No trade has lost more money for more people than the Japanese government debt crash that never happened. The same applies to America’s burgeoning public debt. Peter Boone and Simon Johnson, the latter a former chief economist at the International Monetary Fund, warned last September 19 that “Europe’s crisis will be followed by a more devastating one, likely beginning in Japan.” Since then, the interest rate on 10-year Japanese government debt has fallen by almost half as the Bank of Japan announced an aggressive program of bond purchases.
Former Office of Management and Budget Director David Stockman got his second 15 minutes of fame last week for warning that “yet another unsustainable bubble” will burst and “America will descend into an era of zero-sum austerity and virulent political conflict, extinguishing even today’s feeble remnants of economic growth.” Stockman’s first brush with celebrity came in 1981, when he warned that the Reagan deficits would ruin the economy. There’s nothing like appealing to vulgar prejudice to sustain a career through 32 years of wrong predictions.
Nothing is going to crash, not at least in the next few years. It will end not in tears, but a snooze.
Countries that can pay the interest on their debt can keep accumulating debt for a remarkably long time. Since January 2000, Japan’s 10-year yield has fallen by three-quarters – from around 2% to barely above 0.4% – while Japan’s debt-to-GDP ratio has nearly doubled. Something akin to this occurred in the United States, where the 10-year Treasury yield plunged from 6.5% in 2000 to just 1.69% last Friday, while the debt-to-GDP ratio doubled. Japan’s debt will crash eventually, to be sure, as its working population shrinks by 35% between now and 2050. America’s working population, by contrast, will continue to grow.
Exhibit 1: Japan 10-Year Government Bonds, implied yield (%)
Source: Tradingeconomics.com, Japan Department of Treasury
Exhibit 2: Japan Government Debt to GDP Ratio (% of GDP)
Source: Tradingeconomics.com, Japan Ministry of Finance
Exhibit 3: United States 10-Year Government Bonds, implied yield (%)
Source: Tradingeconomics.com, US Department of the Treasury
Exhibit 4: United States Government Debt to GDP Ratio (% of GDP)
Source: Tradingeconomics.com, US Bureau of Public Debt
America will keep running trillion-dollar deficits as far as the eye can see, and the world won’t come to an end. The present generation of economists, pundits, and hedge-fund heroes will retire before we see the consequences of fiscal irresponsibility. There’s a simple explanation for this, and it’s called “fracking.”
America will produce more energy than Saudi Arabia by 2020 and turn what used to be a colossal foreign trade deficit into a small but comfortable surplus. And that will enable America to keep selling huge amounts of government securities to the rest of the world at fairly low interest rates.
There is a current of opinion that thinks that cheap energy will bring us a golden age of economic growth. That seems Panglossian, considering that natural gas prices already have collapsed to a fraction of their 2006 value, and cheap natural has already outstripped coal as America’s main source of energy. America has already gone through an energy revolution and the economy didn’t budge. Cheap energy won’t get the economy out of the doldrums, but it will make it easier to borrow enough to paper over the consequences of economic stagnation.
That will make no-one happy. Blame for nagging economic misery will continue to accrue to the Democrats. The Republicans will find it increasingly difficult to elicit the kind of popular outrage over government debt that built the Tea Party in 2010. Popular disgust will accumulate against both parties, but no-one will rally to any particular remedy.
Returning to the Japanese debt crash that never happened, the doomsayers had a point: Japan’s enormous personal saving rate has declined to almost nothing as the population aged. Japanese in their 50s and 60s saved heavily for retirement during the 1990s, but began spending their savings as they moved into retirement during the 2000s. America’s personal savings rate, meanwhile, picked up a bit.
Exhibit 5: Household Savings Rates (% of GDP)
Japan’s government budget deficit is now almost 10% of gross domestic product, while household savings are barely over 1% of GDP. Japan’s central bank makes up the different by swallowing most of the new debt issuance. The central bank creates new money to pay for the debt, and that drives down the value of Japan’s currency on the foreign exchange market. Japan’s objective is to increase the inflation rate from negative territory to 2%, which means that Japanese savers (who own most Japanese government debt) will lose money. In effect, Japan’s government is taxing the wealth of the Japanese people. That can go on for quite some time.
At some future point, to be sure, there simply won’t be enough Japanese left to save or be taxed. Japan’s working-age population (15-64 years) will shrink from 81 million today to just 55 million at mid-century, according to the United Nations medium variant scenario. But America’s working-age population will rise from 207 million today to 242 million at mid-century. Elderly dependents, to be sure, will comprise a crushingly large share of the total, while retirement and Medicare costs soar. At some remote future point America’s debt will become unsustainable, but no-one ever won an election on the strength of 30-year forecasts.