JLPT BC 123 | Is the Sky Falling in Japan?

JLPT BC 123 | Is the Sky Falling in Japan? post image

It doesn’t get much mainstream press these days, but Japan has a bit of a debt problem. The national debt will be an estimated 245% of the GDP, which seems simply unfathomable. In order to pay such a debt off, Japan spends something like 23% of its budget on interest payments. And Japan is currently running a budget deficit, meaning it is adding to that every year.

In other countries, natural inflation could be relied on to lessen the effect of the debt year by year (if there was a budget surplus). But of course, Japan has chronic deflation, which actually makes the debt worse. And there are also a whole host of other things on Japan’s plate too – like declining birth rate, retiring baby boomers, forced retirement at 60, chronic savers, etc…

This has led to a ton of speculation as to what will happen to Japan in the near future. And it has ranged from total economic collapse to some extra inflation. A lot of the top advisors have weighed in on the topic actually and judging from the comments people leave, it is a very hotly debated topic as to what exactly will happen. And as with all financial predictions, nobody has a clue how it will all play out.

The truth in these types of situations always lies somewhere in the middle or a combination of things in my opinion. After all, there is the very slight possibility that it all can be avoided somehow.

The Sky is Falling

Kyle Bass is a hotshot fund manager who got lucky with the sub-prime crisis in the States. He is calmly letting everyone know that financial ruin will hit Japan sometime in the next 18 to 24 months. He placed a lot of bets on this, going so far as to buy his house in yen so that he can save money because he is betting the yen will devalue with the crash.

The reasoning behind this (in a very small nutshell) is that right now the Japanese government (and other governments) are spending more than they are taking in. To work this magic they sell government bonds at auction, print more money, or do some combination of both. These bonds are the national debt. And at the moment, a lot of those are owned domestically and continue to be purchased domestically in Japan.

This allows Japan to have a lot of control over its debt. It doesn’t have to worry about making investors nervous, because they all live in Japan and they want Japan to keep working and not go bankrupt. The problem is, the domestic money supply is drying up. When that happens foreign investors step in and the interest rates may go up on the bonds.

If the rates go too high, it is game over for Japan. The country will default and there will be a lot of economic problems as a result (in theory).

For a more detailed, animation-filled explanation of this please check out the following video:

Currently this is resulting in historically low interest rates. For example, if you want to take out a house loan at the moment, the variable rate is about 0.775%. Even for a 35 year fixed rate, it is 2.5% which is almost nothing. That’s because any increase in rates will cause Japan to default according to some sources.  Also, banks are in cut throat competition with each other to get customers, luring them in with cheap loans and making money off of other services.

But, actually, a lot of people believe that countries like America and Japan can’t default. Because, and again I’m paraphrasing here, a country can simply keep printing money. Of course, if you print too much money, you end up like Zimbabwe.

Now there are a couple of ways to solve some of these issues above. For example, Japan currently has a trade deficit at the moment, which makes things even worse. If they could increase trade, they could increase GDP and help them pay off their debts. The easiest way to do that would be to trade with their neighbors, like China. Unfortunately, China and Japan are currently having a hissy fit over Senkaku, a group of islands in the Pacific, which seem to have a lot of oil around them.

Japan could also privatize some of its national assets that it has lying around. This would make the properties more profitable in theory and give Japan some money to pay down the debt. The only problem is Shinzo Abe didn’t campaign with this idea and hasn’t really mentioned it at all.

The current plan on the table is a consumption tax hike from the current 5% to 8% in April of next year and then up to 10% in 2015. This will, in theory, close up the budget deficit a little bit and stabilize things, but nobody really likes the idea of a consumption tax and many fear it could slow down the economy.  Of course, now with the Olympics in the picture, there are a lot of people that are hopeful for a turn around, but no one seems to truly believe there will be a boom.

The Sky will probably Fall but Slowly

Japan has a lot more control over its financial situation than a lot of other countries do. This allows them to do things like order the Bank of Japan to buy up bonds to keep them a float for a little while longer. And since a lot of bonds are owned domestically it can do things like peg the interest rate of bonds so that interest rates don’t go up.

It seems inevitable that some kind of inflation needs to happen in order for things to get better. Higher inflation means the debt gets smaller relative to GDP and that means it will be more manageable. How much inflation is needed? A lot. Some estimate 6% per year in order to reverse the trend.

Japan can do this by devaluing the yen, which would increase exports, but there is one catch. Since a lot of manufacturing has been moved overseas, Japan now needs to import things it used to produce domestically. And of course, since oil is priced in dollars, fuel costs will rise as well.

What seems like the most likely scenario is a slow steady raise in inflation and weakening of the yen. As the yen gets weaker, exports will pick up and things will get better. Hopefully this process will be a slow one, but it will still be rather painful.

Higher inflation will of course cause its own set of problems, much like what is happening in the States now. The middle class will get hollowed out. Money will funnel its way to the rich, and things will get tougher for the retirees living off savings. In theory, wages should increase along with that, but nothing is for certain.

The general spirit of people in Japan though is kind of a しょうがない attitude.  In other words, it can’t be helped so no need to protest it.  For example, a lot of people aren’t happy about the consumption tax, but it seems like most will just deal with it and go on.

