Friday, April 13, 2012

Japan's plunge

For obvious reasons, a lot is being focused on Europe with the problems of Greece, Spain, Italy, Ireland, Portugal......., and even some hints at a hard landing for China.

But Japan, outside of its earthquake, tidal wave, nuclear meltdown problems is not much discussed.  Thus I was happy to see a piece by Michael Pettis on the subject.  He is one of my favorite online financial authors.   Note that his pieces are long, what is below does not even cover all of the issues he brings up with Japan.

The Japan debt disaster and China’s (non)rebalancing

Michael Pettis, Credit Writedowns, 20 March 2012 (Hat tip: NC)

The problem of Japan
But a much bigger problem may be Japan, and I am surprised that no one seems to be discussing the very adverse Japanese impact on the future development of global trade balances. Japan, as everyone knows, has an enormous debt burden that is only made manageable because it is financed domestically at extremely low rates [- in other words the Japanese people save money].  Here is Peter Tasker of the Financial Times on the subject:
When Japan’s bubble economy imploded in the early 1990s, public finances were in surplus and government debt was a mere 20 per cent of gross domestic product. Twenty years on, the government is running a yawning deficit and gross public debt has swollen to a sumo-sized 200 per cent of GDP.

How did it get from there to here? Not by lavish public spending, as is sometimes assumed. Japan’s experiment with Keynesian-style public works programmes ended in 1997. True, they had failed to trigger durable economic recovery. But the alternative hypothesis – that fiscal and monetary virtue would be enough – proved woefully mistaken. Economic growth had been positive in the first half of the “lost decade”, but after the government raised consumption tax in 1998 any momentum vanished. Today Japan’s nominal GDP is lower than in 1992.
Tokyo is clearly worried that it is running out of time to manage the debt, and the indications are that it has finally become serious about reducing its debt burden. What’s more, Japan’s current account surplus has already contracted substantially in the past two years, and in January it ran the biggest monthly trade deficit it has ever run – $5.4 billion, although the early Spring Festival this year may have distorted the number.

This January deficit comes on the back of Japan’s 2011 overall trade deficit, the first time Japan has had an annual trade deficit in many decades. If Japan runs a current account deficit, of course, it means that Japan must turn to foreign sources to finance government debt – a very unwelcome prospect.

After 1990 Japan began the slow rebalancing process, but rather than privatize assets and transfer wealth directly to the household sector, the Japanese did it by having the government assume private sector debt. This was politically much easier than privatizing and removing interest rate and capital allocation distortions, but it also meant much slower growth and burgeoning debt.

Now Japan is faced with the same difficult options that it faced twenty years ago and that China faces today. It can privatize government assets, or it can revert to the bad old days of consumption constraining policies. But if it constrains consumption growth and does not replace consumption with a surge in investment, how can it possibly grow except with explosive growth in the trade surplus? Domestic consumption, domestic investment, and the trade surplus are, after all, the only sources of demand growth for any economy.

One obvious note from reading the above, is that neither spending money or tightening up the budget is a quick fix.  If you drive the bus off the cliff, you own it.
However, what I want to emphasis here is that the nations that run a trade surplus, particularly when they do so by extending credit to the buyers (See: China and Germany) often have at least as big of a problems as the debtor nations.  Recall that the country that was hammered the worst during the Great Depression (the one in the 1930s) was the United States: the great gold holding, debt holding, trade surplus country of its day.

When you buoy up your economy through a trade surplus, you are very much at risk when your customers can no longer afford to buy.   If you add to this collapsing mechanism, the collapse of the debt that was lent out to your former trade partners to keep them buying, you have one huge deflationary spiral.  Japan in the 1990s tried pretty much the same mechanisms we have been trying -prop up the zombie banks, and spend money.   The whole was too big.  Just like our whole is too big.

In reading the rest of the article, one would get the impression that China and Germany would be next.

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