Japan is Not Europe

Japan’s Abe Could Join Reformers’ Pantheon – Bloomberg.

Japan’s Choice: Shrink the Welfare State or Collapse – Forbes.

Japan wishes it had debt problems like the PIIGS. Its problems are much worse. In fact, Japan is in worse fiscal shape than any country in the world. While currently rated AA- by S&P, its fundamentals resemble countries deep into junk territory. Comparing Japan to the world’s B- and CCC+ rated countries is a revealing exercise:

Japan vs. Junk Debt to GDP

Japan’s Debt to GDP ratio is the clear champion a third larger than the runner-up, Greece. The ratio is also expanding rapidly thanks to Japan’s large budget deficits. Due to rising interest and social security costs, Japan is on track to surpass its 2012 performance for the next decade:

Japan vs. Junk 2012 Budget Balance

Surprisingly, none of those countries in the chart rank among the top ten budget deficits for 2012. Those ranked ahead of #12 Japan in order: Afghanistan, Eritrea, Sao Tome and Principe, Guineau, Ireland, Namibia, Cape Verde, Tanzania, Maldives, Burundi and Botswana. Each of these countries is either war-torn like Afghanistan, a small island nation like the Maldives, an African basket case like Tanzania, or Ireland.

Don’t worry too much about them. At least they’re growing, unlike Japan now in its 5th recession in the last two decades:

Japan vs. Junk GDP Growth 2012

Japan is tied for 5th place with Portugal for the largest economic contraction in 2012 behind Libya, Yemen, Greece and the Ivory Coast. Greece is the only one of those countries not to have experienced a revolution in the last two years, but that could change at any minute given the ongoing economic depression and corrupt political class.

The Japanese situation is set to worsen over the coming days, months or years.

Its interest cost in 2012 was ¥9,855bn and rising steadily as it issues more and more bonds. It is projected to rise ¥1tr per year assuming that interest costs remain stable. They won’t, because foreigners will demand higher interest rates to account for increased Japanese risks.

In the past, Japan was able to rely on domestic investors to purchase most of its new debt issuance, so foreigners only hold 7% of the total Japanese debt. However, an aging country means less saving, so foreigners now account for 30 – 50% of new bond purchases. The country is becoming more vulnerable to the vagaries of the world financial markets at the worst possible time.

Japan’s large trade surpluses also assisted in financing budget deficits, but these have become deficits over the past few years because of a strong yen and outsourcing:

Japanese Trade Balance

Japan is slowly losing the advantages that enabled it to run such large budget deficits in an attempt to kick start economic growth since the Japanese Bubble burst in the early 90’s. This comes amidst a demographic storm. The Japanese possess the highest life expectancy in the world. At the same time, they do not have babies. While social security costs will rise ¥800bn per year over the next decade, the ratio of tax paying workers to benefit receiving retirees will continue falling:

Workers per retiree

The ratio is the lowest in the developed world and set to fall to only two workers per retiree by 2020.

All of these factors taken together point to the inescapable conclusion that Japan must default on its debt. When countries get into trouble, the status quo reinforces them for a time, and they will putter along like nothing has happened until all at once something does.

Japan has reached the point of no return. It has no chance of growing its economy enough to pay these debts. That fact will not stop it from trying, and it will deploy the usual monetary gimmicks to forestall the inevitable. Eventually, it will either have to pay higher interest rates to attract investors or print enough money to finance itself leading to inflation. Either of these events will precipitate the Japanese Debt Crisis.

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