The Setting Sun of the Japanese Economy


Europe is the focus for bureaucratic bungling at the moment. It will probably remain in the spotlight for some time. But Japan… Japan is in a class all of its own.

For more than 20 years now, the Japanese economy has been in and out of recession. The bureaucrats have met every ‘challenge’ with a remedy that would have even Keynes turning in his grave – more government spending. Public debt in Japan is expected to reach an incredible 237% of GDP in 2012. No wonder Fitch Ratings downgraded Japan’s debt by two notches to A+.

And the debt continues to grow. Japan’s budget deficit hovers around 10% of GDP. This continual government largesse is tolerated by the markets because of Japan’s ability to fund the expenditure internally. The country’s trade surpluses are legendary. That is, Japan’s private sector produces more than it consumes, meaning it diverts savings into the government sector…that the government then spends wastefully.

Japan balance of trade


But the flow of private sector savings is now drying up. Japan’s balance of trade (see chart) dipped into deficit in 2011…and it hasn’t bounced back. While Japan’s stock of savings remains huge, its flow of savings – previously a torrent – is turning into a trickle. Without adequate flow, Japan’s economy will find it increasingly difficult to fund its deficits at such low rates.

Making matters worse, Japan’s population is aging rapidly. It’s the world’s oldest nation. Official forecasts have the population falling from 128 million (2010) to 87 million by 2060. In the meantime, the household sector will draw down on savings to fund its retirement. This means less for the government.

Despite all these headwinds, Japan’s funding rates (or the return on Japan’s private sector savings) are incredibly low. The other week, the yield on 10-year government bonds dipped to 0.83%, the lowest level since 2003. Yields haven’t traded sustainably above 2% since 1997.

Japan’s bond market is approaching light speed. And things are certainly getting weird. People, blinded and numbed by a 20 year bull market (when yields fall, prices rise) can only see more of the same.

But simple common sense tells you this can’t continue. Not with a terrible demographic profile and a deteriorating balance of trade. In the next few years something will have to give. In my view bond yields will most certainly rise.

Greg Canavan
Editor, Sound Money. Sound Investments.

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The Setting Sun of the Japanese Economy