People the world over are buzzing about the US’ ‘fiscal cliff’, but what Japan immanently faces is something more akin to a ‘fiscal abyss’.
Japan’s economic situation just went from very bad to worse. The country, already doing what it can to keep the lid on its mounting debt, is confronted with an ultimatum from opposition party leaders that either prime minister Yoshihiko Noda call a general election – which he’s been avoiding on concern his party will be ousted - or face a government shutdown that would block legislation allowing Japan to raise 40% of the year’s budget through bond sales.
While it’s unlikely the situation will elevate to that, the event does unearth all the worms just under Japan’s surface. It also iterates just how precarious the country’s fiscal situation is, and how the JGB (Japanese government bond) market is the glue keeping it together. Were this glue to disappear, Japan would face economic ruin.
In other words, if politicians have any consideration for their country’s economic wellbeing, it’s best not to tamper with the sovereign bond market, at least until they address Japan’s broader economic problems through a myriad of other financial tools.
It cannot be overly emphasised how important a functioning JGB system is for Japan’s fiscal survival. The country’s debt system is already quadrillions of yen deep and growing, it has the highest debt-to-gross domestic product (GDP) ratio in the world at 211%. (By comparison, second-place Greece’s is 165%.)
The reason Japan can maintain this debt monstrosity is by continuously reissuing JGBs to domestic buyers – thus containing the situation onshore – at dirt-cheap yield prices. As long as there’s demand for JGBs onshore (which there has been) the government can continue raising cash for its fiscal obligations. And its financial institutions, pensions and insurance companies can continue providing cash and services to an increasingly aging population.
The current situation for Japan is alarming to say the least, though it’s likely Noda will call a general election before November 27, when the Ministry of Finance (MoF) will hold its scheduled debt auctions of two-year bonds, followed by 10-year bonds early December.
Analysts have come to two conclusions of what could happen if these bond auctions are missed. First up, institutional investors, pensions and insurance companies will rabidly vie for the remaining pool of bonds in the market, driving yields down and prices up. Second, the opposite could happen. These bonds whose auctions were missed could get back loaded to the next round of auctions. Unless a greater amount of investors come for bidding bond prices will drop, becoming more expensive for the MoF to raise funds.
Both outcomes create imbalance in the system, and both could cause a further crisis of confidence in the JGB market.
While it’s positive that market analysts believe Japan’s Diet will resolve the problem, which means the system can go back to status quo, that’s as good it gets. Japan can’t ignore that its broader system is flawed and its economic growth will erode unless regulators tackle the country’s fiscal health head on – and JGBs are crucial to this.
Japan doesn’t need any more problems to contend with. Aside from navigating a global recession, considering its pension options for its rapidly aging population, grappling with an overly strong yen, recalibrating its energy protocols after the March 2011 tsunami, being downgraded by global rating agencies, stymieing eroding Sino-Japanese relations, seeing its government ministers resigning, and fighting sky-high debt-to-GDP, it’s certain that Japan has its plate full. Throwing in a JGB crisis and all the financing problems that go with it could push the country to the edge.
If this uncomfortable moment persists into a true JGB crisis, Japan would see more than ¥38 trillion (US$475.83 billion) of financing necessary for already-planned projects stalled. Even now the government has reportedly frozen some of its spending in anticipation of a funding crunch. These are problems that affect real people, and would further cause a crisis of confidence in Japan, which the country cannot afford.
The moral of the story is that no political party can be above Japan’s economic welfare, because not only will it affect the Japan’s domestic institutions and citizens, but the world needs stability from a G8 country and a G3 currency at a time when other geographies are also teetering.
Regulators need to keep their eyes on the prize and start solving some of the country’s problems rather than adding to it. As Asiamoney PLUS has iterated before, this means finally enacting the 10% sales tax, inducing greater inflation, finding more diverse JGB investors and becoming more aggressive in its stance against debt – at least for a start.
Endangering the JGB issuance and investment structure will be a huge step in the wrong direction. Politicians should stop threatening their country with more of these problems and start focusing on the solutions.