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March 24, 2014 7:18 pm
Last summer Takeshi Fujimaki ran for parliament on a platform of economic Armageddon. Japan’s debt was out of control, he told voters, and it was only a matter of time before everyone dumped government bonds, sending yields soaring and the yen skittering all the way to 1,000 against the dollar.
The shock tactics worked. Now the former fund manager holds forth from a suite of rooms in Japan’s upper house, a stone’s throw from the Diet building. But the message is the same: after the Meiji restoration and the second world war, a third huge shock, hyperinflation, is headed Japan’s way.
“A market crash is inevitable,” he says. “The only question is what measures we can take today to lessen the damage.”
Mr Fujimaki is not a lone crank. Although few share his sense of abject despair, no one disputes that Japan’s debt is worryingly high. The International Monetary Fund and OECD both warn that deep cuts to spending must be made, beyond the government’s basic pledge to balance its books – excluding debt-servicing costs – by 2020.
Japan’s finance ministry seems to take a perverse delight in pointing out the world’s worst debt optics: gross central government borrowings equivalent to 24 years of tax receipts, or about $80,000 for every man, woman and child. (The next worst is Ireland, with $60,000, according to Bloomberg.)
Shinzo Abe, the prime minister, is determined to change direction. If Japan can succeed in igniting nominal growth and inflation, the theory goes, the debt will instantly start to look less formidable. Hence the triple stimulus unleashed almost 18 months ago, via the “three arrows” of a flexible fiscal policy, more aggressive monetary easing from the Bank of Japan and various structural reforms to boost competitiveness.
But that plan depends on maintaining order in the bond market – an outcome that is by no means assured. Critics say that rather than fixing Japan’s economy, “Abenomics” could be storing up trouble. All Mr Abe has done is to pile debt upon debt, they claim, while flunking more difficult growth initiatives such as Japan’s entry into the Trans-Pacific Partnership free-trade agreement.
Last year the Diet signed off on two spending packages on top of the regular budget – one to jump-start growth and another to smooth over the impact of the first rise in consumption taxes for 17 years, effective in April. And last week the Diet waved through its biggest budget for the fiscal year ahead. Gross debt issuance comes to a record Y182tn ($1.78tn), about the same size as the economy of India.
“How fast can you ramp up a programme like that without risking spending the money foolishly?” asks Robert Shiller, the Nobel Prize winning Yale University professor, alluding to spiralling costs in Japan’s construction market caused by a lack of workers. “I think [Mr Abe] has got a very hard job. It’s always been true that Keynesian stimulus runs into problems like this.”
So far the bond market seems untroubled. Even as Abenomics has shaken up other assets such as stocks and property, Japanese government bonds (JGBs) continue to sail on serenely, giving the government with the highest debts the lowest borrowing costs in the world.
But many wonder how much longer the game can go on. “Because fiscal stimulus borrows income from the future for immediate consumption, such policies only compound Japan’s already huge public debt, thereby increasing the risk of fiscal chaos,” says Ryutaro Kono, chief economist at BNP Paribas and a prominent hawk. “Are we trying to see how far we can push things before fiscal collapse?”
Mr Abe is going all-out for growth because he has to. Barring the type of scenario outlined by Mr Fujimaki, only growth can fix its debt problem.
State finances have deteriorated partly because of demography. Social security payments to a fast-ageing population have nearly tripled since 1990 to Y31tn – about a third of the total budget – in the fiscal year beginning in April.
But the real problem is that as the economy languished, Japan collected less and less tax, forcing the state to borrow to plug gaps between income and expenditure.
During the high-growth 1980s, tax revenues rose more quickly than spending, keeping total borrowing at less than 60 per cent of gross domestic product in 1990. But those two lines began to diverge in the early 1990s when nominal growth began to sputter, and they spread further apart as Japan tipped into deflation in 1997. Annual deficits narrowed a little in the mid-2000s. But the huge extra budgets to cope with the Lehman crisis, followed by the clean-up after the March 2011 tsunami, pushed them wider still.
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Until now, the finance ministry has had few problems selling its debt domestically, which means it has not been at the mercy of overseas bond vigilantes. Commercial banks were stuffed with deposits from companies and households and had limited opportunities to lend. Where better to put all that cash than the ultra-liquid JGB market, which requires no capital to be set against it?
Insurers, too, had to match yen liabilities with yen assets, while the vast Japan Post group kept buying more JGBs than anybody. Entirely owned by the finance ministry, it was hardly in a position to do otherwise.
As long as prices were falling, bonds were a fair bet. A 10-year bond bearing a coupon of, say, 1.5 per cent had a real yield of 2.5 per cent, if deflation was at minus 1 per cent.
But now that the fall in the yen has pushed up inflation, real yields have turned negative for the first time in decades and are putting one of the objectives of Abenomics to the test. Under the plan drawn up by Haruhiko Kuroda, the BoJ governor, bond-heavy investors are now supposed to shed JGBs so they can put cash to work in riskier assets, supporting the broader drive towards growth.
As long as the BoJ can be counted on to soak up the bonds they do not want, all will be well. So far that theory has held, as the big banks have sold big chunks of their bonds to the BoJ while yields have remained low.
The Abe-Kuroda double act deserves credit for “masterfully” holding confidence together, says Kyle Bass, a Dallas-based fund manager and notorious JGB bear. “But if they do get to north of 2 per cent inflation, then all investors will have to question whether they want to stay in the game.”
Mr Bass is coy on the strategy of his Japan fund, set up in 2010, but says he continues to bet on further weakening in the yen while positioning for a huge rise in bond yields by buying cheap options on interest rates.
Even bond bulls accept that relying so much on the BoJ is risky.
