The Next Financial Ticking Time Bomb
While many eyes are focusing on Europe and America when it comes to the next financial crisis, one sector that people aren’t focusing on is the bond market in Japan. Many investors might not realize it, but Japan might be the next financial ticking time bomb.
How does a financial crisis in the bond market affect the average person? On a basic level, the bond market prices move based on supply and demand, which affect interest rates. With greater demand in the bond market, this pushes up prices and lowers interest rates. A lower interest rate obviously helps prevent a financial crisis from occurring, as it takes less money to pay off the debt—much like a credit card interest rate being reduced.
Conversely, if investors are worried about their funds in the bond market, this will cause selling or a reduction in purchases, a decline in prices, and a rise in interest rates. For countries that have a large amount of debt, higher interest rates will cause a financial crisis, as the funds available to maintain that debt are limited and could run out.
Much like a person who racks up very high credit card debt, at some point the income from the person’s job is not enough to make the minimum payment, let alone pay down the principal. The end result is a financial crisis.
Japan has a massive debt-to-GDP (gross domestic product) level of 211%, much higher than America’s or even Greece’s debt burden. (Source: Trading Economics, last accessed January 7, 2013.)
Even though Japan’s 10-year bond interest rate is only 0.79%, a full 25.0% of government revenue is being spent to service its huge debt burden. If the bond market lost faith in the ability of Japan to pay back its obligations, the bond market would have a sharp selloff, and a massive financial crisis would ensue, certainly spreading globally. (Source: “The Greece of Asia Japan’s Growing Sovereign Debt Time Bomb,” Der Spiegel, January 3, 2013.)
As it stands right now, the reason the bond market in Japan is so complacent is that most of the money being raised is from domestic sources. However, Japan’s population is aging, which will necessitate redeeming funds, and the debt level continues to increase to such a level that external investors will be needed.
I personally don’t believe that international investors would be willing to lend Japan money at less than one percent for 10 years when there are far better alternatives in the global marketplace.
Once the bond market starts to feel the effects of international investors, this could be the first crack of the next major international financial crisis. There is no way Japan can cope with a weak bond market. While Japan is trying to prevent this by having the central bank print money, at some point, this mechanism will stop working and investors will lose confidence.
Even the Bank of Japan Governor, Masaaki Shirakawa, freely warns, “If we don’t deliver fiscal reform, then the yield on Japanese government bonds will rise.” (Source: Der Spiegel, January 3, 2013.)
Most Americans are unaware of the danger if a financial crisis were to begin in Japan. Many international markets are interlinked, with financial institutions predicated on the assumption that the global bond market has a certain level of stability.
If a panic were to ensue in Japan, the third-largest economy in the world, this could certainly spread to every major developed nation, including America.
The danger of a weak Japanese economy has emboldened voters into electing a new Prime Minister, Shinzo Abe, who has stated his intention of a massive stimulus plan. Reports are coming out from Japan that the Abe government will shortly announce a $136-billion fiscal package to help stimulate the economy and prevent a financial crisis. (Source: “Abe Seen Spending 12 Trillion Yen to Boost Japan’s Economy,” Bloomberg, January 7, 2013.)
The bond market has begun taking increased spending into account as the 10-year Japanese government bonds increased to the highest level since August 21, at 0.84%. The 30-year government bond is now at a 13-month high, yielding two percent. (Source: Bloomberg, January 7, 2013.)
The Japanese bond market is still sanguine due to the nature of the constituents, namely domestic investors, who are buying in this market. If the bond market continues to weaken over the next few years and interest rates rise substantially, Japan could begin to see the same sort of financial crisis that many parts of Europe have experienced, namely the inability to maintain and repay its debt, causing further panic in the bond market and driving interest rates even higher.
Due to the level of debt in the Japanese bond market and the extent to which financial institutions are interlinked globally, this situation could unravel into a massive global financial crisis. Obviously, no one can predict the future; however, we should be aware that there are potentially dangerous pitfalls for the global markets over the next few years.