Ichiro Suzuki
The Japanese government keeps piling up debt, as it has been well known for a long time. In the aftermath of a spectacular asset bubble’s bust at the beginning of the 1990s, the government shifted its gear to massive stimulus programs, in response to collapsed demand. The Japanese economy went into a long and persisting period of adjustments of excesses. Bankruptcies ballooned and Corporate Japan relentlessly shrank their balance sheets, shedding debts and dumping not readily necessary assets, the majority of which was real estate. Unprofitable divisions were shut down, taking jobs with it in a land of lifetime employment. Management nonetheless tried to save as many jobs as possible, and labor accepted small wage cuts in exchange for no or minimum layoffs. (Such deals have suppressed long-time expectations for wage hikes, sowing the seeds for mild deflation that persisted for a generation.)
Were it not for the government’s fiscal stimulus, the Japanese economy would have sunk into a much deeper hole. Through aggressive balance sheet readjustments, Corporate Japan rapidly became cash rich with little prospect of deploying it. They were too scared to use the cash in the rapidity of the changing world that was beyond their scope. On the left hand side of their balance sheets there was lots of cash, which was deposited with banks. Amid severe shortages of promising borrowers, banks in turn lend the money to the government, piling up Japanese government bonds on their left hand side of balance sheets, too, hence compressing their yield to maturity all the way down to zero eventually.
With extremely low cost funds at hand, the Japanese government splurged. Never mind that the debt to GDP ratio went through the roof of conventional wisdom. The government issues debt securities in Japanese yen and 90% of the debt holders are Japanese institutions or individuals. There is very little chance that the investors go on buyers’ strike on JGBs to demand for higher yields.
Everything is fine, modern monetary theory (MMT) says. The Japanese government is facing no immediate fiscal crisis despite the debt to GDP ratio in the north of 250% of GDP. Aggressive printing of money did not become an immediate cause for inflation. The price run-up in the last few years was rather attributed to global supply chain dislocation associated with the pandemic and the geopolitical development in Ukraine. So there is nothing to worry about. Print money and keep spending it, and nothing is going to happen.
However, here is a catch. The currency has taken its toll, after 30 years of aggressive printing money. In early 2022, the Japanese yen began to slide against other hard currencies but especially against the U.S. dollar. The major reason behind the slide has been interest rate differentials between the two countries. The aforementioned factors drove Japan’s nominal inflation to the north of 2%, the Bank of Japan’s stated target. The BOJ’s very modest move to lift interest rates in 2024 brought the JGB ten year yield to only 1%, though considerably higher than zero. This is leaving real interest rates distinctly negative at a time when inflation is running above 2%. Japan’s negative real interest rates stands in sharp contrast to noticeably higher rates in the U.S., where ten-year Treasury note is yielding well above 4.5% as opposed to its inflation rate almost comparable to Japan’s. Weaker yen has always been wished for by policy makers and Corporate Japan since the Japanese economy always struggled to cope with the ‘ever-rising’ yen.
Their wish was granted, but too much of a good thing has proven to be acutely detrimental. The yen’s relentless weakness has been exerting mounting negative pressure on the economy. Supply dislocation drove crude oil prices up, and a weak yen made it worse for the Japanese economy. The trade account tumbled into deficit. Consumers are crying on elevated prices of electricity and gasoline but there is little policy makers can do about it other than handing out some subsidies. Should the Bank of Japan embark on more aggressive rate hikes to lift the value of the yen, it would damage the economy, especially crushing small and medium enterprises with precarious balance sheets.
In addition, higher interest rates would increase interest rate payment burden on the government, which would prefer to minimize such costs to the extent it is possible. In the proposed FY 2025 budget, interest payments account for a quarter of total outlays, assuming 2.0% interest rate. Higher interest rates in the market could easily eat into other spending items at a time when a greater amount is needed every year for social security and defense. The Ministry of Finance is put in an unenviable position of balancing these needs and and what the market allows them to do.
Modern monetary theory worked magic, until it has stopped doing so. Something has to give. There are no such things as free lunch.
About the author: Mr. Suzuki is a retired banker based in Tokyo, Japan.
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