Let’s see now…Japan now sells more adult diapers than baby diapers. Its total population peaked in 2004, its working population peaked in 2009 and it has 40,000 people above the age of 100. Its population is set to drop by 40 mn people (30%) by 2050. That same 25% is the proportion of the population above 65. Total debt, household, private, and public combined is running at a whopping 530% of GDP, up from a bad enough 387% in 1989. At 1.4% Interest cost, it means that 7.4% of GDP goes for Interest payments, while household savings, a big generator of worldwide surpluses, is down to 2% of GDP. In fact, it is expected to enter dissavings by 2014, as retirees start to pull in their savings.
Declaimer: This article written was originally in October 2010, and some of the data points may be outdated.
A banker once told me that one of the indicators of (corporate) Bankruptcy is the no of CFOs a co has had in the last 3 years. If we use the same ratio for Japan, it has seen 7 Finance Ministers in the last 3 years. Even our Real Estate cos have not done as well…
Now look at Govt finances.
Now look at Govt finances. 28% of revenue goes to Interest, at an average Interest rate of 1.4%. If the rate doubles, the Govt is now spending 56% of its revenue on Interest; at 40%, you are a basket case equivalent to Argentina, Greece, or Zimbabwe. Quite simply, the zero interest rate regime is a one-way street; like the famed Hotel California of yore, “you can check out any time you like, but you can never leave”.
So how do you get out of a mess like this? I fancy myself as a turnaround expert, but I can’t see a civilized solution to this mess. The Austrian (school) economist would prescribe debt destruction on an unprecedented scale, or a ‘reset’, wherein the savers who ‘invested’ the excess savings (say, 400% of the 530% of GDP outstanding as debt) just see a gargantuan (sovereign) default. There are many ways of doing this:
Inflate away the debt.
- Inflate away the debt. This seems obvious and to many, the only solution. The only problem with this is that a sudden 400% inflation (assuming the same human activity in the economy, with some 400% of GDP added to the stock of money) will have a multiplier. So the actual inflation seen may go into the 1000s, which will completely erode the credibility of Govt, raising Interest Rates into the stratosphere. Once that happens, Interest Rate increases will far outstrip the Inflation Rates, creating a vicious spiral, that will go out of control, Zimbabwe (and Argentina) style.
Remember, I am compressing all the above numbers into a short time frame just for ease of understanding. This will actually have to be stretched over at least a decade if not more, to bring down the average annual inflation indicators to sensible numbers. Exactly when the number gets past the red line, triggering panic among Japanese savers/ investors is the dangerous end-game that is awaiting some legendary Finance Minister….a Bismarck to young Japan, a Hitler to old Japan.
- Otherwise, after Bismarck….Hitler! I say Bismarck because one of the lesser things he is known for is the creation of the Welfare State, which started this business of robbing the unborn voter/ Peter to pay the aging voter/Paul. If the country just initiated the voting reform of disenfranchising the aged voter (above 65, say), that would be a start.
From there to the fascism of Hitler. Just shoot the problem, or send it to the gas chambers of Auschwitz…the savers of Japan, who are now mostly over 65, have trusted the Govt with their money. If you want to default, and still remain in power, you have to do away with your creditor. The $20 trn that needs to be defaulted on by a $5 trn economy, belongs to a set of people who have been saving 32% of GDP for the last 35 years. They have already been getting near zero interest, so they are used to being gypped for the last 20 years at least. Now, when they start asking for their principal back, why not just shoot them?
One way of doing that is to make medical services very expensive (with steep service taxes, otherwise the Doctors will take over the Govt), and take away State funding. People might choose to die quietly in their homes. If they come out on the streets, use the principle of patriotism to promote hara-kiri (or was it kamikaze) for the country. Okay, this train of thought is not for a family magazine, so I shall desist…but not before making the point that debt destruction is best done with death and destruction!!!
- Demonetization is a dangerous game and would need a long-term coordinated effort that would need a visionary in power. First, you issue new currency at a ratio that is unfavorable to the accumulated stock of money, i.e. the savers. Then, you keep issuing new money, which keeps the inflation rate high, but back it up with high taxes (especially indirect taxes). For God’s sake, don’t spend the money now; smaller Govt and no further highways to Hokkaido! That will put the Govt back into a surplus, with which it will pay back its accumulated mountain of debt (now reduced to a molehill).
The Fx markets will figure it out, and the currency will go through a huge shock, the minute the markets figure out the debt (and currency destruction) strategy of the BoJ. A generation of young Japanese will live through a ‘soft Depression’, with high taxes and low real incomes. They will take care of their now-in-penury older generation, praying they die, but unable to kill them because of high real estate prices (which will go through the roof, during the demonetization). Family ties will be closer, glued together by the high prices of real assets. Inheritance will be the only hope of the young, for home ownership.
- Last, and most likely….something that nobody expects….nothing!!! This might just turn out to be much ado about nothing! Outsiders are going to town about debt destruction, assuming street riots and civil war. But that is the Western paradigm, where money matters a lot, savings even more, simply because consumption and lifestyle is the objective of life. But in a world where saving is habitual, the marginal utility of savings is zero (and therefore, the marginal disutility of dissavings is also almost nothing).
Inside Japan, life goes on as usual. Young Japan continues to save, corporate Japan continues to run up large Current Account surpluses and the Govt continues to run deficits and borrow with impunity. Interest Rates might well go even lower, shocking the Western trading floors into covering their Yen and JGB shorts yet again.
The best way to understand that is to look at India, a country of continental proportions with myriad cultures interacting with each other, in the same way that the world economy functions. If the Jains of Jaipur are inveterate savers, the Punjabis of Lajpat Nagar are inveterate consumers/ borrowers.
Now look at debt destruction, when it periodically happens in India. Jaipur is at the receiving end of every scam, from Harshad Mehta to CRB, Prudential Capital, Ketan Parekh, et al. It periodically contributes a fifth of the scam losses every few years; the rest is provided by Gujaratis. Inside Jaipur, there are these ‘domestic defaults’, as big jewelers routinely go bust or decamp with private savings from the black money market. So what happens? Nothing…
Some newspapers see an increase in circulation, the dust settles down and everything goes back to ‘normal’. The city returns to saving for the next blowout. The key point that economists are missing here is the different behavioral reactions to the same stimulus. A debt default is a big deal in an economy (like the US/ Europe) where savings are short, but it is not a big deal in an economy that not only has a large stock of savings, but also a continuous flow of savings to replace the stock lost due to debt destruction. Ask the Jaipur Jain whether he remembers the many scams where Jaipurians have lost money.
This is incomprehensible to Western thinkers but is easier to understand by us Indians. The Indian Govt has been forever looting its citizens (remember Indira Gandhi’s Loan Melas, the NPA crisis, and 16% inflation), without much loss of credibility. It has forever had low international Credit Ratings, but its Govt borrowing program has never seen a hiccup. Even its international borrowing programs have found NRI savers in the worst of times. The ratings did not matter.