As Takehiro Sato, a policy board member, puts it, the more government debt a central bank buys, the greater the appearance of “fiscal dominance” – where monetary policy essentially becomes a ruse to keep the state solvent.
The boundaries are already blurred. Dealers talk about “the BoJ trade” – buying bonds at auction from the finance ministry then flipping them immediately to the central bank to bag a few basis points of profit. One issue of 30-year bonds on February 6 was almost 90 per cent owned by the BoJ a month later. “We are buying tonnes of JGBs; we are monopolising the market,” says Mr Sato.
The BoJ’s grip on the market is nothing more or less than central bank financing of the fiscal deficit
A senior finance ministry official says that it is true that “the BoJ is financing the government, in a way”. But, he adds, it is important to recognise that the BoJ is buying assets for similar reasons as the US Federal Reserve: to keep downward pressure on bond yields and promote a stronger recovery.
He refers to a pact drawn up in October 2012 under the previous government and endorsed by Mr Abe in January last year, under which the BoJ and the government pledged to work together to revive Japan.
“The BoJ will fight deflation and we will continue our efforts on fiscal consolidation,” he says. “That is the agreement.”
But many suspect that the pair will be bound together for longer than the two-year period outlined last April.
“Three, four, five years? We don’t know, but a very long period is needed to get to the target price level,” says Akio Kato, head of the fixed-income group at Kokusai Asset Management, which looks after Y3.8tn in bonds.
And the more long-term bonds the BoJ buys, the trickier its exit. More than 80 per cent of its assets are now in JGBs – much higher than the Fed, with about 55 per cent in US Treasuries – with an average maturity near the maximum eight years. A simple withdrawal of stimulus like in 2006, when the BoJ allowed its shorter-term debt to run off, looks impossible.
The BoJ’s grip on the market “represents nothing more or less than central bank financing of the fiscal deficit, and could ultimately lead to market turmoil”, says Jun Ishii of Mitsubishi UFJ Morgan Stanley.
The finance ministry knows the situation is delicate. Its debt-raising strategy for the year ahead is based on locking in low rates on longer-term bonds, while giving investors more latitude to set maturities themselves.
“As long as stability persists, we will be fine,” says the senior official.
The ministry also claims to have one eye on deficit reduction, noting that the first of two increases in consumption tax in April should allow it to cut new bond issuance by about Y1.6tn in the year ahead.
It admits, though, that its long-term targets for cutting debt are unlikely to be hit. For the past few years, the official line has been that the government plans to erase its primary deficit – the gap between revenues and expenditure, excluding debt payments and bond issuance – by 2020.
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But last summer the cabinet office sketched out projections that implied that the government would miss the target. In February the finance ministry added colour, saying that even with the most optimistic assumptions for growth and cuts to spending, it would fall about Y6.6tn short.
Claims of fiscal discipline are a “charade”, says Mr Bass. “If you really look into next year’s revenues and expenditures, they’re spending Y23.3tn on debt service and Y31tn on social security, and getting Y50tn in tax. Before they even run the government they’ve already spent the money.”
One former BoJ official draws a parallel to spending on social security now and spending on the military in 1945, which accounted for a similar share of tax revenues. “It is unmanageable. Someone needs to make a brave decision to cut it.”
Mr Fujimaki cannot see a painless way out. His Japan Restoration party is a motley group spanning Toru Hashimoto, the gaffe-prone mayor of Osaka, and Kanji “Antonio” Inoki, a former wrestler. But the third-biggest force in the more powerful lower house of parliament is united, Mr Fujimaki says, by a belief that years of “socialist” rule have led Japan astray.
A rebirth is possible, once hyperinflation reduces the government’s quadrillion-yen debt to “peanuts” and a radically weaker currency draws manufacturers back home, he says.
But something has to give. “Maybe we’ll be OK today or tomorrow. But what about the day after tomorrow? Abenomics is weighing down the axle on a car with no brakes.”
Campaigns: The pink movie star helping to fund a vast deficit
When it comes to selling bonds to individuals to fund its vast deficit, Japan’s finance ministry has often resorted to the oldest tricks in the book.
To raise cash for the reconstruction of the earthquake-hit Tohoku region two years ago, for example, it hired a few members of AKB48, an all-girl pop band with a huge male fan base. In 2010 it ran a magazine campaign suggesting that men who bought government bonds were a big hit with women.
“If my future husband does investment, my absolute requirement is stability!” raved one beauty. “I want my future husband to be serious about money,” said another. “Playboys are no good.”
But now that a weaker yen has helped to force inflation higher, the recognition has sunk in that only the most habit-hardened Japanese government bond investors are likely to be interested. Buyers of a 10-year bond to be issued on April 7 will get a coupon of 0.6 per cent a year, or 0.48 per cent after tax – about one-third the headline rate of inflation.
For the current fiscal year to the end of March, the finance ministry used a range of celebrities likely to appeal to older people, such as Ken Matsudaira, a 60-year-old actor best known for playing Edo-period warriors in television dramas, and Shunputei Shota, 55, a popular storyteller in the comic rakugo tradition.
The fact that next year’s theme has yet to be decided suggests that the finance ministry is not anxious to tap any other demographic.
Nevertheless, it knows that individual investors remain a vital source of support for the world’s most indebted government, with gross borrowings of more than Y1,000tn. Households are expected to soak up Y2.5tn of bonds in the fiscal year ahead, according to a ministry issuance plan, one-fifth more than the previous year.
The ministry, however, has not stopped appealing to base motives altogether. One of the four faces of this year’s campaign was 59-year-old Keiko Takahashi, a former star of “pink” movies who appeared on the cover of Playboy Japan in 1982.
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