Tuesday, January 1, 2013

Bond Vigilantes: Japan Isn't So Special

...here, too, Japan looks ordinary...
As I grew up as an economist, I heard from one and all that Japan was special. First, despite its small size, it was going to take over the global economy; as the 19th century had been Pax Brittanica [though with precious little peace], the 21st would be Pax Japonica, to be accomplished without colonies but with other large, developed economies as competitors. Underlying this success, and its clout in export markets, was a set of management practices that rendered its firms superior: governance by insiders who looked to the long and not the short run produced wonders; the MBA-finance skill set contributed almost nothing to this success, so mayhap the lack of such individuals in senior management was salutary. Japanese consumers were odd, too, they didn't buy cars, they shopped at mom-and-pop stores, and they insisted on eating expensive domestic rice. Then there was the bubble, peculiarly Japanese, and the lack of rapid recovery, due to the incompetence of the BOJ and the peculiarities of its Cabinet system that gave the bureaucracy undue power and resulted in on-again, off-again fiscal policy that produced deficits but not growth. All of these positions held a grain of truth, but now look silly – an overreaction, but making that case is not my purpose today.
So how about Japan government debt? – the media and even not-so-conservative politicians in the US and Europe are fixated on reducing deficits in the face of excessive governmental debt. They are reading Greece as a general case. Yet it is a small country whose debt is not denominated in its own currency, and most of that debt is held abroad. It has also been running trade deficits, has an inflated public sector and social security system and on and on. No one has to hold Greece's debt, almost no one held enough that they couldn't dump it. And dump it they have.
If Greece is in fact exemplary then Japan should be in worse shape. It has run large deficits for two decades, without a crisis as an excuse. While the previous government passed a tax increase, the first stage of which will take effect in April 2014, it's not clear the current government won't invoke an "economic conditions" escape clause. It's population is aging, indeed already aged. And however bad Greece might look – debt of 112% of GDP in 2007 – Japan's gross debt is worse, at 214% of GDP in 2012 (OECD estimate) versus 181% for Greece.
Yet carrying this logic to the Japanese government bond (JGB) market has been a disaster. Someday someone will get rich shorting JGBs, but to date that strategy has instead proved a "widow maker". [Google the term and you'll find lots of hits, going back years. Two examples are from Reuters and BusinessInsider].
10 yr JGBs10 yr US Treasuries
But is Japan special on this front? Not if we look at the US. We have somewhat lower levels of debt, somewhat smaller structural deficits, but they are difference in degree and not in kind. (For Japan, the normal figures lump in local government debt as well as the debt held by the Bank of Japan and other semi-governmental entities.) Sure, we have Republicans and Democrats unable to pass little things such as a Federal budget … the Japanese have had the DPJ, and – lucky them? – now have the LDP-Komeito coalition back in power. Meanwhile, Japan has escaped from its bubble, and the US economy is growing. Despite all the hype about the US debt-deficit pairing, bond prices can do nothing but rise. For those looking at Chinese real estate, or anything in Europe, both countries continue to look like safe havens, or (for both economies do have problems) at least havens. Here, too, Japan looks ordinary.
The Cassandras making this case in Japan and in the US may not be believed. But both look rather ordinary, and those among the Cassandras in the market are quite happy to keep taking the bond vigilantes' money.
...mike smitka...