Japan's debt earthquake is rumbling

Junji Kurokawa/AP/File
Japan Ground Self-Defense Force soldiers discuss during a cleanup operation one day after the March 11, 2011, earthquake and tsunami in Kesennuma, Miyagi Prefecture, northeastern Japan. Cleanup costs are speeding up the arrival of Japan's other disaster: burgeoning national debt.

Japan already looked like a slow-motion train wreck before the March 11 earthquake and tsunami hit the nation's coast with such tragic and devastating effect: more than 14,500 fatalities, an estimated $12 billion in damages. It will take years for Japan to rebuild.

Unfortunately, the island nation might not have that much time to recover. Analysts have long doubted Japan's ability to continue financing its huge government debts internally. In my book "The Age of Deleveraging," published last year, I predicted that Japan would hit the wall in the next five to 10 years. Japan's March tragedy, its worst since World War II, has accelerated that timetable.

Since the early 1990s, when Japan tried to offset the twin collapse of its housing and stock bubbles with a round of deficit spending, its debt has been building steadily. From 11 percent of gross domestic product in 1991, government debt soared to 121 percent last year. Throw in intragovernmental loans and other obligations, and the figure leaps to a whopping 227 percent – the highest debt level of any major nation in the world.

The Japanese government has so far avoided the consequences of that debt burden because Japan's citizens own the lion's share of the debt. And they are far more patient than international bond buyers would be. Foreigners own only 5 percent of the government debt, compared with 50 percent of US Treasury bonds. The chink in Japan's armor is its reliance on exports.

Ending nearly three decades of a borrowing and spending binge, Americans are now on a saving spree that has driven up their saving rate from its 0.8 percent low in April 2005 to 5.8 percent in February 2011. I believe that rate will head back to double digits. That slowing in spending growth will curb the US appetite for the exports on which Japan and many other economies depend for growth. If Japan's trade and current account balances fall into negative territory, as is likely, it will be forced to import capital and pay much higher world market interest rates.

Japan's citizens may be satisfied with a 1.24 percent yield on a 10-year Japanese government bond. But in world markets, that rate would have to jump 2.7 times just to match Germany's equivalent financing costs, 2.8 times to match America's, and 4.4 times to match Australia's. All three nations have far less onerous debt than Japan does.

The effects of such a rate hike would be devastating for Japan's deficit and debt outlook. Each percentage point rise in the government's average borrowing cost would hike its deficit by about 7 trillion yen ($87 billion). If Japan's interest rates equaled Australia's (more than a fourfold increase), its deficit would rise 66 percent – a huge increase with no rise in spending!

That could initiate a self-feeding debt spiral unless the government slashes spending elsewhere. But such action might so weaken the already morose economy that the deficit, even without interest costs, would end up rising, not falling.

It was probably the haven appeal of Japan with its serene culture and stable if flat economy that fundamentally propped up the yen for two decades. But with the speeding up of the train wreck, that haven image will probably disappear. Ever-pessimistic Japanese consumers may retrench even further, intensifying the smashup.

Out of the wreckage would emerge a much stronger Japan, but the financial recovery could be every bit as prolonged as the post-tsunami recovery that the island nation has already begun.

A. Gary Shilling is president of an economic consulting firm in Springfield, N.J. His latest book is "The Age of Deleveraging."

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