Investment Contrarians

Japan Could Be the First to Fall

By for Investment Contrarians |

It seems the term “financial crisis” has become synonymous with the European Union.

One of the most recent headlines noted with alarm that government debt within the European Union had reached a record. That is, debt-to-gross domestic product (GDP) reached a record high of 87.2% at the end of 2011, further exacerbating the financial crisis.

Of course, quietly here in the U.S., government debt or debt-to-GDP has approached 101%, but we are not as of yet falling apart like the European Union.

Of course, no one is talking about Japan. Currently, Japan’s government debt or debt-to-GDP is 220%.

When Japan’s financial crisis hit back in 1989, it began a deflationary spiral that has persisted until today: over 20 years later. Japan’s stock market—over 20 years later—is still over 75% below its high reached at the peak of the financial crisis, back in 1989. Japan’s GDP growth rate has not surpassed one percent for over 20 years.

If Japan has such a high government debt level, then the European Union and the U.S. can avert a financial crisis as well since Japan has had no issues for over 20 years.

The problem with this theory is that Japan’s government debt was issued to its citizens and kept within the country since the financial crisis hit in 1989. The government debt of the European Union and the U.S. are owned by entities outside of their respective countries.

It is equivalent to saying that the Japanese government debt was kept “within the family,” which has prevented another financial crisis, at least until today.

Japan kept its banks alive and kept its massive government debt going by issuing bonds at very low rates to its citizens. The citizens bought the government debt and accepted little money in return, but it did not destroy the citizens’ lifestyle, because the country experienced a sustained drop in the price of goods and services: deflation.

The problem today is that more Japanese citizens are retiring. There are currently more retirees than there are workers to pay for those retirees.

Not only does this mean that tax revenues are falling, which further increases government debt, but also now the “family” is not large enough to continue buying the massive amount of government debt that needs to be issued.

The reason retirees bought the government debt was to have money for their retirement. Now that they have retired, they need to live off of that money, so they are cashing in their government debt bonds.

This is forcing the Japanese government, for the first time in 20 years, to look outside of the country for someone to buy its government debt.

The bond market sees 220% debt-to-GDP and says it is going to need much higher rates to take on that risk. Shut out of the bond market, the Bank of Japan has no choice but to print money to buy its own government debt, and that is exactly what it is doing now.

The problem is that, as it continues to print money, it will eventually lead—as history has shown—to hyperinflation. The Bank of Japan has explicated said that, after more than 20 years, it is aiming for one percent inflation.

The reason why this could lead to the next financial crisis is that, if the Bank of Japan is successful and inflation begins to set in, Japanese citizens could begin to spend today, in order to avoid higher prices in the future—especially after experiencing deflation for over 20 years.

With the massive amount of money in circulation and growing, a large money supply chasing few goods means higher prices for those goods—and, as history as shown, the possibility of hyperinflation and the next financial crisis.

The reason why the European Union and the U.S. don’t have the luxury that Japan did is that institutions and central banks outside of their respective countries own their government debt. They will not tolerate what Japan has done to itself for the last 20 years.

Japan’s time is up. It could be the first country to fall.

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  • johnpro2

    I like the article ..we do not hear a lot about Japan even though it is the 3rd biggest economy. In the end, it is the lenders who lose their money, either by default or whittled away by inflation.

  • brucek

    Yes, Johnpro, and the lenders are any of us who have Japanese stocks/bonds, etc. in their retirement portfolios, correct? Not sure where the safe places are anymore, under the old mattress is looking better and better. Seems like every gov't in the world is spending out of control, probably no more than the US, but as long as the 'investors' are investing, and there's more taxes to steal from it's citizenry, they'll keep on it.