Thursday, January 27, 2011

Japan's Footsteps

Today, S&P cut Japan's credit rating for the first time in 9 years, down to AA-.

Following WWII, Japan enjoyed abundant growth through the 1970s, rising to a fever pitch during the 80's, but beginning in 1990 has suffered economic decline, even during times when consumer spending was immense and the world economy favored Japan as much as one could hope. Japan's industries are still highly competitive and successful, and they continue to produce some of the best cars and electronics in the world. But there was an unspoken counterbalance to Japan's success, which was hardly reported on at the time, nor in recent news either.

In the 80's, while the world was heaping praise over Japan's economy, with ongoing predictions that it was set to become the next world economic superpower, there was an elephant in the room: Japanese growth went hand-in-hand with massive government debt. Earning a million dollars in sales is good, but not if you have to borrow two million dollars to cover production costs. Even those who knew about Japan's borrowing at the time might have viewed it as sensible infrastructure spending that would one day result in healthy net profits. But that is not how it played out, or if it did, it is Japanese industry who now enjoys the benefits, while the government and people are saddled with debt.

The entire Japanese economy has been stuck in a protracted recession since around 1990, and compounding the problem of earlier spending, the Japanese government succumbed to Keynesian policies of additional government spending projects in futile, unsustainable, and ultimately fruitless attempts to stimulate their economy. Today, Japan's debt situation is worse than Greece's (who has been facing civil unrest over their credit issues) with a whopping 200% public debt to GDP ratio, which is second in the world bested only by Zimbabwe. For as bad as U.S. mispending and debt are, we are closer to 75% debt-to-GDP, which is comparable to the better European economies like Germany.

From the CIA world factbook: Japan's GDP is $4.3T dollars, and public debt is 196% of that, which would be $8.5T. Tax Revenues are pretty robust at $1.8T (around 75% of the U.S. government's net income; consider Japan's GDP and population are both about a third of ours). Government spending is $2.3T.

I would say tax revenues like that are outrageous, but apparently the Japanese are okay with it. For years Japan has maintained a zero interest rate policy with quantitative easing, similar to ours, or rather the inspiration for ours, so their treasury bonds have been cheap. Even if government debt averages 5%, which is probably an overestimate, yearly interest payments would be $420B which sits easily within Japan's annual income. In fact, their national-debt-to-tax-revenue ratio isn't that far from what we have in the U.S., with the main difference being per capita taxes are way higher in Japan.

So, it is definitely not panic time for Japan, and the numbers don't even look terribly concerning, so I don't fully understand this recent downgrading of their credit rating, unless fewer tax revenues are forecast due to Japan's aging demographics.

I guess the point is: Japan offers evidence for the failure of Keynesian policies. Best the U.S. not follow their lead. Another point: China's situation today is not greatly different than Japan's back in the 80's.

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