Friday, October 26, 2012

Fiscal Stress in the World's Second Largest Debtor Nation


A relatively lightly covered story gives us an indication that the debt demons are now beginning to hound Japan, the world's second largest debtor in both nominal and when measured against GDP.  Since I hadn't posted an update on Japan's fiscal picture for some time, I thought that it was time to catch up.  For the purposes of this posting, I am using a conversion rate of 1 yen to 0.0125 USD or 80.5 yen to the USD.

In its latest release, Japan's Ministry of Finance shows the following central government debt data:


In total, Japan's central government debt is now 976 trillion yen, the equivalent of $12.127 trillion; this compares to $16.2 trillion in total federal debt for the United States.  With 2011's GDP of $5.867 trillion, this puts Japan's debt-to-GDP at 207 percent, the highest in the world after Zimbabwe.  Fortunately for Japan, most of its debt is covered by long-term (greater than 10 years in duration); 54.5 percent of its bonds mature in ten years or longer with only 8.1 percent maturing within the next year.  Here is a bar graph showing the maturity profile of Japan's outstanding stock of bonds:


The average maturity of Japan's bond stock is 7 years.

Here's a chart showing Japan's 10 year bond rate over the last five years:


Currently, Japan's 10 year bonds are yielding just over three-quarters of a percent, its five year bonds are yielding one-fifth of a percent and its one year bond is yielding less than one-tenth of a percent.

In case you were curious, here is a curve showing the yields on Japan's entire spectrum of bonds from 2 years to 40 years:


Here is a set of curves showing the historical yields on Japan's 10 year bonds in light purple compared to those of the United States, the United Kingdom and Germany:


While Japan's 10 year bond was yielding between 3.5 and 4 percentage points less than the U.S., U.K and Germany in 2008, that has closed to just under 1 percentage point today.

Here is a bar graph showing the balance of General Bonds since 2000 and the amount issued every year:


As you will have noted in the first chart on this posting, General Bonds form about 70 percent of Japan's total central government debt.

Japan does have one thing in its favour; unlike the United States, most of Japan's debt is held by Japanese banks, pension funds, households and insurance companies as shown here:


Over the past decade, foreign investors have held between 3 percent and 7.9 percent of Japan's debt, currently holding only 6.2 percent of the total as shown on this bar graph:


For comparison, in August 2012, foreign countries held a total of $5.43 trillion worth of United States Treasuries with China holding $1.1536 trillion worth and Japan holding $1.1215 trillion worth.  According to SIFMA, in August 2012, there were a total of $10.749 trillion worth of outstanding Treasuries as shown on this chart:


This means that foreign ownership of U.S. Treasuries now sits at 50.5 percent, just under ten times the level of Japanese bond foreign ownership.

Despite the few positives working in Japan's favour, the country faces its own fiscal cliff.  Over $600 billion worth of spending cuts and tax increases are due in January in an attempt to rein in debt growth. This year alone, nearly $480 billion worth of debt financing is needed to finance this year's budget deficit.  As shown on this graph, a substantial portion of Japan's government revenue is swallowed up servicing their debt:


Lastly, here is a historical look at Japan's history of overspending (the gap between the red and blue lines):


Japan has obvious political problems that, while different than the United States, make it difficult for the nation to pass legislation necessary to control debt.  Since 1989, Japan has had 16 Prime Ministers, with the last six serving terms of roughly one year or less each.  This is currently why Japan is facing a fiscal cliff; political deal-making hinges on the calling of another election.  

Stress from Japan's fiscal situation may well be the world's canary in a coal mine; if the world's third largest economy sneezes because of its debt problems, the rest of the world will definitely catch a cold.

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