The next phase of this ongoing global crisis may take place in Japan’s economy, not in Europe or the US. This may seem unlikely, given what’s still going on in Europe. Youth unemployment is over 50% in Spain. You’re seeing the limits of economic and monetary policy in Europe. People (some of whom admittedly have vested interests in keeping a cheque from the government coming) are resisting the elite’s policy changes and money shuffling.
The next stage of the European debt crisis is political. But the next stage of the world monetary crisis will probably begin in Japan’s economy. It all goes back to last year’s devastating earthquake, tsunami, and nuclear crisis. That sequence of events has turned Japan into a long term net energy importer. And that single change threatens to send Japan into a major debt crisis this year.
Here are the relevant facts about Japan’s situation:
Japan has run a huge government deficit for years. The current debt-to-GDP ratio of 230% is the highest in the developed world. Before last year’s earthquake, this wasn’t a problem. Japan was a nation of savers. And with a current account surplus, it could finance its own deficits with its own savings. Japanese savers were happy to buy government bonds, which, after all, were a lot better than stocks or real estate – especially for a large group of savers approaching retirement age.
Well, retirement age is now upon Japan. That is one complicating factor for Japan’s ability to sustain large deficits. Retirees are starting to live off their savings, instead of socking the money away with the government. But it gets worse.
The single-biggest economic consequence of last year’s three-part tragedy is that Japan is likely to run current account deficits for a long time. Why? It will now have to import energy, which means buying it at competitive prices on global markets (this is good for Australia, actually).
Japan’s fleet of nuclear power plants will stay idle for some time. It may never get back to full capacity. As you know, Japan is not a nation that’s rich in hydrocarbons. But it’s high end manufacturing industry requires tremendous amounts of electricity.
That electricity will have to come from either coal or natural gas.
It’s not hard to see where this story is going. And we’ll get their shortly. But aside from the rather bullish energy picture, the other major economic consequence is that Japan’s fiscal deficit is becoming more unstable by the day. As the figures above show, the interest on public debt has grown so large that it’s nearly consuming all of the government’s annual tax takings. Annual deficits continue to grow.
When you reach the point where you have to borrow more money just to pay the interest on money you’ve previously borrowed, you’ve reached what Hyman Minsky called the stage of “Ponzi Finance”. Japan is nearly there.
Now, the first consequence of reaching this point is that Japanese interest rates may start going up. That would be disaster. A rise in interest rates would consume even more of the government’s annual tax takings. You’d see a feedback loop in which debt costs quickly spiral out of control.
But that’s only if Japan must borrow in international markets. Keep in mind the Japanese government is not the only government seeking to borrow trillions of dollars (yen, euro) in the next five years.
This demand for credit will crowd out corporate borrowers. And in any event, the borrowing needs of governments exceed the amount of savings the world has accumulated. Something has to give.
What I expect to happen is that the Japanese will simply monetise new debt. Instead of selling the debt to investors, who will demand higher interest rates based on Japan’s deteriorating fiscal condition, the Bank of Japan will print money. This means Japan may be the first Western Welfare State that reaches the endgame phase of Ponzi Finance.
Dan Denning
Editor, Australian Wealth Gameplan
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