Monday, July 26, 2010

Why No Alarm Bells for Japan?

The above question generated much discussion on LinkedIn in Group 'Economist of the World'. I have attached my opening post and following discussion for visitors' review. I thank Daryl, Kamal, Poonam, Jacky, Richard and Sep for sharing their thoughts in the comments.

(I sincerely regret the use of the acronym 'PIIGS' in the discussion by some.)

Why No Alarm Bells for Japan?

Ashutosh Agrawal • Hello everyone. The above question is no less than a puzzle for me.
Greece which is on brink of bankruptcy has Debt/GDP ratio of about 120%. Lot of hue and cry has been seen over it. Stock markets and Euro have all suffered. Next anticipated failures in line are Italy, Portugal and Spain which yet have Govt debt/GDP ratio less than that of Greece. A lot of serious warnings are also given for US also which has the ratio of about 90%.

But surprisingly, Japan is comfortably sitting on top of the debt pile with 200% ratio. And deflation and contracting population makes it further worse by putting downward pressure on GDP. Its the second largest economy and yet there are only rare warning flares given out. Why? What is special about Japan which gives the confidence that it is not on brink of failure?
20 days ago


Daryl Montgomery • A good question indeed Ashutosh. The alarms bells are going off, but no one is listening.

In general, the media only reports on a crisis after it has erupted, not before, no matter how obvious it is. How much reporting did you see on the subprime crisis before capital markets started to implode? Japan is indeed a major crisis about to erupt.

Japan differs from Greece and the other PIIGS in that it can engage in 'money-printing'. Japan differs from the PIIGS and the U.S. in that it has funded its massive debt internally by drawing on the substantial savings of its people. That source is now just about depleted however. Japan will have to turn to the global capital markets to fund its government deficits in the future and compete with the U.S. a number of other countries for a decreasing pool of money. To the extent that it can't borrow enough, it will have to print money (as will the U.S.and the UK). This could lead an interesting reaction of deflation turning into severe inflation in a relatively short period of time - something that few have considered.

The obvious follow up to your question is: What will happen to other countries and the global financial system as Japan becomes increasingly stressed? If Greece, which represents only 2% of the eurozone economy can wreak havoc on the global financial system, imagine how big a problem Japan could cause.
18 days ago

Ashutosh Agrawal  • Thank you Mr. Daryl. Your answer did satisfy my curiosity. But also made me bit wary as you clearly mentioned that Japan is in trouble. I was hoping otherwise as another dip would be disastrous for sure. Even for a growing economy like India.

However I get a feeling from your comment that Japan's troubles are yet to become serious and there is still some time before the internal borrowing gets exhausted. Maybe this is the right time to intervene before the second largest economy starts accelerating downhill, dragging the whole world down with it.

Our discussion is just another warning flare. Hope someone in Japanese leadership sees it. ;)
18 days ago

Kamal Gupta • It is Japan's huge forex reserves
18 days ago

Poonam Arora • Prime Minister of Japan, Naoto Kan has already warned collapse of Japan under its huge debt mountain in its first major speech only. Population of Japan is ageing and as more and more Japanese citizens retire, they would sell their long holded govt. bonds to cover the expenses and Japan would left with no other option but borrowing from global capital market as Mr.Daryl rightly pointed out.
17 days ago

Ashutosh Agrawal • Thanks for the insights. So is it that Japan can afford to not to act for some time longer? If yes, then how long? How long before Japan turns to Global market or tries liquidating its reserves to service the debt?

Should Japan take some concrete steps now to rein in the debt or should wait? Is there any possibility that the problem will correct by itself in near future?

I am still trying to understand the reason for inaction though the danger is not immediate.
17 days ago

Kamal Gupta • Japan has to act pretty quickly. It is a rapidly greying society and not immigrant-friendly. If it does not change its immigration policies, it will anyways implode in the next forty years.

Just like Russia, and a number of European countries.
17 days ago

Jacky Mallett • Japan is a highly overpopulated volcanic mountain chain. I'm not sure what particular hazard it risks by allowing its population to naturally drop to a more comfortable level, besides the tragedy of its population having to adapt to more living space in Tokyo.

Less can be more.
16 days ago

Kamal Gupta • An ageing population means more demanding hands, less of productive hands. You start eating up the capital that you have built up, and then implode.

The population will first shrink gradually, and then the pace of shrinking will accelerate.

