A totally new danger -- new to me, anyway -- was brought to my attention today by Ambrose Evans-Pritchard in his article It is Japan we should be worrying about, not America. I'll attempt to translate some of it into plain English.
The basic problem is that Japan has borrowed wayyyyy too much money. They've been even worse than the US, and now owe more than twice their total GDP. They may, in the not too distant future, be forced either to default (stop making debt payments) or to print massive quantitites of new money, thus collapsing the value of the yen.
When you loan a government money by buying its bonds, there is always a risk that it will never give you your money back. You can buy insurance to protect yourself against the risk of not being paid back. It currently costs $63 per year for every $10,000 you've loaned to Japan (the loan in this case is for 5 years). That's a much higher insurance premium than for other major governments; the same sort of insurance only costs $22 if your loan was to the United States. These insurance costs for Japanese government debt have spiked higher just recently, a sign that people are becoming more doubtful about Japan being able to handle its debts.
Part of the problem is that the new left-leaning Japanese administration wants to... well, "borrow and spend," in an attempt to extricate the country from a horrible deflation. However good the intentions, Japan is already in debt up to its eyeballs and this is only making the fiscal situation more dire.
On top of the new round of borrowing and spending, Japan has a heck of a lot of elderly people, and various retirement funds are having to sell off Japanese government bonds in order to give people their retirement money. When all these old folks were still working, their pension funds were buying government bonds, i.e., they were loaning oodles of cash to the government. Now it's time for the government to start giving that money back.
And here we come to the Spooky Quotes section of the piece:
If Japan's bond rates rise to global levels of 3pc to 4pc, interest costs will shatter state finances.
No one knows exactly when a country tips into a debt compound trap. But Japan must be close....
"The debt situation is irrecoverable," said Carl Weinberg from High Frequency Economics. "I don't see any orderly way out of this. They will not be able to fund their deficit. There will be a fiscal shutdown, a pension haircut, and bank failures that will rock the world. It is criminally negligent that rating agencies are not blowing the whistle on this."
"Irrecoverable" is not a word one likes to see in an econ piece. It means, as I said earlier, that Japan is stuck with two really awful choices. It can default on its debt outright-- thus saying "Screw you!" to its lenders. Or it can print brand new money to pay its bills, eventually collapsing the value of the yen. When the yen gets decimated, that's essentially another way of defaulting, because although they will be paying people back, they'll be paying them back with toilet paper.
Now, I really doubt that they would simply stop making payments (default). If they did, the amount of interest that other major governments would have to pay to their lenders would shoot up rapidly, because everyone would be spooked. Government debt would no longer look like the "safe haven" investment it's assumed to be. People would be a lot more skittish about loaning money to governments, and would demand a lot more interest. Skyrocketing interest rates would completely crush stock markets, bond markets, and real economies worldwide. Frankly, I'm not sure Japan could even get away with it; other governments would presumably intervene somehow to avoid a catastrophic global deflation.
Option #2, then: Japan starts printing money to pay its bills. That dilutes the value of existing yen, so the value of yen starts to go down. This often ends in a sudden loss of confidence and Japan could then experience hyperinflation. When Thailand experienced a currency collapse in 1997 it spread to a number of other Asian currencies like an epidemic disease. If one of the world's major fiat currencies implodes, what happens to the others? Aren't all purely paper currencies impugned when one of them utterly falls apart? But if so, then this scenario might end in global hyperinflation; a collapse of all currencies (to varying degrees, but in all cases disastrous). Sure, there might be some little ones that would survive (maybe the Swiss would return to strict gold backing), but such currencies would not be plentiful enough to facilitate global trade as we've come to depend on it.
I certainly hope I'm missing something here. If Japan's situation is "irrecoverable" and if they could drag the rest of the developed world down with them, then it might not matter what Western central banks do from here on out.
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