Thursday, March 17, 2011

Is Japan Bankrupt?

Earlier this week, I noted that Japan may be a game changing event by noting:

Japan: One of the world's largest economics has had a devastating earthquake. 'Nuff said.Last year, Barry over at the Big Picture posted a story that Contrarian Edge argued Japan would be the first sovereign default. At that time, Japan had nearly a 200% debt/GDP ratio. Will they be able to fund recovery?

Pragmatic Capitalism has a different take on the issue, one that is incredibly well thought out.

In essence, these pundits say Japan is on the brink of a bond market collapse that will result in the inability of the government to finance its debt which leads to a Greek scenario. Of course, what these people fail to recognize is that Japan is fundamentally different from Greece in that Greece is a currency user and Japan is a currency issuer. Whenever someone compares Japan or the USA to a Euro nation you should immediately dismiss them and stop reading their content – they clearly do not have even the most basic understanding of monetary systems.


Like the budget surplus in the USA in 1999 the surplus in Japan exacerbated the private sector debt problem as the public sector surplus resulted in private sector deficit. This ultimately resulted in en epic bubble collapse. Their solution was less than precise. Rather than take the Swedish approach the Japanese decided to let their banks earn their way out of the crisis. This only prolonged the inevitable deleveraging. This was combined with insufficient budget deficits that would have allowed the private sector to deleverage more quickly. This debt deleveraging resulted in anemic economic growth and persistent deflation. What ensued was a series of start and stop recessions and recoveries that happened to overlap with a difficult period of economic growth in many other parts of the world. As we all know it hasn’t been a pretty picture.


There is, arguably, no better measure of a nations solvency than CDS prices. If you review the recent change in Japanese CDS you’ll notice that they are remarkably low considering the size of their public debt. You’ll notice that Greece and Ireland are more than 6 times higher than Japan currently (via Bespoke):


What about their bond market? If you’ll recall the solvency crisis last year in Europe one of the defining characteristics of risk was surging yields. As I often say, there really are bond vigilantes in Europe. If there are vigilantes in Japan they sure are asleep on the job. Just look at Japan’s 10 year bond at 1.2%! It has actually declined in recent weeks. Investors clearly aren’t concerned about solvency. And rightfully so. There is no such thing as Japan running out of Yen.

Read the whole thing - it is well worth it.