Reconstructing Japan could cost about $180 billion, or 2 to 3 percent of Japan’s annual output of goods and services as measured by gross domestic product. That represents a massive rebuilding project. How will indebted Japan finance it?
One solution is to sell foreign holdings. All told, Japan is the second-largest foreign purchaser of US Treasuries, behind China. It has effectively kept demand for US debt on the rise and American interest rates low.
Even if the Japanese decide not to sell off their holdings of US Treasuries, the government might cut back on further purchases as it focuses on its own rebuilding efforts, Dan Fuss, manager of the $18.5 billion Loomis Sayles Bond Fund, told Reuters. “A big buyer of bonds is taken out of their market. Japan will be less able to add to their reserves and less able to buy Treasuries.”
That would put upward pressure on US interest rates (including what consumers pay for credit) and inflation. The dollar would probably take a hit.
The other option, though, is for the Bank of Japan to print money to finance reconstruction. That’s not a good long-term solution for a country so mired in debt. However, in the short term, “we have reached a critical point where the disaster is so severe the BOJ will engineer liquidity mechanisms that will reduce the likelihood of forced selling in the Treasury market,” says Christian Cooper, head of US dollar derivatives trading at Jefferies & Co. in New York.