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


  1. Japan is a strange, strange, strange case, and yes a potential warning to the US. But as the article you posted points out, there is large difference between Japan and the US. Japan is a land of savers, where the US is not. This leads to two fundamental differences.

    First, Japan has been able to sustain a debt-to-GDP of 180% since 2005 because it's population owns most of the debt. The US can not follow Japan's debt path unless US citizens concurrently save much more.

    Second, because Japanese save so much, they don't consume, and their economy is not lifted by consumer spending. As the article points out, the Japanese gov't has had to step up its own spending in hopes of generating growth, because of the absence of endogenous consumer spending. The US is not in this situation. Growth can come in the US from consumer spending. The question is where will US citizens get the money to spend? Answer this question, and I think you'll find out from what sector growth will spring.

  2. Always omitted in these accounts is the contribution of "off-shored" manufacturing. Are Toyota, Honda,Sony "Japanese" companies.Do you think the activities of Japanese owned companies in the US and Europe, Asia and Latin America might be relevant to Japan's debt carrying capacity?And if so,how?

    The question would be, it seems to me, to compare Japan and US outsourcing of manufacture in its contribution to the debt carrying capacity of the respective domestic economy. As part of this it would be interesting to try and separate the forex effects of off-shoring (US "exorbitant privilege" vs Japanese hedging of US privilege) against the real effects of building capacity to do something.

    Britain's approach to preserving "invisible earnings" (insurance, factoring, interest, fees and commissions) in the 1960's, while dismantling domestic production, and not replacing it with off-shored capacity, would be an interesting reference point.

    But that gets into the whole question of what the dollar might be good for nowadays, and not many people want to go there at all.

  3. There is a certain level of GDP decline that would be offset by the declining population. One could almost argue that growth may not be all that necessary if the country is getting smaller.

  4. YY- interesting point, but this makes the increasing nominal debt load even more frightening (less people to support an increasing level of debt).

  5. Japan used to have a high savings rate - but they don't now. The Japanese household savings rate has decreased from an average of 12 percent in 1989-1995 down to less than two percent in 2007. (This is shown in Chart 1 from Dave Rosenberg's, "Turning Japanese, I Really Think So" treatise when he worked for Merrill Lynch, dated 28 Oct 2008.) This isn't too much different than US consumer savings levels.

    From a macro view, the Japan government's debt has swapped places with the huge decline in the previously very sizable business and the comparable much smaller personal debt.

    In the US, the situation is reversed whereby the consumer comprises, versus the business portion, the bulk of the $40 trillion of US private debt. But no matter, the existing $15 trillion of government debt will expand as the private debt contracts, essentially doing a flip-flop over the next fifteen or so years. By then socialism will have wiped away much of our capitalism.

  6. I thought the myth of high Japanese savings had been dispelled. Apparently not.
    I think they now save less than the US.