S&P Downgrades JGBs, Media Flips Out

01/30/2011
By

TOYKO (majirox news) – TV and radio commentators and other talking heads went into a predictable tizzy on January 27, when Standard and Poors (S&P), an American rating agency, announced that they were cutting Japanese government bonds investment grading from AA to AA-.

“This could mean bankruptcy for Japan,” said one Japanese TV news broadcaster.

It’s not that bad. The sky is not falling. Much of the financial world veered in another direction by greeting this announcement with a big, collective yawn.

“Japan needs to forget about the views of the credit agencies, which have not had a terribly good track record recently,” said England’s Financial Times (FT).

According to the FT, Japan’s leaders have an opportunity to issue more and more bonds at the lowest interest rates since the Babylonians invented accounting. In other words, the FT says that Japan has the ability to continue digging deeper into debt for a long time.

Reuters wrote that Japan has a massive pool of savings, is the world’s largest creditor nation, and enjoys a steady flow of foreign earnings from a trade surplus firmly in the black. “The ratio of Japan’s tax burden to national income is one of the lowest in the OECD,” noted Reuters.

However, Japan is hardly without a tremendous number of positive points in its current economic situation. Similar positive comments were made in the Wall Street Journal and other financial newspapers worldwide: AA- is still quality investment grade.

So what’s the problem?

Takahira Ogawa, S&P’s director of Asian sovereign debt, said, “The government has finished compiling its 2011 fiscal budget bill and is set to draw up plans for social security and tax reform, but it is unlikely that it will pass through the Diet.”

The question is whether lawmakers can and will put these ideas into action. Because Japan has not recorded any nominal economic growth for 18 years, the nation’s debt has snowballed beyond its capacity to bear it.

S&P is looking beyond the limited view of the world’s financial newspapers, which are asking whether or not Japan can add more debt. Apparently, it can, and it can continue to do so for quite some time.

As far as S&P is concerned, that is not the point.

Without real reform, there’s no point in adding more debt, as it will not pull the economy out of the doldrums.
S&P submits that Japan’s entire economic system is broken, and as of yet, there exists no consensus on how to repair it.

Nicholas Benes, head of the Board Director Training Institute of Japan and a former member of the Japan Investment Council of the Japanese Cabinet, adds that in the next year, Japan could even see a slow downward spiral.

“Consider that it takes a very long time to fiscally turn the tanker when so much of your yearly deficit is new borrowings, a significant part of which is to pay interest on prior issued bonds, even if you had the political will to charge consumption tax now, which they do not have,” he says.

Benes notes that if 10-year bond rates are at 1%, and if there is another down rating that drops them (after the second downgrade) to 1.5%, investors have a 5% capital loss on what was supposed to be a low-risk investment.

“Banks and corporations may not be happy holding these bonds anymore, so domestic selling could happen in the foreign institution market, which will be increasingly important, however it can allocate money whenever it wants,” Benes says.

Japan also has an aging population, and consumption is plummeting. Japan’s investment policies seem to be structured to starve its internal economy while at the same time diverting more and more financing into exports, as though increasing exports are the sole answer to Japan’s economic problems.

In reality, Japan is facing a world where its exports are becoming increasingly non-competitive with each year. In 2004, Japan became a gross importer of all domestic appliances. In 2010, it became a gross importer of all electrical appliances, including such items as TVs and computers.

It hedges its agriculture with tariff walls. Japanese rice tariffs now run 700%, and peanuts, which benefit about 1000 peanut growers nationwide, run over 1000%. Due to a thicket of regulations, national customs, and economic nationalism, there is less and less foreign investment each year in Japanese industry.

At the same time, Japan is facing runaway costs, as it must deal with the social welfare costs of an aging population. It has shown no inclination to reign in its generosity to vested interests, particularly those to big industry.

Japan, like Italy, which was in a very similar position in the 1990s, will no doubt be able to stave off a sovereign debt crisis. After all, as almost all of Japan’s public debt is Yen-denominated, if worse comes to worst, all Japan has to do is print more money.

If only it were that easy.

Reuters concluded in a recent survey, “Many voters accept the idea of a sales tax hike in some form to fund social security, but the government has…failed to convince voters of their vision to cure Japan’s economic ills with a painful tax increase…the government will need to get serious about cutting spending..and scale back some welfare benefits to improve public finances.”

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