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Upcoming Government Funding Crises: Japan Edition

Tyler Durden's picture


One of our favorite strategists, SocGen's Dylan Grice is out with a masterful in its simplicity analysis, looking at the possibility of a funding crisis enveloping the governments of the developed world, and originating in the place where ever more people see brewing trouble: Japan. The full presentation can be found  here, and while we recommend a full read, for those strapped on time, here are the cliff notes.

Risk is back: in fact, it is as if nothing ever happened. Junk spreads and the VIX are practically at the levels where we were before the first cracks in the housing bubble appeared. Is the economy really sufficiently stable to merit such risk metrics?

In answering the last question, one needs to look no further than the governments of the developed countries. In one word: insolvency. The ratio of total net liabilities, including off balance sheet, to GDP is at 400%. Greece is at 875% (the Greek finance minister once again was comforting anyone who cares to listen that the country does not have a funding crisis. We are waiting for this third promise in this regard).

Such insolvency typically can end in only one way: hyperinflation. The chart below captures the budget deficits a few years before hyperinflationary episodes in five countries during the 20th century.

Why are budgets so inflated: one word - stimulus. Or taking from the future (and funding it handsomely) to avoid political, financial and social unrest (as well as maintaining even a slim hope of a second term). The entire world now runs on one ongoing stimulus: from the US, to the UK, to the EU, to China - the spigot has been turned on. And where do look to make sure that this is a viable structure? Where else - Japan. After 20 years of off again, on again stimulus after stimulus and quantitative easing episode, the country still has deflation. Where is this alleged hyperinflation. It may very well be coming. Japan's budget deficit has been funded over the past decades with internal source of capital. Prudent Japanese savers had been buying up JGBs hand over fist due to their perceived safety. Yet something is changing - demographics (and not only in Japan, but in the US as well, as an aging baby boomer population hits retirement). The Japanese demographic decline is in full swing, with the working age population now dropping materially.

And as more and more of the domestic population enters asset run-down mode, savings decline, and existing assets are sold.

Indeed, the demographic shift is already having an impact on Japanese holdings of JGBs.

The biggest problem for Japan, however, is that it can not afford to ween itself off bond issuance. Japan's current debt service amounts to 35% of pre-bond issuance revenues, while the ratio of revenues from bond issuance to that from tax collection is expected to rise over 100% in 2010: "tax revenues will be less important than borrowing as a source of income."

Will foreigners agree to purchase JGBs at 1.5%. No. Due to the abovementioned structural considerations, Grice notes "I doubt there is any yield international capital markets can find acceptable that will not bankrupt the Japanese government."

And if wholesale selling of assets does in fact occur, this will mean very bad things for America:

This is far from just a JGB market problem. As Japan's retirees age and run down their wealth, Japan's policymakers will be forced to sell assets, including US Treasuries currently worth $750bn, or Y70 trillion "eight months" worth of domestic financing. At nearly 10% of the outstanding US Treasury stock, this might well precipitate other government funding crises (bearing in mind that the Japanese model is the argument buttressing confidence in Western government bonds in the face of deteriorating fiscal conditions). At the very least I'd expect it to trigger an international bond market rout scary enough to spook all other asset classes.

Will 2010 be the beginning of the end of flawed Keynesian economics?

Maybe Japan's will be the crisis that wakes up the rest of the world and triggers some tough decisions on world-wide debt loads. Or maybe not - maybe the Greeks will beat them to it? or the Irish or the UK, or the US? Like banks in 2007, developed market governments today rely on sustained capital markets more than any time in their history. What if they shut?

It should be a very interesting year.


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Tue, 01/12/2010 - 18:20 | Link to Comment bugs_
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Maybe we can get the Japanese to jump on board

the Amero.

Tue, 01/12/2010 - 18:25 | Link to Comment Anonymous
Tue, 01/12/2010 - 20:46 | Link to Comment Anonymous
Wed, 01/13/2010 - 01:26 | Link to Comment dark pools of soros
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and Isreal.. they are both annoying

Wed, 01/13/2010 - 01:36 | Link to Comment Cheeky Bastard
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and Italy ..

Wed, 01/13/2010 - 02:06 | Link to Comment MsCreant
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A bomb a nation?

