By Chaahat Khattar
Mathematics is always fun and it is even funnier if you explore something new in it. Japan recently did. Japan’s economy has been ballooning so much (catch the sarcasm in it) that it took Bloomberg not much time to introduce a term we did not hear of before- Quadrillion. In August 2013, Japan’s public debt crossed 15 zeroes mark which looks like 1,000,000,000,000,000 Yen. To make things sound a bit sophisticated (possibly not as much embarrassing), Bloomberg went on to term this number as a 100 Trillion which is definitely not as much fun to sound.
As per Organisation for Economic Co-operation and Development (“OECD”), the economy of Japan is the third largest in the world by nominal Gross Domestic Product (close to USD 6 Trillion), the fourth largest by Purchasing Power Parity and is the world’s second largest developed economy. This little nation (only by virtue of its size) is world’s third largest automobile manufacturing country (Toyota, a Japanese automobile major is world’s biggest automobile company), has the largest electronics goods industry (Sony Electronics is a market leader in several segments such as television, gaming consoles, commercial appliances, cameras etc.), and is often ranked among the world’s most innovative countries leading several measures of global patent filings. Japan is the world’s largest creditor nation, generally running an annual trade surplus and having a considerable net international investment surplus. As a matter of fact, United States of America owes Japan around USD 1.1 Trillion making Japan the second largest lender to USA, just couple of billions short of People’s Republic of China. Japanese economy after facing a short-term recession as an aftermath of disastrous earthquake and tsunami in 2011 bounced back and The Tokyo stock market has surged about 65 percent since last fall. In the second quarter, the economy expanded by 3.8 percent, which is faster than other developed economies and the moderate inflation which is necessary for an economy to grow is back.
With all these rosy numbers and accolades around, it is so hard to believe that such a nation is struggling and is just blowing off recession and financial meltdown every other day. Japan’s public debt is ever increasing. It is 233% of the Gross Domestic Product (“GDP”) which is worse than US’s 80% and even worrying than Greece’s 155%.
There are several reasons for this position of Japan. The most important being the stimulus packages Japan’s government has been announcing in the recent past. Almost after every quarter the government has been announcing multi billion dollar stimulus packages and then the Bank of Japan (Central Bank of Japan) announces separate stimulus packages like the USD 117 Billion one which it announced in the beginning of 2013. This is too much for monetary easing and can lead to financial institutions becoming depended upon the public money.
Economic recessions have impacted Japanese economy severely. Exports have fallen down and country has moved from trade surplus to trade deficit. Going back to the point of stimulus packages, the investors lose interest in such an economy which has pushed down the value of government bonds in Japan hammering the value of Japanese Yen (“JPY”) and as JPY gets badly affected, the oil import bill for Japan has increased the net import bill.
The demographic situation is also a reason to be blamed on for Japan’s economic catastrophe. This is more of a natural factor leading to unwanted consequences. The young population in Japan is low, birthrate is low, death rate is high (Japan is losing close to a million people every year), immigration is low but number of Japanese people over the retirement age is very high (The average Japanese farmer is 66 years old, his farm is less than five acres in size, and he is the beneficiary of his share of about $50 billion of annual government subsidies) which puts pressure on the social security system of the nation.
Now Japan has been caught up in the vicious circle of debt. As much as the government has raised, it is required to pay more as interest payments, as a result of tsunami, the spending on public works have increased leading to more borrowing and also as more money is being spent on social security, government needs more funds again leading to higher interest payments on increased borrowing.
Someone might wonder that if the situation is so bad in Japan then why we are not forecasting a US or European crisis like situation for Japan? The answer is very simple. Most of Japan’s debt is internal unlike US or European nations. In numbers, Japan owes USD 3 Trillion to external sources which is less than its GDP. So a breather for Japan is that the money is flowing internally only and the government ends up paying interest to its own banks and it does not have to go through the real test of bonds markets for raising funds from external sources.
In order to bring the atrocious budgetary deficit under control, Japan under the leadership of Prime Minister Shinzo Abe have taken three primary steps so far which journalists refer to us “Three Arrows” or “Abenomics”. One we have already discussed about giving financial stimulus and infusing capital into the businesses. The other one deals with monetary easing. With due help from Bank of Japan, knowingly or unknowingly Japan has been printing more currency (increasing money supply in the economy) in the recent past in order to increase inflation. By doing so Japan has planned to increase consumption thereby bringing GDP on track. The third arrow talks about structural reforms in the economy. To help unlock that money, Abe has aimed his third arrow of economic policy at growth-inducing reforms from trade liberalization to steps elevating the participation of women in the workforce.
So far, the Abenomics has been influential but definitely not revolutionary.
The growth rate is positive and so is inflation but that could be short term and the three arrows might not be sustainable in the long run. Japan for the first time since 1997 has also increased sales tax from 5% to 8% which was expected to generate close to USD 8 Trillion in revenues for the government but at the same time to cushion it up, Abe announced a USD 5 Trillion stimulus so the net realizable benefit of USD 3 Trillion to the government seems like peanuts and questionable. Also, Japanese firms might just hit back with lower profits to pay lower taxes that can lead to worst-case scenario. Will Japanese exports really increase over the coming months and years? In a theoretical, static world, maybe. But in the real, dynamic world, not a chance, at least not in a sustained way. Why? Two main reasons: First, strong yen during much of the time period before 2013 caused traditional Japanese exporters to move production facilities overseas to much cheaper areas. As a result, many “Japanese” goods now are actually Chinese or Korean or Filipino or Vietnamese. Therefore, the lower yen does not increase shipments of these products from Japan. In fact, many of these goods now are imported by Japanese retailers at increased prices, reflecting the yen’s decline. Other nations will retaliate against a lower yen. They will monetize their own debts, increasing the supply of their own fiat currencies, driving down those currencies’ values. If Japan opts for cuts such as cut on its spending or social welfare, it will not help much as that will reduce demand in the system and it will be like a situation where a struggling firm multiplies its revenue by sacking thousands of employees or by introducing austerity measures which provides a cushion for short run but in the long run such firms end up being acquired or filing for bankruptcy.
Now the point of discussion is that what Japan should do? It seems like it is into a hole it cannot really get out of. The real thing is that yes it is true Japan is in real mess but what it can do is that try not to dig the hole deeper and instead try to refill the same and Japan itself will come to a better position. Growth will be the key to Japan’s rebound. Japan will need to focus more on multiplying its GDP growth, ensuring inflation in the economy and controlling upon the stimulus packages it has been giving. Japan enjoys the fact that it can control the interest rate it has been paying on debt as most of it is internal so it can take up the risk of engineering a higher inflation oriented economy. This will further help Japan in reducing Debt-GDP ratio which will make Japanese Government Bonds more lucrative to buy thereby generating more of external money supply in the economy. Government should promote tourism, immigration and bring back the industries it has lost when JPY was becoming stronger.
In a nutshell, Japan has an interesting time ahead. In 2020, Tokyo will be playing host to Summer Olympics and for that Japan needs to have a sustainable and extremely stable economy. No wonder the government is using all its arsenal in order to bring the economy back on track but more than that it must know that Japan is a developed nation and the industries it has must be sustainable enough to create cushions for themselves and letting people have more income enabling them to go for shopping and boost the economy.
 The Economist
 The New York Times
 Japanese Linguafilt Blog
Chaahat Khattar is an ardent economist and is working with an international consultancy firm. He is an MBA and pursuing Masters in Business Laws. He is also a Harvard University alumnus and a certified financial modeller. He has keen interest and experience in authoring research papers and case studies and have contributed to various renowned journals. Chaahat can be reached at firstname.lastname@example.org