The Impending Japanese Crisis
The financial world has given little focus to Japan’s dire economic predicament. It could be the pervasive belief problems aren’t considered a problem until they are a problem, much like many of the world’s apparently not-so-apparent problems. While I do feel the day of reckoning will come for the many profligate nations—most of whom are in the West—Japan may already be at bat.
Central bankers and politicians around the globe are orchestrating similar monetary and fiscal policies; however, Japan is running out of time.
Half of Japan’s ¥43 trillion ($467 billion) tax revenues will be directed towards interest on its national debt in 2013. Debt service at 0% interest rates in Japan is already cannibalizing its budget. This indicates Japan has a much shorter leash in terms of digesting future rate hikes versus other countries, which at this point appears discipline will be imposed by the market with or without the Bank of Japan’s blessing. Prime Minister Shinzo Abe is
pushing for 2% “price stability” (inflation) targeting for the BOJ’s mandate. Abe may need to be careful for what he wishes for as inflation will put upward pressure on interest rates. Japan can’t even afford a modest move in rates that would surely collapse the already crippled Japanese federal budget.
Culturally, Japan is very much consensus-based when it comes to public statements. Rocking the boat isn't encouraged in many East Asian cultures, so don't look for significant dissent from Abe's cabinet or policy board members at the BOJ. One can be certain more outspoken statements will be sprinkled throughout the FOMC minutes before you'll see anything material arising out of Japanese leadership--and that's not saying much.
The Bank of Japan is exceptionally aggressive in getting its supposed deflation under control. According to Deputy Governor Hirohide Yamaguchi, the money cranks at the BOJ are gobbling up, “A wide range of financial assets, including government bonds, corporate bonds, CP, exchange-traded funds, and real estate investment trusts,” through its Asset Purchase Program. The Bank’s most recent concoction includes the Stimulating Bank Lending Facility where the BOJ will lend an unlimited amount of long-term funds at a low interest rate for any net increase in lending by Japanese financial institutions. So, infinite lending with no loan qualification restrictions—and the Bank isn’t finished! The Deputy Governor noted they will see, “Whether there is anything that can be done further as a central bank.” One can only imagine what rabbit will be pulled out of the next hat, if there can even be one.
The shroud of the Bank of Japan's so-called political independence is beginning to fall. Masaaki Shirakawa, chief of the BOJ,
announced his premature departure from the standard 5-year tenure at the Bank. As if the central bank wasn't accomodative enough, Prime Minister Abe is already seeking a more ambitious inflationist to head the BOJ. What more can the Bank do?
The likely scenario will be for its central bank to overshoot its 2% inflation target, an already underreported figure as they exclude “volatile” items such as food, resulting in further deterioration for the Japanese economy.
The Yen plummeted in response to the hype, supposedly a promising sign for exports while ignoring the vast dependence on foreign imports. It’s important to keep in mind
Japan constitutes 15-17% of total corn imports globally, by far the largest, and grows virtually none within its borders. Most of this corn goes directly towards cattle feed. The island nation is very hand-to-mouth when it comes to agriculture with very little reserves as Japan has what amounts to less than 15 days’ worth of corn supply for the entire country.
So what happens to Japanese food prices when you consider the currency risk? The Yen has already lost 20% of its value vis-à-vis the USD since September. Considering the depressed estimates for U.S. crop yields going into the summer, Japan may feel a double whammy where rising corn prices are accelerated even further by a weakening Yen.
If the deliberate depreciation of the Yen wasn’t bad news enough for the Japanese citizen, consider other structural problems facing the country.
One quarter of Japan’s population is age 65 or older—double from only 20 years ago. Looking at the 2013 federal budget, social security expenditures have
increased by 10.4% year-over-year. Social welfare programs dominate the budget for now, but drastic reform is necessary given the untenable fiscal situation. In January, Finance Minister Taro Aso bluntly told Japan’s elderly to “
hurry up and die” as a solution to the ominous entitlement tsunami.
All the elements appear to be in place for Japan and the rest of the world to be caught flatfooted. One could point to Japanese accumulating massive amounts of foreign reserves, yet the
bulk of those reserves are in U.S. treasuries. It would be highly impractical for any meaningful liquidation of those assets onto the open market, so it’s not likely foreign paper will alleviate Japan’s structural issues.
Another issue seems to have snowballed since the fall—the severe tension built up between rivals Japan and China over the Senkaku (Diaoyu) Islands. The result,
exports to China dropped by 10.8% highlighting the de facto boycott of Japanese goods in the People's Republic. Although Japanese automaker sales have
since recovered somewhat in China, this issue won’t be going away anytime soon. After spending a summer traveling throughout China, my interactions with Chinese citizens demonstrated how longstanding grudges aren’t quickly forgotten.
The hostility is being reflected by other current trends between the two countries. Tourism from Japan to China has plummeted by
upwards of 80% since the September protests, and indications of bookings show it has carried over into Q1 of 2013. The nationalistic divides are relevant to monitor going forward given how fragile the Japanese economy is on so many fronts.
While excessive leverage, loose money, and massive deficits are pandemic across many industrialized nations, Japan’s number may be called sooner than its peers’. Significant moves are already taking place in the Yen, but have yet to work into their impending JGB time bomb. Market sentiment is beginning to shift.
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