Nomura economist Richard Koo is back!
He comes out with new notes every once in a while, but he’d been in a rut for a while, hitting on the same points about the folly of spending cuts in the U.S. and Europe.
This time he circles back to the area of his greatest expertise: Japan.
Because Japan has gone into trade deficit in some recent months, the calls for an imminent Greece-like collapse in the Japanese bond market have intensified. Hedge fund managers like Kyle Bass are hoping to make a monster return when this happens.
But it’s not going to happen, as Koo explains:
Closer look at “JGB crash” argument
Moving on to Japan, proponents of a consumption tax hike in the taxation debate that has been going on for several months frequently invoke the specter of a crash in the JGB market.
The fact that Greece’s debt crisis triggered severe economic problems in the eurozone has lent added impetus to such arguments, and there are indeed numerous hedge funds outside Japan seeking to profit by shorting JGBs.
Those citing the risk of a JGB crash point to Japan’s recent trade deficits, ageing population, and sharply declining savings rate as evidence that—regardless of past events, or lack thereof—Japan faces a major crisis in the next few years unless something is done.
Why JGB market has not crashed
Listening to their arguments, one would be forgiven for thinking that a collapse in the JGB market is imminent. What we need to remember, however, is that there have been similar warnings for the last 15 years, none of which came to fruition.
The biggest reason for this is that Japan’s corporate sector has become a massive net saver in spite of zero interest rates. While the economy weakens, the private sector—households and businesses—is saving a net 9.5% of GDP each year. The government’s large fiscal deficits are simply a reflection of this phenomenon.
This becomes clear when we look at flow of funds data, which show a pronounced inverse correlation between the savings of private businesses and government deficits. The correlation between the financial surplus/deficit of nonfinancial companies as a percentage of GDP and the general government surplus/deficit as a percentage of GDP was –0.790 between FY1980 and FY2010, a very high figure. When private financial institutions are added, the correlation rises to –0.846.
Moreover, all of the periods in which companies increased savings correspond to economic recessions in Japan. This is because the fiscal deficits are a direct result of the recessions caused when rising corporate sector savings produced a deflationary gap in the private sector.
So basically, Japan really isn’t in that much debt.
Public sector debt is just the flip side of private sector savings, and ultimately those private sector savings wind their way into Japanese Government Bonds.
The following chart, which you can click to enlarge, shows the big pickup in the net financial surplus of Japanese corporates, which again, is just the inverse of the deficits being run by the government.