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Jan 29, 2011

Japan is "Too Big to Save"


Katie Benner of Fortune
Japan downgrade: The beginning of the end?

Brian Hunt Editor in Chief, Stansberry Research

Brian Hunt of Stansberry Research tells a sad tale of the United States dollar losing its reserve currency status and the dire consequences which will result.

But Japan got a 10-year head head-start on the mire we are facing and Japan's imminent implosion, may be what causes the detonation of the volatile mix of debt in the U.S. economy far sooner than anyone would expect.

Japan downgrade:
The beginning of the end?

When Japan's economy collapsed in the late 1980s, the government chose not to write down bad loans or take the pain of massive restructurings. Instead it launched a massive borrowing program in the hope of stimulating the economy enough to outgrow its rough patch.

Government debt grew from 66% of gross domestic product in 1989 to 226% in 2009 -- by far the largest percentage of any industrialized nation. (The U.S. figure is 93%.)

Despite the spending, Japan's economy never strengthened, and the country fell into a cycle of increased deficit spending.

Certainly Japan's woes are no secret. But perhaps paradoxically, because the country has stagnated for so long, many assumed the economy had bottomed out.

Sure, a recovery may not be likely -- but a collapse?

Hard to imagine, or so one might think.

The debt problem could push Japan's rating into the BBB category after 2015, S&P said in November, "and by 2025, the country's fiscal indicators might weaken to the extent that they would be more typical of the performance we currently associate with speculative-grade sovereigns (those rated 'BB+' or lower)."

Today's downgrade pushed its long-term rating from AA to AA-minus.

While the move came as a surprise to some, a handful of investors and economists saw the downgrade as an acknowledgment of what they have believed for years: Japan is en route to a national debt crisis and a massive devaluation of the yen.

…sometime in the next five years, the Japanese government will have to pay such high interest rates to sell its bonds that the government will effectively go bankrupt.

"The Japanese have created the circumstances for the greatest financial failure in world history," Kyle Bass says.

The worldwide impact will be "awful."

Seniors now make up about 23% of the country, according to estimates from the Organization for Economic Development and Cooperation. That's nearly twice the percentage of retired citizens in the U. S. and three times that of the rest of the world.

The graying of the population is playing out in two ways that could have disastrous consequences for Japan.

First, entities like life insurance companies and the Government Pension Investment Fund will be net sellers of Japanese government bonds going forward so that they can gather cash to support the new pensioners.

Meanwhile the population is in long-term decline -- the working-age group peaked in 2009 -- so there are fewer workers and a smaller pool of tax receipts to support the retirees.

Japanese tax revenues have collapsed to levels not seen since 1985, both because of the demographic shift and the global recession.

That means Japan has to sell more bonds even as its traditional customers begin selling more than they buy.

The rub: "The available pool of capital to buy bonds is no longer greater than the debt needs," says Bass.

Japan will someday have to entice new investors, mostly from other countries -- and it doesn't have an appealing story to tell.

The government currently runs a deficit of about $500 billion a year and growing.

And it has the highest corporate taxes and among the highest income taxes in the world.

Attempts to raise the nation's value-added tax have been rejected by the people.

Efforts to raise capital by liquidating the country's $2.8 trillion in financial assets (many of which are U.S. Treasuries) would send the sort of desperate signal that would hurt the price of Japanese bonds.

In short, if Japan wants to sell bonds to the rest of the world, it's going to have to offer higher interest rates. But if Japan paid what the rest of the G-7 pays, its interest costs would immediately exceed its revenues.

Current debt payments are about $244 billion a year.

Bass has calculated that every percentage point in higher yields adds another $125 billion in annual interest expenses. So if investors demand just an extra two percentage points above current yields -- bringing Japan in line with what Canada would pay to issue debt -- that adds $250 billion in annual interest payments to the country's debt figure.

That eats up the nation's entire $489 billion in revenue.

Most importantly, the difference between Japan, which seems relatively sanguine, and the struggling EU nations, which seem to flirt with disaster everyday, is that no one has enough money to bail out Japan.

"If Lehman Brothers was too big to fail, then Japan would be too big to save," agrees Costello.

-- Katie Benner of Fortune Magazine

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