Now that so many countries are having their sovereign debts so carefully scrutinised, who will be next? Some are in no doubt. Jonathan Allum of Mizuho quotes Ambrose Evans-Pritchard on the subject.
His call? “The shocker will be Japan, our Weimar in waiting. This is the year when Tokyo finds that it can no longer borrow at 1% from a captive audience and when it must foot the bill for all those fiscal packages that seemed such a good idea at the time.”
The “good/bad” news, says Allum, is that the article in which this quote appeared was published in The Daily Telegraph in January 2010. Since then, even as Italy has joined Greece, Spain and Portugal on the bond vigilante list of baddies, the yield on the benchmark ten-year Japanese Government Bond (JGB) has gone down rather than up. It was 1.335% then. It is 1.08% now.
And that has happened at a time when inflation has finally returned to Japan. In January 2010, headline inflation in Japan was -1.3%. Today it is 0.3%. Core inflation is 0.6%.
So why haven’t JGBs collapsed and why hasn’t the yen gone with them? I’ve written here about the yen before. It’s all about the fact that currency strength is relative, and about the fact that Japan is a substantial creditor nation to the world (Stratton Street analysis shows that it has Net Foreign Assets equivalent to 60% of GDP).
But a note from strategist Max King throws a little more light on the matter of JGB prices. The view that Japan is on the road to insolvency is, says King, “melodramatic”. Sure, its debt looks very high indeed. But add in government assets and it is instantly cut in half. It also comes on very affordable interest rates (around 3%) and is largely domestically owned.
And while it is true that domestic ownership will fall as the population ages, that “isn’t necessarily a problem”. Why? Partly because very low inflation means that the real yield on JGBs is actually relatively generous. Buy a benchmark ten-year bond in the UK and you’ll get a yield of 3.07%. With inflation at 4% or so that means you are making a negative real yield. Buy a Japanese ten-year at 1% with inflation at 0.3% and you’re making a real return of 0.7%.
And partly it’s because “for the central banks of China and other emerging economies, Japanese bonds look a lot more compelling than those of peripheral Europe or the US”. Note that China bought $16bn of Japanese bonds in April and another $6bn in May.
The fiscal deficit will have to be cut at some point of course but, while few people believe it to be so, it is entirely possible that Japan will grow its way out of debt. Let’s not forget that in per capita terms Japan has grown incomes much faster than the US over the last decade (I admit this isn’t much of a hurdle but still…) and that it wouldn’t take much growth to push corporate tax receipts way higher.
How might it happen? For that you’ll have to read this week’s magazine. I’m editing the story today. It’s out on Friday. If you’re not already a subscriber you can get your subscribe to MoneyWeek magazine.