Illustration by Kiji McCafferty
Strong Yen Won’t Survive Japan’s Fiscal Cliff
As its current-account surplus fades into deficit, Japan will be forced to import money at high international rates to finance its government debt. Huge amounts of money creation by the Bank of Japan could temporarily postpone the ensuing debt death spiral.
Monetary easing, however, won’t help Japan address the challenges presented by its rapidly aging population, which will result in restraints on consumption that slow growth and increase the cost of government-debt service as a share of gross domestic product. Furthermore, retirees are consumers, not producers, of goods and services, putting additional strain on those still working to produce enough for their own needs and for the elderly.
Yet, uniquely among major countries, Japan has the means to respond to this crisis. The decades of current-account surpluses and the related capital exports have created a huge pile of foreign assets. The Finance Ministry estimates that foreign reserves and investment assets, including $890 billion in U.S. Treasuries, total $3.19 trillion more than foreign holdings in Japan, as noted in Part 2 of this series. That’s the biggest capital surplus of any country. Japan could systematically liquidate those foreign holdings and use the proceeds to buy imported goods and services to support the growing number of retirees.
This idea, however, has two shortcomings. First, the Japanese persist in their “export or die” philosophy, and systemic trade and current-account deficits are anathema. Second, the resulting chronic trade and current-account gaps could imply chronic capital imports at higher interest costs, further threatening a government-deficit and debt spiral, as discussed in Part 4.
Last year’s earthquake and tsunami have brought this reckoning closer, with imports jumping and exports plummeting. Japan has essentially no domestic energy supplies, so imports of coal, liquefied natural gas and low-sulfur Indonesian crude oil have increased to offset the power loss from the shutdown of Japan’s nuclear reactors. In addition, post-tsunami rebuilding will require Japan to import much more steel, cement and other building materials, as well as food to replace tainted domestic supplies.
Since the earthquake and tsunami in March 2011, the Japanese trade balance has been negative -- its deficit in 2011 was the first since 1980. With Europe in a recession, at best modest economic growth in the U.S., and a probable hard landing in China, Japanese exports and economic growth will remain under pressure. This will be compounded by the drag on exports during the recovery from the natural disaster and by the continuing reliance on imports for energy and other needs to rebuild.
The strong yen, at least until recently, has been a concern for Japanese exporters and the government as their nation’s competitive edge atrophies. Japan once dominated consumer electronics, though TVs, digital cameras and game consoles have become old-tech, and producers there largely missed out on mobile devices. Also, businesses continue to move production offshore; last year, almost 62 percent of Japanese vehicles were assembled somewhere else. South Korean productivity continues to outstrip that of Japan. Higher energy costs and the supply-chain disruptions from the earthquake and tsunami have accelerated offshoring, as has the weak domestic economy.
Japan’s exports have become a surprisingly small share of GDP, only 15 percent last year. That’s not much more than the U.S.’s almost 13 percent and far less than Germany’s 47 percent and China’s 30 percent in 2009. Japan has traditionally targeted specific industries such as automobiles and consumer electronics for global domination with state-of-the-art efficiency, as noted in Part 1 of this series, but otherwise has a predominantly inefficient domestic-oriented economy.
The effects of the earthquake and tsunami, then, will probably accelerate the erosion of Japan’s current-account balance. There may be a selloff of Japanese government bonds in anticipation of the higher yields needed to attract financing from abroad to cover current-account deficits. The 0.87 percent yield on 10-year Japanese bonds would need to double to equal the yield on U.S. 10-year Treasuries.
The effects would be devastating for Japan’s government deficits and debt, which have relatively low yields throughout the yield curve. Each percentage-point rise in the government’s average borrowing cost would increase the deficit by about 7 trillion yen ($90 billion), or 15 percent.
As Japan’s government debt of 1,085 trillion yen matures over time, it will be subject to any higher refinancing rates. The average maturity of Japanese government debt is six years and 11 months. Yet 17 percent of that debt matures this year, 52 percent in the next five years and 76 percent in the next decade. Markets anticipate, so Japanese bonds throughout the spectrum will probably plummet in price and leap in yield at the first sign of a current-account deficit, maybe even before.
Foreign investors who sell Japanese bonds short would obviously prefer the yen to weaken, not strengthen as it has for years. It was probably the haven appeal of Japan with its serene culture and stable, if flat, economy, as well as other reasons discussed in Part 1 of this series, that have buoyed the yen for two decades. The accelerated timetable for a fiscal reckoning means that image will probably vanish and the yen will drop considerably.
(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 fifth in a five-part series. Read Part 1, Part 2, Part 3 and Part 4.)
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