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.
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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):
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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.
7 comments:
Holy cow, thanks bonddad. That was the missing piece to my own understanding of the money supply. The derpy right-wing idea making waves is that the Fed issues currency to fund deficit spending, which is laughably wrong. Congress spends the money and the Treasury manages the account. The Fed just manages the money supply, by way of interest rates and fractional reserve lending. But that debt starts with some "solid" money; cash from the U.S. Mint isn't enough. Most "solid" money is actually deposits. Despite all the herp-a-derp about hyperinflation, in fact there isn't enough cash to fund the economy if debt multiplied the amount a hundred times over. So where is the money coming from? This is the part I couldn't figure out. If conventional monetary theory was true, either the government would be on the verge of bankruptcy or there wouldn't be enough money for the economy to function. One or the other would collapse, if not both, and every year would be like 1938.
Voila, the missing piece. The government spends it into existence.
Finance is extremely counterintuitive :)
That link is brilliant. I think I get it now, actually. At least mostly :). Summary:
If you are a country that cannot print it's own currency, then you operate much like an individual operates. If you need to spend money, you must borrow it. If you borrow too much, rates go up and make it too expensive to borrow. At some point you go into default.
If you are a country that can print your own currency, then debt is just part of a larger picture of money supply. You need to manage the money supply and you do that through the issuance of treasuries and through spending. If the money supply outgrows the productive capacity of the country you get inflation. If the money supply is too small you get deflation.
The US Debt, really isn't debt in the traditional sense of the term. In theory, we can simply print money and spend it, so we need not borrow. It is just a tool of monetary supply.
So really looking at debt isn't valuable in any way from the outside. Instead it's all about inflation/deflation. If the rate of inflation is too high, then there needs to be an adjustment, and if the rate of inflation is too low, there needs to be an adjustment. The debt is a detail.
Am I getting it? :)
Steve -
I'd say so, but I see two more facets to it that are probably beyond the scope of the link, but complete the big picture. Those the value of money and the role of taxation.
First, the role of currency as a holder of value. It's not. If any goldbug asks you the "rhetorical" question why the dollar has steadily lost value since the introduction of the Fed, the answer is: Because the dollar was never meant to be a store of value. It's a medium of exchange, so it merely needs to be relatively stable. If it holds its value between the time I get my paycheck and the time I buy the beer, it's doing its job. In fact, inflation is always deliberately kept positive, to provide an incentive to do something with the money besides sit on it. If you want a store of value, buy assets.
Second, why tax at all? The country really just issues currency and spends it to grease the wheels of the economy. A wealthy country doesn't need to punish its citizens by forcing them to work, do they? If we set up a generous welfare program, the essay leaves us with the impression that the limitations are just on the money supply side. But this is false. In fact, I'm now convinced we tax to force productivity out of our citizenry by creating a demand for dollars. If you just gave every farmer a big handout, they'd all stop farming and the price of food would hyperinflate no matter now little the government spent otherwise. A healthy system ensures both food exists for money to buy, and money exists to pay for food. For that purpose, SOMEONE's gotta do SOME work.
However, a flaw is emerging in that part of the system. Productivity in America is now so absurdly high that you really don't need that many people working. . . but the unforgivable demand for dollars remains. The modern monetary system requires people to work, even if their productivity isn't needed. Those whose skill sets are part of the surplus are punished with poverty, even if they're willing to work. We actually should institute a stronger welfare system (and CCC) so the money supply doesn't create a labor surplus we don't know what to do with. That sounds like I'm contradicting my earlier statement, but like the link said, it's a balancing act. The welfare system can't be too generous, and we need to preserve the part that rewards productivity so there will always be businesses eager to provide goods & services people want.
The big mistake the Republicans are making is that the government is beholden to its debt obligations. It's not. You can't default when you lend money to yourself. You can technically run a deficit on paper, if you want, but you'll never collect. They use a "husband-wife" analogy, but I don't think that gives the right intuitive picture. It's more like a personal regimen. Say you pick up walking as a hobby, starting at 1000 paces a day. One day you're tired, so you stop at 900. Your regimen now has a 100 step deficit. Do it again the next day and you now "owe yourself" 200 steps. You can walk 1200 steps the 3rd day to "balance the budget" but you'll just be exhausted on day 4. More generally, why should you decide to punish yourself for taking it easy yesterday? Letting it go uncontrolled might be a sign of some other problem, such as, maybe you're getting lazy. BUT one thing that WON'T happen is you pointing a gun to your own head demanding all the steps you owe yourself. And even if the "step debt" climbs to a billion, really, as far as your health is concerned you should just focus on getting back to 2000 steps a day. Excessive deficits matter, but government debt does not. In fact, I now realize that tracking the debt is one of the dumbest things the government is doing. We're only doing it because Congress still thinks we fund the government with cash.
One more thing:
"we can simply print money and spend it"
I hear this a lot as an argument about the risks of hyperinflation. It's technically true but very misunderstood. It's not that the government CAN print money and then spends it, like it's some kind of fallback option if we completely lose control. It DOES. It's the NORMAL mode of operation.
A good book on the subject is "This Time is Different: Eight Centuries of Financial Folly," by Ken Rogoff and Carmen Reinhart. The book is somewhat technical, but it has a good discussion on the principles of sovereign debt. I doubt the authors would say that Japan is close to defaulting on their debt or having their debt restructured. Modern day industrial countries can have large debt to GDP ratios and not worry about defaulting. However, emerging nations often default even when their debt to GDP ratios are very low, even lower than .2.
One surprising view the authors have is that they regard printing money as a form of defaulting on their loans. So they would also say that it is unlikely that Japan will turn on the printing presses to pay off their loans.
Technically, nations rarely go bankrupt, at least not in the sense that corporations do. Nations usually have enough assets to pay off their debts if the wanted to. Moreover, they can always restructure their debt payments. Thus, the decision to default is usually political.
Excellent, you guys discovered Modern monetary theory (MMT).
This intro here is well worth a full read
@Dragonchild MMT also says we don't have conventional fractional reserve banking anymore. It is a gold standard relic. They are many countries with zero reserve requirements- Australia, Sweden etc:. If the money multiplier of fractional reserve banking were correct, for those countries theoretical loan creation capacity goes to infinity. In other words Australian money supply would approach infinity!! Obviously that is not correct. See article
In reality, according to research by MMT economists banks create new money by lending. Maybe that is why they are so dangerous :D. Banks don't lend out deposits, in reality loans create deposits. The real constraints for loan creation are capital requirements on the supply side and credit worthy consumers on the demand side. So enforcing strict capital requirements and lending standards are essential.
The difference between bank created money (horizontal) and federal government created money (vertical) is that bank created money is balanced by a private sector liability. The change in NET financial wealth of the private sector is zero. With vertical money there is no co-responding liability in the private sector. So in that case NET financial wealth of private sector (actually non-government) increases by the same amount.
The recent disaster’s financial impact would be on a far larger scale than the Kobe quake. The USD/JPY currently is almost at record high against the USD. It would continue to appreciate while funds are repatriated in the near term. However inevitable increase in government spending, with already high debt levels would ensure that it is confined to raise the necessary funds domestically.
Economic consequence of the Japanese earthquake
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