Japan’s Unsustainable Deficit-Financing Model
Financing government debt and deficits hasn’t been a problem for Japan: Until recent years, the country’s big-saving consumers provided the funds to finance the shortfalls.
Unfortunately, this also meant that Japanese consumers weren’t spending that money. In fact, there was so much saving left over that Japan had money to export. This is demonstrated by its trade and current-account surpluses.
The Japanese think and act quite differently from Americans. During the deflationary depression of the 1930s, U.S. consumers lacked incomes, with the logical consequence that they didn’t do any spending. During the Japanese deflationary depression that started in the early 1990s, consumers had money, but didn’t spend it. Were they too scared about the future? Were they content with their lifestyles and not desirous of more goods and services?
The dynamic in which the Japanese government’s fiscal stimulus is being saved by consumers and then recycled back to the government to finance its deficit is unsustainable. Consumer spending has been flat since the mid-1990s, while exports have provided what little growth there was. Furthermore, consumer borrowing has gone nowhere since 1990. Most importantly, the household saving rate fell to 7.3 percent last year from almost 20 percent in the 1980s.
Kentaro Katayama, a visiting scholar at the Japanese Finance Ministry, points to four things that have pushed down the consumer-saving rate. First, economic stagnation has reduced incomes and robbed consumers of the growth that earlier went into high levels of saving. Second, increases in old-age pensions and public long-term-care insurance lowered financial risks and the need to save, especially for older people. Third, attitudes in Japan have changed, and consumers now put more emphasis on enjoying life and less on preparing for the future with saving and investment.
Finally, Japan’s population is declining, the first of any Group of Seven country to do so. Fertility rates, at 1.21 births per woman, are also the lowest of major developed countries, well below the 2.1 needed to sustain population in the long run. Many younger Japanese women now have professional opportunities and are delaying or avoiding marriage. In addition, the number of older Japanese is growing much faster than their counterparts elsewhere, and the Japanese have the highest life expectancy of any developed country. Older people save less than the young as their incomes drop in retirement and they cash in their savings since they still consume.
Also, Japan is the least open to immigration of any major industrial country and lacks an influx of newcomers, who tend to be younger and save more. There’s no such thing as an immigration visa, though foreigners have been allowed in for extended “training sessions” during times of labor shortages. Baseball isn’t a native sport, yet Japanese teams have limited the number of foreigners on their rosters.
The Japanese people own 93 percent of their government’s debt. By comparison, almost half of U.S. Treasuries are held outside the U.S. As of last Dec. 31, Japanese banks owned 41 percent of government obligations, which accounted for about a quarter of their assets. This has isolated Japanese government finance from the rest of the world and allowed the yields on 10-year bonds to run at less than 2 percent in the last decade and less than 1 percent today. At the same time, domestic investors don’t seem to object to these low nominal returns, partly due to patriotism and partly because, with deflation more often than not in recent years, their real yields are much higher.
The chink in this domestic financing armor, as I’ll discuss tomorrow, is exports, which drive Japan’s economy, corporate profits and cash flow. A retrenchment by U.S. consumers -- I predict their saving rate is headed for more than 10 percent -- will curb imports, which are the exports on which Japan, China and many other countries depend for growth. In the post-World War II years, a 1 percent decline in U.S. consumer spending cut imports by 2.9 percent, on average.
In addition, China will lower its growth in already excessive industrial capacity, and that will include capital equipment and other Japanese exports. The Chinese government’s target for real gross-domestic-product growth was recently reduced to 7.5 percent from 8 percent, and it will fall to 5 percent or 6 percent in the hard landing I have predicted.
The slowdown in China, along with the European debt crisis, pushed Japan’s Topix Index to its lowest since 1983 this week.
Furthermore, gone are the days when Japan could import designs and technology from the West and then beat the originators with minor improvements and superior manufacturing. Toyota Motor Corp. took the best of Mercedes-Benz and Bayerische Motoren Werke AG, and improved on them to produce the Lexus. Now Japan has fully exploited these opportunities and must develop new designs and technology. That takes more time and money.
Absent strong domestic demand, weak exports will keep capital spending subdued and, in time, will result in a decline in Japanese gross corporate saving through capital consumption and retained earnings. The net effect will be to depress Japan’s current account, probably into negative territory.
(A. Gary Shilling is president of A. Gary Shilling & Co. and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” The opinions expressed are his own. This is the third in a five-part series. Read Part 1 and Part 2.)
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