Standard & Poor's is threatening to cut Japan's credit rating, which doesn't sound like that big a deal in a world where no one's credit is quite what it used to be. But Japan is a special case. It's been borrowing like crazy at rates two or so percentage points below what the U.S. pays on 30-year Treasuries. And it intends to further ramp up its borrowing to keep the economy from falling back into deflation.
A lot of people think this is a really bad plan:
It is Japan We Should Be Worrying About, Not America, and A Global Fiasco is Brewing in Japan, by Telegraph's Ambrose Evans-Pritchard
Debt Issues by economist Paul Kasriel
No Way Out for Japan, by blogger Mike Shedlock
The gist of the argument is that Japan is heading for a "debt trap," which will unfold as follows: When its pool of domestic savings runs out (as it will in the coming year) the Japanese government will be forced to borrow from foreign investors, who will doubt its ability to pay and demand a higher interest rate. As billions in short term paper roll over at ever-higher rates, interest costs will rise, requiring even more borrowing, which causes investors to demand even higher rates, and so on, until it dawns on the markets that this is a self-reinforcing cycle. Buyers scatter, rates spike, the economy crashes, game over.
Japan, with its ageing population, massive government debt, and anemic growth rate, appears to be headed this way sooner rather than later. This is clearly bad for the people who depend on, say, a government pension or interest on government bonds, which includes most of Japan's population. But what does it mean for the rest of us?
There are three possibilities, one relatively benign, two not:
1) The "strong" currencies like the dollar, euro and yuan actually benefit as global capital hides from the storm produced by the implosion of the world's second or third largest economy. The cost of goods imported from Japan goes down, which is bad for specific competing companies but good for overall inflation. The markets are volatile for a while but life goes on, with easy money more or less balancing debt destruction.
2) Once Japan goes, all bets are off, literally. This isn't Greece, with its miniscule share of Euro-Zone GDP. If a global powerhouse can spend and borrow itself into bankruptcy, the logical thing to ask is who else can do it. Which countries are travelling the road that leads to a debt trap, running up huge debts and financing them with short-term paper? When that list is compiled it will be seen to include the U.S. and most of the Euro-Zone. The cost of credit insurance will soar and interest rates will rise, which will choke off risk-taking in the financial markets, sending stock and commodity markets back to their 2008 lows and beyond. Governments will ramp up the printing presses but this time they'll fail because no one wants to borrow, even at zero percent. Cash is king, the dollar, euro and gold are hoarded, and we're back in the 1930s.
3) The world's central banks see Japan's implosion coming and preemptively start buying up assets with newly-created paper. An unlimited printing press trumps a huge but finite debt collapse, and we enter the first-ever global hyperinflation.
Scenarios 2 and 3 are a bit apocalyptic, but the numbers justify the speculation. We've never been here before, not by a long shot, and the bigger the imbalance the more serious the consequence. Everyone sees Japan coming...the question is, will it matter?
