increase you print 180% of gdp of debt you'll have rampant inflation.

Now what you should discover out of that explanation is that I just explained to you Greece as well. You can't a little bit inflate your way out of a sovereign debt crisis and you can't a little bit default on your debt to get out of a sovereign debt crisis. Just think about what the implied yield on 10 year Greek bonds was when they announced the first "small" haircut. Markets may be a little bit less harsh to monetizing an equivalent amount of debt, but there is going to be a reaction. And that reaction is going to increase yields which will end up propagating further monetizations because the sovereign will not be able to keep on paying the yields that the market will demand.


So I think of course in Japan you are going to either have monetization and an attempt to inflate their way out *or* they are going to default. But in each case at least 80% of the debt will need to be covered. Either an 80%+ haircut in a hard restructuring or monetize at least 80% of the debt(not 80% of GDP, 80% of the debt which means at least 170% of GDP of debt). Mark my words there is no way that they could get away with monetizing 25% of their debt and that lasting long. No way! Its either almost all monetized or almost all defaulted there or potentially a combination of the two that adds up to almost all of the debt there is nothing that comes back less.

[Wonkish1]

First, I'll say that I wouldn't count on their being that much money outside of Japan to repatriate. In a normal economy, sure. Japan isn't normal though. Do you have any idea how hard it is for Japanese money to get out of their country?...

Fascinating but unconvincing. First of all, if withdrawing money from the country is as hard as you say, then it would tend to protect their economy from capital flight, which would definitely help them in a crisis, not vice-versa.

Secondly, Japan had a positive net asset position of 250 trillion yen (about $3 trillion) at the end of 2010, and it is relatively stable.

Thirdly, the Tsunami showed that the Japanese are definitely willing to rapidly repatriate funds when needed in the case of an emergency. In case of a true crisis, they're not going to be thinking about how to get the money back out again, just how to get it home and safe, or put to use.

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I'll play taciturn to your verbose.

1. The quantity theory of money is valid in the long run, but not the short term, where monetary transmission is like pushing on a string in a bad economy.

2. Academic papers have concluded that the US Federal Reserve's quantitative easing program reduced real interest rates.

Tis true that capital flight will be harder to happen in Japan, but I mentioned my comments in regards to repatriation not in regards to capital flight. So your talking about a separate issue.

Question how much of Tsunami do you think was repatriation and how much do you think was a huge influx of charitable money into the country?

I'm not saying that no repatriation will happen in Japan, but instead relative to most countries they probably have much less foreign cash that wants to find its way home especially if they have a Chinese situation where money wants to get out and the state is doing everything in their power to prevent it from moving out.


1. Interesting to see you agreeing with quantity theory over the long term. Just like in the short term a stock price can reflect something very different than its fundamental value so to is the case of the money supply and prices. But I've never heard of someone at a company taking the position that its a good idea to destroy the fundamentals of their company in some stupid attempt to boost the stock price. Plus its doubtful that their strategy would work. So I don't get the idea of destroying the long term fundamentals of the money supply(and therefore the economy itself) in the attempt to try to improve things over the short term and rarely are they ever successful in getting the desired short outcome anyway.

2. First, I'll dispute the notion that its as cut and dry as any "academic paper" claims. If you pull up a graph of all treasury durations and the announcements of QE you see two things. A) Is that short term rates fall right after the announcement. Seems like a great success right? Well... B) Long term rates spike immediately after the announcement and continue to stay higher. So the one thing the Fed has been the most successful at is steepening the yield curve. That is of course until they announced Operation Twist(of which I was a supporter of because given all the short duration QEs it probably moved things back in the direction towards normal).

Beyond that I'd say of course a small amount of sovereign debt monetization can lower the yields over the short term. I mean its another buyer for the debt. Buts it also the buying of debt with money created out of thin air. And that is a pressure the other way. Like in a lot of decisions in finance the making of one can often have conflicting pressures. I mean what is the effect of inflation on housing? Well it boosts income and real assets, but also raises interest rates so those are pressures that duel against each other. These counter pressures are often referred to as financial paradoxes(as weird as the term sounds it actually has a useful meaning).

But the ultimate point here is that when it comes down to these situations economists, financiers, investors, etc. understand the dominant pressure over the long haul. And in this case there is no avoiding that pressure at one point or another. And that is if they monetize a chunk because their cost of capital has risen it will exacerbate the rise in their cost of capital causing the requirement to do more monetizations. And this will happen quite quick as evidenced by Italy recently. I mean a year ago Italy was sacrosanct. They were one of the solid nations that would be among the bailing out nations not among the ones being bailed out. 100 basis pt increase in their cost of capital over a couple days and they are in full crisis mode. The history of market corrections usually is not one of a slow correction. Its of everything going along fine and then a violent split happens slapping them across the face. Which gets back to the "financial paradox" thing I described before. Japan could start monetizing a very, very small stream today and probably everything would seem fine for a while. The issue is that one day and you don't know what would do it an inflation data report comes out or news of a sovereign default in Greece or something and it just violently turns against you and then each an every attempt to monetize only exacerbates the downfall of the JGB when prior to that black swan event every attempt to monetize made things a little easier on the Japanese economy.

Looking out over the medium to long term armed with that information I don't see any way possible that Japan hasn't monetized or defaulted on at least 80% of its debt. There is just no way. And today the Japan's finance ministers are just trying to thread the needle by not making any big announcements or anything so they can skate along without risking anything that might cause a rise in JGB rates. That is their strategy.