Wed, 01/13/2010 - 03:09 | Link to Comment Anonymous
Wed, 01/13/2010 - 05:24 | Link to Comment whacked
whacked's picture


Wed, 01/13/2010 - 15:43 | Link to Comment Anonymous
Wed, 01/13/2010 - 06:11 | Link to Comment Anubis
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Dude, I read some of those articles and also others on the same blog - but the amount of information and interconnected logical assumptions behind their theories (they call themselves Modern Monetary Theorists (MMT)) are really huge. Based on what I could snap up from the texts they seem to claim it's ok to run up unlimited amounts of debt and this should not cause any particular stress. While the benefits of being able to spend money are obvious (health care, schools, defence, employment, etc). 


I don't have weeks to read thru all their theories, though I will give it some time - but would you or others be so kind and tell me if MMT's think unlimited deficits are quite ok? 

I got it wrong, if so, where? And if I got it right - can you explain why there is supposedly no harsh consequences by running enourmous deficits? What about long term inflation, debt default risks, etc.? 



Tue, 01/12/2010 - 18:25 | Link to Comment Gilgamesh
Gilgamesh's picture

Not enough people are talking about the US demographics.  We've got a few more retirees coming up.  How quickly can government's retirement age be pushed back?  And good luck funding not only their benefits but also inflows into equities with all those Extended Unemployment checks...

Tue, 01/12/2010 - 19:19 | Link to Comment MsCreant
MsCreant's picture

Or push back the age you can serve in the military?

Tue, 01/12/2010 - 19:48 | Link to Comment Doc
Doc's picture

Already been done.

Wed, 01/13/2010 - 00:43 | Link to Comment Tethys
Tethys's picture

I would suspect that the US government has been thinking about demographics for a while and that is why, unlike Japan, they have done their best to keep the borders wide open.  Lots of young, cheap workers coming in and having lots of children - at a much higher rate than the 'natives'.  And those kids are instantly citizens.

Of course, this approach doesn't work so well when the job market tanks.

Wed, 01/13/2010 - 02:14 | Link to Comment Stevm30
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Yes, that kind of long-sighted, deliberative thinking is exactly how our nation's leadership guides its actions...

Tue, 01/12/2010 - 18:32 | Link to Comment pros
pros's picture

Look at debt numbers for USA:

$billlions (12-10-2009 Fed Z.1 Release)

U.S. Govt (table d.3)                           $7,566.5

State and Local (d.3)                           $3,309.1

GSE debt/GSE gteed MBS (L.4)              $8,123.4  

Total                                                $18,999.0


3q GDP SAAR                                     $14,242.0

debt to GDP = 133.4%


add:   $7,944.3 debt of financial sector with implicit guarantee

         $2,100.0 federal reserve obligations

=    total of $29,043.3  or 203.9% of GDP


add unfunded liabilities of SS system (table IV.B6 2008 Annual Report of SS Trustees)


=$42,643.3   or   299.4% of GDP


The U.S. is insolvent by all accepted measures.

Tue, 01/12/2010 - 22:39 | Link to Comment pbmatthews
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You left off unfunded Medicare Liabilities...another $35 trillion.


$77,643.3 or 545% of GDP

But then again, who is counting?

Wed, 01/13/2010 - 05:01 | Link to Comment Nout Wellink
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It is easier to watch this:

Tue, 01/12/2010 - 18:34 | Link to Comment Stevm30
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One alternate outcome to hyperinflation, which will prevent ultimate collapse for up to several decades would be a world currency, and requisite world sovereignty to support it.  The creditor nations will demand, and receive, equality in the constituent parts of this body... (Bank of the World headquarters, Shanghai?)  Of course, any fiat system is destined to fail, and so will the world currency.  It just might take another generation to get there.  In the meantime, good citizens are encouraged to prepare... because the collapse of that currency will truly destroy civilization as we know it.

"The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks." Lord Acton

Tue, 01/12/2010 - 19:31 | Link to Comment Anonymouse
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I think I read something about a One World Government.  About 2000 years ago I think.

Can't remember where....

Wed, 01/13/2010 - 01:51 | Link to Comment nabi
nabi's picture

That would be the book of Daniel, I think:

DANIEL 7:23 "Thus he said:  'The fourth beast shall be a fourth kingdom on earth, which shall be different from all other kingdoms, and shall devour the whole earth, trample it and break it in pieces.'" (NKJV)

Yep, he nailed that one almost 2,600 years ago...

Tue, 01/12/2010 - 19:42 | Link to Comment Anonymous
Tue, 01/12/2010 - 18:34 | Link to Comment SDRII
SDRII's picture

good article in about leaked China/Japan repproachement (article in NYT last week if recollections erves). Japan has been edging away from US in terms of basing, policy poodle etc.


and Lui always a good read..


