Japan's Scary Budget
While all over Europe, governments are forced to face up to the fact that the markets have suddenly become alert to the dangers posed by the huge debt loads carried by modern-day welfare states, Japan's government just piles on more and more debt on its existing debtberg with seeming impunity.
In Italy, Mario Monti's 'honeymoon' is already over. He just passed a fairly strict 'austerity' budget (recently denounced by the Northern League as a 'recessionary budget' – and rightly so, as it leaves the bulk of spending untouched and mostly imposes new taxes), but Italian bond yields are already back on the rise. Note here as an aside that the current level of the yield on Italy's 10 year note is not directly comparable to the time when a similar level was first reached, as the benchmark bond used by data providers has in the meantime been changed to a higher-yielding one – alas, it is the direction in which yields are heading that is relevant. Monti's real fight meanwhile is still ahead – he will have to challenge powerful vested interests as he attempts to implement structural reform.
Alas, over in Nippon, home to the second largest government bond market in the world (Italy's is the third largest), the just published budget for 2012 appears largely untouched by such concerns. A handful of prominent contrarian hedge fund managers such as Hugh Hendry and Kyle Bass are actively betting on the demise of this seeming debt perpetuum mobile. Of course, there is a saying in the hedge fund community with regards to JGB's that one needs to keep in mind here: they are referred to as 'widow-makers'. Many a fund manager has lost money betting against the JGB market – and so far JGB's show no sign of breaking down:
The 10 year JGB futures contract over the past five years: thus far the uptrend remains intact – click chart for better resolution.
However, in spite of the reputation of JGB's as 'widow-makers' and the seeming serenity with which Japan's government can keep increasing its public debt load, the time may soon come when those betting against this unsustainable dynamic will be proved right. We will show further below why that day may now finally be drawing near.
First, here is what Bloomberg reports regarding the latest budget:
Japan’s budget for the year starting April showed the government more dependent than ever on bond sales to fund spending as Prime Minister Yoshihiko Noda struggles to tame the world’s biggest public debt burden.
The government will sell 44.2 trillion yen (6 billion) of new bonds to fund 90.3 trillion yen of spending, raising the budget’s dependence on debt to an unprecedented 49 percent, a plan approved by the Cabinet in Tokyo yesterday showed. Spending will shrink for the first time in six years after the government delayed appropriations for the nation’s pension fund and used supplementary expenditure packages to pay for earthquake reconstruction.
Noda’s first budget may fail to reassure credit-rating companies and analysts monitoring his efforts to control public debt twice the size of annual economic output. The government trimmed 2.6 trillion yen from the package by allocating special bonds to delay pension funding until a planned sales-tax increase boosts revenue. “The government is trying to maintain surface appearances by playing with the numbers,” said Takahide Kiuchi, chief economist at Nomura Securities Co. in Tokyo. “This budget clearly shows Japan’s fiscal situation is worsening.”
Noda will submit the budget bill to parliament next year. The primary deficit will narrow to 24.1 trillion yen, the Finance Ministry said, equivalent to about 5.1 percent of gross domestic product. Noda aims to post a primary balance, achieved when revenue matches spending, excluding bond sales and interest payments, by 2020.
New bond issuance will surpass tax revenue for a fourth year, the government predicts. Receipts from levies have shrunk about a third after peaking at 60.1 trillion yen in 1990. “It’s very regrettable that bond sales will exceed tax revenues and that debt dependence rose to 49 percent,” Azumi told reporters in Tokyo yesterday. “I think the reliance on bonds to compile budgets is reaching its limit.”
Non-tax revenues including surplus from foreign exchange reserves halved to 3.7 trillion yen. The budget plan includes a 3.8 trillion yen special account for reconstruction spending. Expenditures in the current fiscal year’s initial budget totaled a record 92.4 trillion yen. The government had planned to cap new bond issuance at 44.3 trillion yen next year.
An aging population and reduced growth since an asset bubble popped in the early 1990s have left the nation with debt projected at a record 1 quadrillion yen this fiscal year.
(emphasis added)
Dreadful Dreams and Japan's Peculiar Situation
As we noted a little while ago, the Japanese ministry of finance is these days the 'Ministry of Dreadful Dreams'. The 'dreadful dream' that keeps Japanese finance ministers awake at night is that interest rates may one day rise. So far, Japan's debt load has escaped the scrutiny of investors due to a peculiar quirk: its bonds are primarily held by domestic investors, many of whom are subject to 'financial repression' on account of regulations. Moreover, Japanese society is very cohesive and no-one in a position of institutional power is likely to upset the curious arrangement by which the bond market is held aloft voluntarily by selling his holdings. Alas, Japan's biggest pension fund has become an involuntary net seller of JGB's – as the ratio of retirees to the working population has passed the threshold where it has to pay out more than it receives in revenue. A similar problem could arise from the mass of individual investors, as the country's aging population has been running down its savings quite quickly in recent years – soon the personal savings rate will turn negative.
On the positive side of the equation, the Bank of Japan has been running a fairly conservative monetary policy in recent years after several failed experiments with 'quantitative easing'. Although it has implemented 'ZIRP' (zero interest rate policy), the money supply has been growing only very slowly, keeping the yen strong and leading to only slight increases and in some years even slight declines in consumer prices (this condition is of course a far cry from the country being 'mired in deflation' as the financial media regularly assert). The big question is for how much longer this relatively tight monetary policy stance can be kept up. The BoJ is nominally independent, but the government can revoke its independence at any time if it thinks that debt monetization is needed. If such debt monetization is coming, it will likely be pursued under the pretense that a 'fight against deflation' is needed – the BoJ may well be persuaded to adopt such a policy 'voluntarily' if threatened with the potential loss of its independence and if such a fig leaf can be used to disguise the policy's true aims (note however that the current BoJ governor Masaaki Shirakawa sounds as though he would be more likely to resign than support an inflationary policy).