My Two Cents

It is very easy to start believing in doomsday scenarios. Half the videos on YouTube about the financial situation talk about global financial collapse and how the world is going to turn into Mad Max at any moment.

The truth though is that nobody really knows what in the world is going to happen. Everyone is kind of guessing. Personally, I’m trying to get as much money into assets as I can just to be safe. That is one of the reasons I’m scrambling to find a house at the moment. Granted housing and land in Japan aren’t exactly the best investments, but you have to live somewhere.   Also, I want to lock in these great interest rates in case something goes haywire.

But, what about you? What do you think of the financial crisis? Let me know in the comments below.

Boring Disclaimer Legal Crap

Since this article is about finance, I might as well just come out and say that I haven’t studied economics in any formal sense and I really have no idea what I am taking about. Please don’t make any financial decisions based on what I wrote. Do prudent research before making any investments. Never take investment advise from some guy with a blog about the JLPT.

And also, if I have made a mistake in my explanation of the situation, please by all means let me know in the comments.

Photo by IvanWalsh

{ 6 comments… add one }
  • Russell October 5, 2013, 3:57 pm

    Yeah I can definitely see Japan’s decline in the far future. Just looking at brands like Sony and Panasonic for example, they aren’t what they use to be. Companies like Samsung and LG are starting to be just as good quality at a greater value. That, plus the population problem. I think China is the new frontier but unfortunately I have no interest in learning Chinese and am not really interested in Chinese things. Like, Japan just has a lot of cool stuff, the girls, the anime, cars, well known guitar brands etc. China doesn’t have any of that stuff.

    • Clayton MacKnight October 7, 2013, 1:52 pm

      Well, Japan has always lumbered behind the next big thing. They tend to come up with a better, more, efficient version of whatever is hot. They just tend to be a bit slow about it. For example, hybrid cars, ultra-sharp LCD screens (Sharp’s Igzo). And the PS4 seems like it will win this round of the console wars. Inside Japan, Panasonic is well-known as the place to get high-efficiency solar panels as well, only time will tell if those panels make it outside of Japan or not though.

      The one area they seem to be clueless is smartphones and tablets. I’m a bit surprised Sony hasn’t tried to build up a pure gaming tablet with some juicy features for gamers. There is definitely a hole in the market for that, a pure gaming tablet that has a lot of muscle without all the fancy do-dads and Sony has the market position to create a good ecosystem around it. Maybe the price point is too high? Of course, Sony also missed the mark on iPods. I mean they did create the first portable music player, the Walkman, and they didn’t see MP3 players coming?

  • Adit October 6, 2013, 4:22 pm

    This is good material… Since I currently learning finance, this is very interesting. Especially, the part about domestic government bond buyout. That’s the reason why Japan is able to reach stability for so long (although there are many bubble and burst). Many times, government depending on intervention and help from outsiders, in form of investment. I really interested on how they managed buyer from domestic market. Raising of inflation in Japan will probably get a lot of bad press for the government, since they are maintaining 0-3%, (I never heard ever reach 3%)… Well, it’s true like Russell says, I have great interest in Japan because there are many things interesting, out-of-common kind from your normal life.

    • Clayton MacKnight October 7, 2013, 2:04 pm

      There have been some mini bubbles here and there of 2% or 3% inflation, but on the whole I think they average about 1% deflation. That’s why a government bond earning 1% is actually pretty good because it means you are getting a real return of 2% which is better than pretty much anything else. Housing/real estate is drifting down, stocks don’t usually move that much. A lot of people invest in foreign money like New Zealand Dollars because of the interest they earn.

      But, I think one reason I have some confidence in the Japanese market, is because a lot of people just buy things just because that is how they have always done it. Anyway, it’ll be interesting to see how it plays out, as long as it is a fairly slow process. 🙂

  • Ginbura October 8, 2013, 3:48 am

    For an alternative take on the Japanese economy, I suggest you look at this TEDx talk by the head of Equity Research at JP Morgan Japan: https://www.youtube.com/watch?v=BQEQ9jVUkbg whose economic scholarship I have rather more respect for than that of Kyle Bass.

    PS. Love the podcasts – I too am in the process of taking the big leap and purchasing a home in Japan, and look forward to hearing all about your experiences 🙂

    • Clayton MacKnight October 12, 2013, 11:35 pm

      That’s a great presentation, thanks for sharing. It added a lot more to the picture. I’m very curious how this whole consumption tax bump is going to play out. Hopefully things will keep on trucking.

      The housing market is insane at the moment. I heard they are building like crazy before the consumption tax hike (which affects new houses, and apparently doesn’t affect used houses). Also there are some incentives in Abenomics for building new houses? I’m not sure what those are though. This housing boom is jacking up the cost of building supplies by up to 20%. Anyway, the biggest thing to look out for is ghost towns. There are places that are starting to pop up where people are moving out in droves and into new houses which destroys a neighborhood. Something like 16% of houses are unoccupied at the moment. Granted most of that is in the countryside and ‘terminal’ communities, but still something to keep an eye out for. Everyone wants a condo in the city or a house 10 minutes walk from the station these days.

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