Tue, 01/12/2010 - 18:47 | Link to Comment D.M. Ryan
D.M. Ryan's picture

Japna in an inflationary crisis... now that would be the shock heard 'round the world.

Tue, 01/12/2010 - 18:51 | Link to Comment asdf
asdf's picture

they will be fine. Japan has the lowest external debt levels of all developed countries. If they're smart, the BoJ just buys the bonds from the pension funds. Japan has a core deflation of -2%, any kind of inflation fears in a land with a huge account surplus is la la land.

Tue, 01/12/2010 - 23:37 | Link to Comment Oso
Oso's picture

kind of irrelevant when every government on earth is attempting to tap external capital markets.


further, as Grice points out, even a small increase in yields will be crushing in terms of debt service.

Tue, 01/12/2010 - 19:26 | Link to Comment Anonymous
Tue, 01/12/2010 - 23:34 | Link to Comment Oso
Oso's picture

1) yes, they will save.  but there arent enough aggregate savings to fund the government spending requirements.  So, yields will start to rise and government will have to turn to external borrowers.

2) savings will be used to live on.  food. water. clothing.  medical care. etc.

3) yes. and yes.

4) yes, but the old people havent agreed to die en masse within the next year.  retirement usually lasts 20-40 years ;)

5) yes. um.... no. 

Tue, 01/12/2010 - 20:13 | Link to Comment hambone
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I really feel this is what those last moments prior to WWI or WWII felt like when the global system is under such strain and stress so as we can almost hear the creaking of the bulwarks...There are so many options as to which will be the spark that ignites the piles of dry tinder (Soveirgn default, commodity spike, blah blah).  Strange days when we maintain the present system, our present jobs but wonder for how much longer...and then what?  Minor adjustments, titanic shifts, chaos?  Who f****ing knows but the wait is strange.

Wed, 01/13/2010 - 11:25 | Link to Comment Invisible Hand
Invisible Hand's picture

Hambone has echoed my feelings exactly.

I feel like I am in a out-of-control car on an icy road tensing for the impact but not sure if I will hit the guardrail, the tree or the oncoming semi.

If I was young and healthy, I would be less worried as I was always the smartest (one of anyway), hardest working guy in the room.  Now, older and ill, I know I cannot hope to win this fight and must simply await my fate.

That's a big change for Americans, who always thought they could do anything and controlled their fate.  However, this is how most people have always lived.  Small boats in a raging torrent, trying to steer towards a little success and happiness but knowing the odds are against them.

These will be the times that "try men's souls."  Sometimes, how you lose says more about your character than winning.

Tue, 01/12/2010 - 20:27 | Link to Comment merehuman
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The big question is     WHEN? Will we have any warning other than what we have now?

Tue, 01/12/2010 - 23:22 | Link to Comment Molon Labe
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Mostly, institutions go broke real slowly over a protracted period of time, and then all at once real fast-like.  The insiders know it is going to happen; but even they don't know when.  They hold on for as long as they can and hope for a miracle, trying to benefit as much as they can before the ship sinks.  Every now and then a miracle appears. 

Those fortunate enough to work for insolvent institutions like U.S. automakers, large financial institutions, huge conglomerate insurance companies, or non-governmental/governmental agencies with/without the backing of the full faith and credit of the U.S., will see their most diehard atheist co-workers have Saul of Tarsus like conversions as their taxpayer funded miracles materialize before their eyes just in time to save their bonuses, stock options, and pensions.

Those who are not so fortunate...

Tue, 01/12/2010 - 20:43 | Link to Comment RobotTrader
RobotTrader's picture

"The big question is     WHEN? Will we have any warning other than what we have now?"

Answer:  Most like, NEVER.

Japan has been running massive deficits as a percent of GDP for years, and financing it ad infinitum at 1.5% rates, and experiencing deflation at the same time.

Furthermore, Japan's Nikkei is outperforming every other index right now...

Tue, 01/12/2010 - 21:19 | Link to Comment Anonymous
Tue, 01/12/2010 - 23:42 | Link to Comment Anonymous
Tue, 01/12/2010 - 20:50 | Link to Comment Anonymous
Tue, 01/12/2010 - 20:56 | Link to Comment max2205
max2205's picture

No worries. Remember the Asian Union and it's new currency. Come on get creative!!!

Tue, 01/12/2010 - 20:58 | Link to Comment Anonymous
Tue, 01/12/2010 - 21:06 | Link to Comment Carl Marks
Carl Marks's picture

Anyone have a yen for treasuries?