It is beginning to happen in Russia. It would have happened in the US if it had not opened up immigration. If you look at the demographics, at the census figures, you will find that the population of "white" Americans has shrunk, but has been more than made up by increase in population of non-white Americans and immigrants- mainly from Hispanic America, but also from China, India, Carribean countries.

Immigration is the last major barrier to trade still remaining. Natural forces will bring it crashing down, though maybe not in my lifetime.
15 days ago

Richard Di Bona • Interesting discussion – a few observations and possible angles:

As Poonam stated, Japan has had warnings attached. But for the Western (and hence effectively World Press) perhaps it’s best to concentrate on matters closer to home.

Remember that Japan has been in a slump since about 1989. One exacerbated, not relieved, but interest rates close to 0% for much of that time (and sometimes even negative interest rates). This helped give rise to the avalanche of malinvestments undertaken with public purse/ peoples savings in post office bank accounts. IMHO a stark warning to many western countries that seem to be seriously considering attempting to spend their way out of an overspending-induced crisis!

What has probably kept Japan Inc.’s head above water to date is innovation: both by small and large firms. Much manufacturing may be offshored, but most of the high margin works as kept at home. For as long as they can retain intellectual capital in Japan, as a whole Japan has something going for it. This is after all less commoditised than tourism & agriculture (both major income earners in the PIGS).

That having been said, in order to redistribute income from the intellectual capital holders to the populace as a whole (increasingly required due to demographics as Ashutosh and Kamal point out), tax rates are destined to rise and at some stage a tipping point may be reached.

But this is unlikely to be immediate. Also after 20 years of slow growth, lost generations etc Japan is not in the state of shock that PIGS are following recent boom years.
15 days ago

Ashutosh Agrawal • Thanks Kamal for clarifying the effect of a contracting population. A contracting population also mean a lower consumption/demand overall. And then the Govt. keeps spending to create demand, hence digging itself deeper into debt. Culturally, Japan does not welcome immigrants and I don't see any signs of that changing.

Thanks Richard for bringing in the angle of intellectual capital. I do agree that Japan is ahead on innovation. By which they tend to create value for the world and are not much constrained by a lower demand back home. But how long will that innovation edge last as other countries catch up in development.

It seems that factors which are keeping Japan afloat may not long last. But the danger is not immediate, I guess and I sincerely hope so!
But these things have a way to accelerate on their own. Some months back no one was even talking of a Euro-wide crisis.
15 days ago

Jacky Mallett • Economic arguments based on schadenfreude should be inherently suspect. The simple problem with most of the arguments here is that the productivity improvements of the last 20 years are being ignored. What impact can a dropping population have on production when you have robotic factories being run by a handful of people?

Japan blew its monetary system out with an equity capital feedback loop back in the 1980's. It never properly addressed the fractures in the monetary system that that created, but consequently and probably serendipitously it has dodged the Asset Backed Security bullet that is currently taking out the United States and European monetary systems.

The underlying economy is one of the most productive in the world, especially when the lack of natural resources in the Islands is factored in. Probably the biggest are under employment, with a lot of make work, the lack of physical space in the major cities, and the need to import food. All of which will alleviate themselves naturally as the population reduces to a more sustainable level.

In realms of scientific inquiry outside of Economics it is fairly well known that it is possible to saturate systems to the point where performance drops off as increasing numbers are added to the system.
15 days ago

Poonam Arora • Looking at all the aspects of the economy of Japan, it is not wrong to say that its the time when Japan needs to take some actions not only to increase its revenue and reduce expenditure/subsidies but to raise producitivity/intellectual capital and address structual problem of rapidly graying population also. I agree with Mr. Jacky that factories in japan are being run by a few productive people but overall impact of low saving because of ageing population can not be ignored here. Although Japan still has advantage of rising yen against both the dollar and the euro and being the net lender to the rest of the world but these long overdue fiscal austerity measures need to be addressed now.
13 days ago

Sep Van de Voort • Yesterday Standard & Poor's warned that it may lower Japan's debt rating after this weekend's election results. Premier Kan's ruling coalition lost its majority in the Upper House which makes its plans to deal with the public finance problems less credible. Such a down grade by S&P could potentially be the catalyst to open eyes of investors for Japan's immense problems which Ashutosh rightly pointed out in his opening comments for this tread. Not only is Japan a volcanic mountain chain, as Jacky Mallett said, they're dancing on the volcano as well :-)
13 days ago

Ashutosh Agrawal • Thanks Sep for the update with regards to S&P.
Even after the financial crisis we still look up to rating agencies to provide guidance. Hope they don't miss this time.
5 days ago

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