Photo: Flickr/Peter Roberts
As the debate on government debt has taken the centre stage in United States and Europe, it may be useful to take a look at Japan, the country that best exemplify, in all its complexity, the issue of sovereign debt.According to the McKinsey Institute, in 2009 Japan had a total debt including State, Local Government, Corporate and Households of around 471% of GDP. At 225%, Japan also has, by far, the highest sovereign debt/gdp ratio in the world and far larger than the the United States with a debt “only” at 98% of GDP. While it is beyond the purpose of this piece to explain how the country could dig itself into such hole, it is more relevant to point out that Japan has been able to finance its ballooning debt for more than a decade not only without any problem but also at an extremely low cost. And that is in spite of a decade of flat growth and an ageing population. How was it possible?
Below some key reasons:
1. QE has been policy in Japan for more than a decade. It has been so extensive, that today the BOJ’s balance sheet is larger than the country’s GDP. To put it in prospective, it would be the same for the US Fed to have bought $15 trillion in assets instead of roughly the $2.7 trillion they purchased up so far.
2. Japan’s high level of foreign currency reserves (about $1.1 trillion) and Japan’s undeniable exports prowess, have often been used as the argument that on a “net” (i.e. after reserves) basis, the debt is actually much lower.
3. 95% of sovereign debt is held by Japanese, households and institutions, with foreigners only holding about 5% of total. For anyone who has been to Japan or understands its culture it is known that a Japanese would rather do harakiri than questioning Nippon credibility. It should therefore come as no surprise that there has been no material domestic challenge, so far, to the creditworthiness of their sovereign debt in spite of the objectively staggering level.
Does the above mean that Japan will continue to be able to grow its debt forever? If history has any relevance, probably not. Rather, there are signs that the wind may be turning. The recent natural disaster have not only re-arranged Japan’s geography but the nation’s production capacity, infrastructure and, consequently, fiscal needs. While the full economic implications of the earthquake may have yet to play-out, the huge debt-load is starting to warrant a fresh look from credit rating agencies, foreign investors and, possibly, even from Japanese ones. Furthermore, their currency and gold reserves cover today only about 9% of sovereign debt and offer less and less coverage as they are largely USD denominated. The USD has lost 32% of its value against the Yen over the last decade and stand to loose even more as the Federal Reserve seems bent to use inflation as a way to cure America from its own debt problems.
The word “credit” comes from the Latin credere = believe. The Japan case clearly shows that debt can escalate to extreme levels until the credit-worthiness of the borrower comes into question. It is becoming apparent however, that, should another global financial seizure like the one experienced in the fall of 2008, we may see the proverbial “house of cards” coming down.
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