Tuesday, December 8, 2009

The Real Lost Decade: Japanese GDP Edition

I found the following piece from Martin Gremm (a longer bit than I normally post, but interesting), which details how Japan reacted to the initial bubble popping in their economy in the early 1990's and the pain it caused not then (important), but 10 years later (i.e. the beginning of the most recent 10 year period).

The government's response to the financial crisis inflated the national debt from 65% of GDP in 1992 to 180% in 2005. The Debt to GDP ratio has held steady near these levels since then.

Currently, Japan spends about 24% of their annual budget on interest payments. Any significant increase in interest rates would push this expense into crippling territory, but so far rates have shown little inclination to rise.

A decade of long-term interest rates in the low single digits should lead to inflation, but in Japan inflation has been very tame. We can understand why this is the case by looking at how money flows through the Japanese economy.

The first major difference between the US and Japan is that the savings rate in Japan is very high and many Japanese invest their savings into government debt. Ninety-three percent of the Japanese national debt is held internally. This would be unthinkable in the US because consumers are themselves over-leveraged and can't lend much to their government.

Japanese banks tend to use deposits to buy government bonds rather than lending them out to consumers. Presumably this reflects a reluctance of individuals and businesses to borrow, and a reluctance of banks to lend to any but the most credit-worthy borrowers.

In effect, the Japanese population lends its savings to the government, either directly or by keeping its savings in a bank, which uses the deposits to buy bonds. Interest payments are usually reinvested back into government bonds.

This process creates significant demand for Japanese government debt, which keeps bond prices high and interest rates low. It also prevents inflation, because a lot of bank deposits are used to fund the budget deficit rather than consumer and business spending, which could drive up prices.

This unusual arrangement enabled Japan to sustain an inherently unstable situation for the last decade. If the Japanese population decides to spend money instead of saving it, or the banks decide to look for higher returns by lending to individuals and businesses, inflation and interest rates will rise and Japan will have to address its debt burden.
With this as a backround, Bloomberg reports on Japan's horribly revised GDP figure and the government attacking the problem of debt, with more debt:
Japan’s economy expanded less than a third of the pace initially reported in the three months to September as companies slashed spending.

Gross domestic product rose at an annual 1.3 percent rate, slower than the 4.8 percent reported in preliminary figures last month, the Cabinet Office said today in Tokyo. The revision was deeper than the predictions of all but one of the 17 economists surveyed by Bloomberg News.

Stocks fell after the report underscored concern about the sustainability of a recovery that is under threat from deflation and a rising yen. Prime Minister Yukio Hatoyama unveiled a 7.2 trillion yen ($81 billion) stimulus package yesterday to ensure the economy avoids another recession next year.
While EconomPic had stated that each of the last two quarter's figures looked "odd" (see Q2 and Q3 posts), there was NO clue that it was due to massive errors in their estimates. Trying to ignore this, the broader issue is what this all means with regards to the Japanese economy. Even with massive stimulus, the country can not "eek" out a positive nominal GDP print and is becoming closer and closer to the brink every month.

How bad? Over the last ten years, the Japanese economy has SHRUNK in nominal terms... that is in Yen, the Japanese economy produces less now than it did 10 years ago.

A smaller economy means they have less of an ability to service any level of nominal debt, all else equal. Yet as the first paragraph of this post indicated, Japan has taken the opposite path which I feel is HIGHLY instructive for a potential "slog through" period within the United States should we continue to move down the path of ever increasing debt loads within the household and public sectors, without corresponding economic growth.

The question I keep asking myself with regards to the United States and Japan... where will this growth come from?

Source: ESRI