The big news went almost unnoticed. Bloomberg was there, however, and had this report: “Housewives With Frying Pans Protest Japan Tax Hike as Debt Soars.” What’s the story? “About 200 housewives marched down a shopping street in central Tokyo, beating pans with ladles and shouting slogans criticising a government plan to double Japan’s 5% consumption tax,” notes the newswire.
These ‘apron protestors’, as they’ve been nicknamed, “say it’s a bad time for Prime Minister Yoshihiko Noda to rein in public debt that will be over 230% of national output this year, the biggest anywhere”. Japanese public debt amounts to $93,000 per person, compared to $33,000 in America – and Greece. Yet, as Bloomberg points out, “Japan’s bonds have never been more popular”. Panicked by the euro crisis, bond investors see Japan as a ‘safe haven’, driving yields to near-record lows.
You’re probably thinking what most of the world’s financial press thought. This story seems small. Unimportant. Insignificant. But it is the story of our time… a harbinger of the coming worldwide financial implosion.
Do you recall reports in 2001 as Argentina slipped into the biggest default the world had ever seen, $100bn-worth? Groups of housewives, the cacerolazos, began beating on pots, protesting against the corralito, in which their savings were trapped by the government. This led to a breakdown in the financial system, including the above-mentioned defaults. Argentina had borrowed too much money from foreign creditors. It couldn’t pay. This led to a variety of measures (including taking dollars out of their citizens’ bank accounts and devaluing the peso) to correct the situation. In the end, nothing worked, except the default.
Lead indicators for Britain's economy
Bad debt is bad debt. The debtor can hem and haw, he can delay and obfuscate. But he can’t pay. Sooner or later, the day of reckoning comes and all hell breaks loose. That is why this story is important. To keep up with its debt, Japan is taking money from citizens – via a sales tax.
The tax is modest. It should be no big deal. But there is only a limited amount of real purchasing power in an economy. It is this that must, ultimately, be the source of debt repayment. A sales tax merely transfers money from households to the government. Japan’s households are already not big spenders. The extra tax will make them spend less, leading to further economic weakness, and possibly even the need for more borrowing.
In their book, This Time Is Different, Kenneth Rogoff and Carmen Reinhart argue that, after government debt passes 90% or 100% of GDP, it weighs so heavily on the economy that it is very hard to avoid a major breakdown. In small countries, or those that can’t borrow in their own currencies, the breakdown comes quickly. In large ones, it can take years.
Japan has the world’s third-largest economy, after America and China. It also has a printing press. Today, a printing press in the hands of a debtor nation is like a bomb strapped to the back of a bank robber. It only works if people think you’re crazy enough to pull the cord. If you seem ready to blow yourself up, people will give you money. Bank clerks hand over stacks of $100s. Investors give you billions, sure you will print enough to ensure they get it back.
This bank-robbing phenomenon makes it easy to sustain debts far beyond those any sensible person would deem healthy. At 230% of GDP, an interest rate of 5% would mean that more than 11% of output must be used to support past spending. Japan’s government collects 28% of GDP in taxes and borrows another 10%. Were rates to return to normal levels, Japan would have to halve its spending in order to stabilise its debt. Is that likely? No. It is probably not even possible. Cutting government spending on that scale would bring such a sharp drop in GDP and tax collections that the whole economy would fall apart. More likely, Japan will print money to cover its debts. This will spook investors who will drop Japanese yen and Japanese bonds. Still a disaster, but of a different sort.
In short, Japan’s debt is bad. It is just a matter of time until the world realises it. Maybe a year. Maybe five years. We will see. But when Japan’s debt goes bad, investors will begin to take a hard look at other big economies that also have printing presses, especially America’s. At the time of writing, the US could still probably escape disaster. It is a political issue now. A government with enough guts and foresight could cut spending by 10%, foreswear borrowing and avoid the Japan trap. Will that happen? We wouldn’t bet on it.
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