Try counting this number: 106,610,000,000,000. If you are having trouble computing, you may be sure that the law of large numbers is getting lost in translation in Tokyo as 2020 wraps up.
Japan-based analysts long postulated when this econometric theorem might kick in where the swelling government debt is concerned. This is when Tokyo’s borrowing numbers reach a critical mass where the public gets numb to their magnitude – and they lose potency.
Tokyo’s annual budget for fiscal 2021 – yes, that is the number in our top line above – is an unprecedented 106.61 trillion yen. In dollar terms, a cool US$1.03 trillion.
The amount that Prime Minster Yoshihide Suga’s government plans to spend is as mind-blowing as it is telling.
This sum comes on top of the more than $2.2 trillion Suga’s Liberal Democratic Party already tossed a Covid-19-addled first half of 2020. And since taking the reins of power on September 16, Suga has been forced to roll out an additional $700 billion of emergency aid as deflationary pressures made an untimely return.
So worried is Suga about the fallout that he resisted calls to suspend the “Go To” travel program subsidizing domestic tourism. Though it’s pumping growth into cities from Sendai to Kyoto to Kagoshima, it’s also increasing risks of Covid-19 transmission.
The scheme is a microcosm of the tension between public health and Tokyo’s recovery imperative.
Suga “is taking a political thrashing as the number of new daily Covid-19 cases hits record highs and criticism of his response intensifies,” says analyst Scott Seaman of Eurasia Group. He “will remain under fire this winter, but he will likely be able to rebuild support among voters and within his ruling Liberal Democratic Party as the third wave recedes.”
Yet the trillion-dollar-plus budget for fiscal 2021 is a harbinger of financial fallout to come, perhaps most notably in a bond market that’s been hibernating in recent years.
The limits of stimulus
Suga risks making the same mistake his predecessor Shinzo Abe from 2012 to 2020 did: believing that stimulus alone can restore Japan to its 1980s greatness.
Abe mostly relied on the Bank of Japan easing to pump energy into an aging and rigid economy. He also, however, primed the fiscal pump. Abe erred by hiking sales taxes twice, once in 2014 and again in 2019.
Both boosts – ultimately to 10% – slammed household spending. The one in October 2019, for example, led to a 7.3% contraction in the last three months of that year.
Yet the party that Suga and Abe represent continues to prioritize the demand side of economic fine-tuning over supply-side reforms, just like the LDP has been doing since the 1990s, back when deflation sank its teeth into Japan Inc.
Japan is now on its 12th prime minister since November 1997. That was when the collapse of the then-100-year-old Yamaichi Securities signaled the scale of the bad-loan crisis. It’s on its 11th leader since the BOJ first cut interest rates to zero in 1999 and its 10th since the central bank pioneered quantitative easing.
Since 1997, there have been few efforts to restructure the economy to modernize labor markets, cut bureaucracy, revive innovation or learn to grow without adding to the national debt.
The most successful reformer was Junichiro Koizumi. During his 2001 to 2006 tenure, he cut public works spending by 10% in short order. That was a shock to Japan’s decades-old “concrete economics” model.
Koizumi prodded banks to write down the hundreds of billions of dollars of bad loans. He pulled off the most audacious privatization in decades: the 400,000-employee Japan Post.
That was a vital step. It ran the globe’s biggest savings bank. Not only was it a competitive challenge for the private sector, but the place politicians went to help fund pet projects.
When Shinzo Abe took power in 2012, his “three-arrows” Abenomics program was really just a dusting off of what Koizumi had hoped to accomplish a decade earlier. The Big Bang that Abe promised ended up being a series of modest pops here and there.
Mostly, he prodded the BOJ to take an even more outsized role in supporting growth. He also upped Japan’s government borrowings.
Massive jolts, diminishing returns
That’s led to a diminishing returns problem. Japan’s challenge in 2020 has not been the supply of yen sloshing around the system. It is a dearth of uses for them.
A central bank’s superpower is generating credit that then gets the private sector to lend, borrow and deploy money. The multiplier effect this creates can get multi-trillion-dollar economies back on track.
Over time, though, the formula breaks down. Like a patient requiring ever-bigger doses of a medicine to get the intended effect, economies need bigger and bigger jolts. In late 2018, arguably, the BOJ reached that point. Around that time, the BOJ’s balance sheet topped the size of Japan’s entire $5 trillion economy.
The BOJ’s epic debt purchases, beginning in 2013 when Haruhiko Kuroda became governor, effectively deadened trading in the bond market. In recent years, there have been many days when not a single government security traded hands.
The BOJ’s huge exchange-traded fund purchases recently made it the biggest holder of Japanese stocks. It takes the onus off corporate executives to raise their competitive games. It also “is like subsidizing several large asset management companies,” says economist Kimie Harada of Tokyo’s Chuo University.
One risk is a stock market plunge if the third Covid-19 wave now hitting Japan slams gross domestic product (GDP) anew. Another is that the surge in Tokyo borrowing suddenly disturbs the calm in Japan’s bond market.
By most estimates, the BOJ has hoarded roughly half of outstanding government securities. That arrangement helps keep yields on 10-year Japanese government bonds at zero.
Yet potential threats can even come from abroad. In late October, for example, a rocky auction of seven-year notes in the US panicked global debt investors. The resulting spike in 10-year JGB rates to 0.030% was enough to pull the BOJ into the market to calm the turmoil.
The sell-side threat over the horizon
The question is whether Japan’s skyrocketing debt load will soon give punters a reason to sell.
The return of deflationary forces is particularly unwelcome. With aggressive stimulus, Suga’s predecessor Abe managed to generate Japan’s longest expansion since the 1980s. That also pushed Japanese consumer prices into positive territory – until the coronavirus hit.
In October, core prices fell 0.7% from a year earlier. That was the biggest slide in nearly a decade. The yen’s rally toward the 100 to the dollar level as investors lose faith in the US doesn’t help. It’s an added headwind for the BOJ as Kuroda’s team grapples with a coronavirus-wracked economy.
The worry for investors is that a cratering economy might have Suga’s government teeing up even more debt auctions. The BOJ, notes economist Takeshi Minami at Norinchukin Research Institute, is “already doing what it can on inflation.”
It can still try to minimize bankruptcies by backstopping corporate financing, Minami notes. But options for aggressive easing moves are few and far between.
That will have Suga’s party relying on increased borrowing – additional binges that get investors’ attention. As analysts at Fitch Solutions put it: “Given that the three extra budgets are entirely financed by debt, with new issuance of Japanese government bonds, we estimate that Japan’s debt to GDP ratio will climb to 282.1%, from 271.7% previously calculated in June.”
It’s a precipitous increase for a Group of Seven economy, yet one that could continue to grow in the year ahead if the coronavirus fallout intensifies. Added together, Japan’s worst preexisting conditions – including a shrinking population – and the bond market may have a rough ride with skittish investors.
Until now, Tokyo could rely on a mutually-assured-destruction dynamic. The reason nearly 90% of JGBs are held domestically is that they are the asset of choice across sectors. They constitute the core safe haven investment for banks, endowments, insurers, local governments, pensions, trading companies, universities and the growing ranks of retirees.
Because no one really has an interest in JGBs losing value, mass selling is extraordinarily rare.
Until now, at least. The year ahead will test Japan’s fabled bond market calm as rarely before. The law of big numbers all but ensures it.