Tue, 01/12/2010 - 21:18 | Link to Comment Anonymous
Wed, 01/13/2010 - 12:47 | Link to Comment Anonymous
Tue, 01/12/2010 - 21:20 | Link to Comment aus_punter
aus_punter's picture

I think the marginal seller of Yen is virtually non - existant.  Being short the long end of JGB's has been a widow maker of a trade for my entire career thus far..... his view may be correct at some point but it seems to be virtually impossible to monetise. 

The notion that Japan swings to hyper inflation whilst the rest of the world languishes in deflation seems like a bit of a stretch also

Wed, 01/13/2010 - 12:49 | Link to Comment Anonymous
Tue, 01/12/2010 - 21:24 | Link to Comment buzzsaw99
buzzsaw99's picture

Japan's policymakers will be forced to sell assets, including US Treasuries currently worth $750bn...

Don't worry, zimben will buy them.

Tue, 01/12/2010 - 23:09 | Link to Comment Psquared
Psquared's picture

But they've still got Uncle Ben and his cronies. I am sure BofJ will (if not already) line up at the trough and the Fed will buy their bonds too. It already appears the USCB is allowing foreign banks to have access to the discount window. Seems like it would be an easy operation to buy their bonds and monetize their debt too.

We keep watching this slow motion train wreck and wonder when it will happen already but I think they have things up their sleeve they have not even tried yet. For that reason I wonder if they can't keep this going for years ... if not decades.

As a last resort they can resort to outright printing of dollars and skip the middle step.

Then, at the last moment, just before cart before the horse starts careening downhill, a currency reset, and bingo ... problem solved.

The black swan of course will be something like a 7.0 earthquake in Haiti or Google denying the Chinese access to its search engine.


Tue, 01/12/2010 - 23:09 | Link to Comment Anonymous
Tue, 01/12/2010 - 23:53 | Link to Comment poydras
poydras's picture

Let's compare who may be worse.

Japan's international net assets 2008: 44% of GDP; USA: -18%

Japan's aggregate debt to GDP: 283% (Note that Japan peaked at 345%; private debt has dropped dramatically while public debt has expanded); USA >350%

Japan's trade surplus in 2008 was $88B; USA $673B deficit

Another factor to consider when comparing countries is inflation. In Japan, they have mild deflation. There is inflation everywhere else.

I am bit confused as to where why there is such focus on Japan when the US fundamentals are so much worse. I have difficulty visualizing how we make it through the year. I welcome any counterpoints.

Tue, 01/12/2010 - 23:57 | Link to Comment Anonymous
Tue, 01/12/2010 - 23:56 | Link to Comment Anonymous
Wed, 01/13/2010 - 12:55 | Link to Comment Anonymous
Wed, 01/13/2010 - 00:07 | Link to Comment Anonymous
Wed, 01/13/2010 - 04:28 | Link to Comment Anonymous
Wed, 01/13/2010 - 10:33 | Link to Comment Winisk
Winisk's picture

The real world runs its own life, because there is no stopping a flowing river.

Yes.  There is so much focus on the inevitable crash of numbers but the reality of life is that we we still have the same humans, living on the same earth, consuming the same resources as the day before the crash.  What will change is the distribution of those resources.  Like a river, the flow and volume will change as a result. What needs to be focused on is where the flow of resources get redirected to. My feeling is that there will be a virtual big ZAP in monetary systems around the world, resulting in the quality of life shifting about, but it won't lead to the collapse of human civilization at this stage.  That will came later when the ecosystems can no longer support our growth.

Fri, 01/15/2010 - 22:14 | Link to Comment SABTrader
SABTrader's picture

It's a good point. Fiat money has always been fiat money with no intrinsic value but it has been fully accepted by the world since 1971. Some said this was an experiment that would end soon but I can't see any alternative. Paper and electrons are just too convenient and if i don't play the game i don't eat. What's the alternative to the banking system we now have?

At some stage the debt the GDP ratios are going to look absurd - as soon as interest rates go up but noone is willing to pull that lever. Right now it seems that if you are a government and you're not printing money you're making a mistake. Printing money lowers it value and makes products easier to export thus keeping people employed but really it's just a way of giving your workers a paycut without the unions whinging.

'every CB's aim is to devalue its own paper "to help its own economy".'

My main objection to printing money is how a few profit enormously while the majority see all they own get devalued. The rich get richer and the poor get poorer. When the US prints a new note with one more zero, watch out.

Wed, 01/13/2010 - 06:30 | Link to Comment Anonymous
Wed, 01/13/2010 - 12:59 | Link to Comment Anonymous
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