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Japan’s Cautionary Tale: Debt and Demographics - Part 3
5 min read

Japan’s Cautionary Tale: Debt and Demographics - Part 3

Japan’s Cautionary Tale: Debt and Demographics - Part 3

Japanese Macroeconomic Indicators

Welcome to Part 3 of this series. If you have not read the first two installments, they can be found here and here. Part 3 will cover macroeconomic indicators. These indicators cover information that investors, both inside and outside of Japan, may use to determine if Japan is a good place to invest.

Our goal remains to clarify the cause and effect relationships between monetary and fiscal policy and the resulting behavior of Japan’s citizens. In Part 4, we will be drawing conclusions from the information we present in the first three parts.

Let's begin our analysis of macroeconomic indicators by looking at the balance sheet for the Bank of Japan (BOJ).

Bank Of Japan Balance Sheet

Fig. 1

Assets owned by the BOJ have increased by more than 6 times in the last 10 years. In fact, the BOJ’s balance sheet eclipsed its GDP back in 2018 according to this article. The same article also points out that the BOJ owned roughly 45% of the government bond market, a figure which is likely significantly higher today due to the current crisis. In addition to bond purchases, the bank has also greatly increased its presence in the equities market. According to a report from Q3 in 2019, the BOJ owns 8% of the equity market. Again, a figure that is likely to be significantly higher today.

Japanese Public Debt to GDP

Japan has the highest public debt to GDP ratio in the world, higher than profligate and dysfunctional countries such as Greece, Italy, and Lebanon. With a declining tax base detailed in the first part of the series, the only ways “out” are to enact either painful austerity (the correct choice) and/or inflate the debt away. Similar to the BOJ's balance sheet, the public debt to GDP ratio has increased almost 5-fold since the peak of the Nikkei back in 1989, ostensibly as a means to re-inflate and/or sustain asset prices. Neither goal has been achieved as will be illustrated later.

Japanese Private Debt to GDP

In contrast to public debt to GDP, private debt to GDP has shrank since the peak of the Nikkei back in 1989. Japan is currently mired in a 30-year struggle between deflation (evidenced by increased savings rates) and inflation (evidenced by balance sheet expansion). The term “Japanification” was born from this struggle. Japanification has come to describe the anemic economic growth that has plagued Japan for 30 years despite extraordinary monetary stimulus.  This term can also be used to describe other national economies following a similar path.

BOJ Benchmark Interest Rate

The Bank of Japan’s main monetary policy tool, its benchmark interest rate, has been stuck at 0% for over 20 years and has actually been negative since 2016 (held at -0.1%). Lowering interest rates is a tool that central banks use to try and stimulate the economy. The BOJ monetizes debt by purchasing assets, usually in the form of government bonds, and the theory is that the sellers of the government bonds will use the cash to stimulate growth in the economy. Despite being proven incorrect time and again, the theory described above has essentially been made permanent.

Japanese 2-Year Bond Yield

The two-year bond yield has been below 1% for over a decade and has been negative since 2016. Just as a refresher for the reader, what a negative bond yield implies is that the creditor actually pays the debtor to hold their debt. A theoretical example would involve lending someone 100 dollars and receiving 90 back a year later, something the average consumer would reject outright, but the BOJ doesn't play by the normal set of economic rules (or so it thinks). A negative interest rate policy perverts the time value of money.

Japanese 10-Year Bond Yield

Although it hasn’t happened yet, I would not be surprised to see the 10-year bond yield fall below 0%. Perpetually low bond yields, in the aggregate, are a sign of slow to no economic growth and, contrary to popular belief, tight monetary conditions. Stagnant growth has been Japan’s lot for over a generation at this point with no signs of abating.

Nikkei

The Nikkei is the Japanese equivalent of the S&P500. It peaked more than 30 years ago and has not come close to its former peak. As evidenced by the interest rate charts above, attempts to re-inflate the stock market have failed. Nevertheless, the Japanese government and central bank have doubled and tripled down on their failed policies with no end in sight.

Japan's GDP

The chart above shows Japan’s GDP going back more than 50 years. GDP essentially peaked in the mid 1990’s and, with the exception of the local peak around 2012, has remained below that number ever since.

GDP is calculated in the following way: GDP = C + G + I + NX (where C=consumption; G=government spending; I=Investment; and NX=net exports). This is important because government spending is a critical component used to calculate GDP. As we learned above, Japan has the largest public debt in the world. Despite decades of debt monetization and ZIRP (zero interest rate policy) Japan’s GDP currently sits below levels from the mid 1990’s. Also during this time, the “G” component above has fast become the key factor in the GDP calculation, especially post 2008 financial crisis. This calculation is not designed for the long term because as "G" increases, it crowds out the productive parts of the economy. Therefore, if government spending was stripped out of the calculation things would look like an even bigger disaster.

Key Takeaways From Japan's Economic Indicators

  • The Bank of Japan has used extraordinary balance sheet expansion to purchase the assets of the federal government and stock market leaving price discovery broken due to the crowding out effect.
  • Extraordinary monetary policy has been used for decades to fight deflation and prop up asset prices. This policy only benefits those who held the assets being targeted prior to the intervention. Those who did not already own assets prior to the intervention are forced to pay artificially high prices, therefore making themselves poorer, in order to participate in the market.
  • Public Debt/GDP is the highest in the world.
  • The Japanese stock market peaked in 1989 and was in a bear market for the next 20 years. Extraordinary monetary policy, in response to the 2008 financial crisis, has propelled the Nikkei upward but it still rests far below its 1989 peak.
  • Japan’s GDP remains below 1996 levels.

In next weeks’ final analysis, all of the information contained in Parts 1-3 will be combined in an attempt to forecast Japan’s long term outlook. We will also be taking a brief look at some additional countries which have engaged in similar behavior as Japan in an attempt to forecast their long-term outlook as well.

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