Japan Running Out of Money

By Danny Esposito for Investment Contrarians | Jul 17, 2012

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Recently, I penned an article describing Japan’s government debt woes. The country has a 220% debt-to-GDP ratio, by far the largest government debt-to-GDP ratio in the world.

I also noted that Japan’s government debt was circulated within the country: over 90% of Japan’s government debt is owned by the Japanese people and the Japanese corporations.

That is about to change, as Japan’s demographics reveal that more people are retiring than entering the workforce. As more people retire, they will naturally spend the money they saved and not buy new government debt.

As a matter of fact, for the first time in nine years, the Japanese Pension Fund sold more bonds than it bought because of the fact that more retired people are asking for the money they saved.

As if this situation weren’t bad enough, other circumstances are hurting Japan’s government debt situation. Japan relies very heavily on exports for its economic growth.

Its largest economic partners are China, Europe, and the U.S. Since China’s economic growth is slowing and the U.S. economy is rolling over as well, Japan’s exports are weakening, impacting the country’s economic growth. Since Europe is in a recession, this further exacerbates the decline in Japan’s economic growth model.

Due to the unfortunate tsunami disaster that ravaged the country, Japan has no energy sources to speak of and so must import all of its energy needs. Higher imports of energy coupled with fewer exports due to the lack of economic growth worldwide means the country has now begun to run current account deficits.

In 2011, Japan had a current account deficit for the first time in decades.

When a country has a deficit, it needs to pay for it by creating more government debt. This is why the finance minister in Japan has warned his bickering colleagues that the country will run out of money by October of this year if they do not come to an agreement and pass the deficit spending bill to cover the nation’s expenses.

There is no doubt that the politicians will come together and form some type of agreement to print the money and increase the government debt. However, this just highlights how bad the situation is getting in Japan.

With economic growth languishing and government debt increasing, the Japanese government passed a bill to double the sales tax in the country in order to help pay for the deficit.

Currently, the interest rate on government debt is below one percent. Even at these low levels, 50% of all tax revenues—the money that the government takes in—goes to service the government debt.

With little economic growth and current account deficits now the norm instead of the exception, if Japan needs more funding, it will need to go outside the country to fund the government debt, but foreign investors will not accept low interest rates since the debt-to-GDP is so high.

If interest rates rise to between 2.5% and 3.5%, 100% of all tax revenue would go to service the government debt, leaving nothing else to pay for energy imports or for other services that the country depends on.

The situation in Japan continues to deteriorate, and the fact that economic growth worldwide is slowing rapidly is exacerbating the situation, creating current account deficits. Japan will do everything it can to ensure interest rates won’t rise, but being forced to finance government debt outside the country may throw a serious wrench into its plans.

Tags: China, economic growth, government debt