- By Clyde Prestowitz
Clyde Prestowitz is the founder and president of the Economic Strategy Institute (ESI), where he has become one of the world's leading writers and strategists on globalization and competitiveness, and an influential advisor to the U.S. and other governments. He has also advised a number of global corporations such as Intel, FormFactor, and Fedex and serves on the advisory board of Indonesia's Center for International and Strategic Studies.
Because it is of such long term global importance, let’s drill down and look at the full truth and implications of today’s Japan.
We can start with debt. Most of the public discussion lists Japan’s national debt at about 230 percent of GDP. That’s true if you’re talking strictly about the debt of the Japanese government. But as Tokyo resident and long time Japan watcher Ken Courtis notes in a new presentation, what’s happening in Japan is that private debt is being transferred to the public balance sheet. Over the past thirteen years, private debt equivalent to about 100 percent of GDP has effectively been transferred to the public balance sheet. Remaining private debt is about 270 percent of GDP which implies that Japanese government debt could be 500 percent of GDP in the not too distant future.
Indeed, Courtis notes that Prime Minister Abe’s new stimulus plan could easily explode the government budget deficit to 10-12 percent of GDP over the next twelve months. At the same time, the new government has more or less merged fiscal and monetary policy by essentially bringing enormous political pressure to bear to force the Bank of Japan to achieve a 2 percent inflation rate through aggressive quantitative easing (QE) measures. So far this has resulted in a substantial weakening of the yen which is already providing a boost to exports. But it will also likely lead to a sharp increase in interest rates with very significant consequences.
Consider that ten year interest rates in Japan are about 0.75 percent. Deflation in Japan has not been the crushing force often portrayed in western media, but it has been running at about 1.5 percent annually, meaning that investors in Japanese bonds are earning a comfortable, safe 2.25 percent. With the economy growing only very slowly, the banks have not been lending much. Rather they have been stuffed with Japanese Government bonds (JGBs). They now hold one third of all Japanese government debt and equivalent to about 83 percent of GDP.
Now suppose that the Bank of Japan actually does get inflation up to the desired 2 percent. Interest rates would rise, let’s say to 2.5 percent to pick a number. Now investors aren’t earning 2.25 percent. They’re earning only 0 .5 percent and likely taking their money out of Japan. At the same time, debt servicing would, of course, explode. Right now debt service equals 25 percent of the annual budget. If interest rates triple, debt service would suddenly be three quarters of the budget. Today, the budget is ½ health, pensions, social security, and education; ¼ debt service, and 1/4 th everything else. If debt service suddenly became 3/4ths of the budget, the budget would simply disintegrate. On top of that, the fall in the value of JGBs would torpedo the banking system. So it’s clear that a substantial rise in interest rates could have potentially dire effects, not only for Japan, but for the rest of the world as well.
Of course, Abe is hoping that he can get the Yen to Y100/$ and hold it there while it drives exports and revitalization of production which in turn would drive up the GDP, employment, wages, and tax revenue which could cover the increased cost of debt service. If he can do that for a reasonably sustained period, Abe and Japan will be heroes of the highest order.
But can he? What if there are simply not enough able workers to sustain the required increase in production? What if the products and services Japan can produce and provide are simply no longer competitive with those from Korea and China? What if Japanese corporations fail to invest aggressively enough? What if Japanese can’t operate in the global economy as readily as Germans, Chinese, and Koreans?
These are the key questions for which Japan and the world hope Abe has answers.