A note on Banzai Bonds
Yesterday, leading rating agency Standard & Poor’s maintained its credit rating for Japan at AA-. And although the state of public finance should give some reason for concern, S&P nevertheless is quite confident that Japan’s future current account will be sufficient in the black in order to absorb the domestic funding needs. Well, it used to be like that but since a year or so, things have dramatically changed.
A lot has been written on the JPY surge and the fact that Japanese international trade has become more and more uncompetitive due to the strong currency. And it certainly has had an impact, no doubt about that. Last year, Japan posted a trade deficit for the first time since 1980. And 1980 is no co-incidence either because in 1979, the world fell victim to a second negative oil-shock. Looking at the final 2011 numbers, we could conclude that the strong JPY is forcing exports down (-9,3%) and pushed imports up (+9,8%). But when looking at a geographical split-up on imports, we immediately see that the yearly increase was most significant in the case of the Middle East, hence energy. And the Gulf is now responsible for 14% of total Japanese imports (including Russia, it amounts 16%). Especially the yearly increases in case of Saudi Arabia and UAE is eye-catching, respectively +27% and +33%. Overall mineral imports increased by 24% in 2011.
Chart : evolution Japanese imports coming from Saudi Arabia in bio JPY
The reason is of course self-evident, being Fukushima and the need for more fossil fuel imports. But there is more at stake because not only is the trade balance going into the red, the global balance of payment is also under pressure. And if this deteriorating trade balance trend persists – for reasons of a strong JPY or further energy import needs and price hikes on commodities – it could easily wipe out the narrow surplus on the total current account.
Now why Banzai ? Well, so far, no one really seemed to care about the Japanese debt problem, in spite of its huge accumulation of annual deficits (currently 9%) and its mass public debt overhang (gross debt 230% of GDP). And a significant roll-over problem this year amounting almost 60% of GDP in maturing debt, a repetition of last year’s exercise:
No problem say a majority of economists, there is still a huge domestic savings’ surplus which can be addressed. Well, not entirely. We already mentioned the balance of payment problems currently on our hands but in addition, the domestic savings’ rate has year by year being sliced down, from almost 20% 2 decades ago to a meager 2,5% as we speak. So far, it seems the population has been willing to finance this debt at an average 1% in a deflationary environment. But Japanese banks and insurers are loaded with the bonds as well :
And these same financial players in Japan lately have been sounding the alarm bell. Japanese banks’ risk management over JGBs was in the spotlight early this month when the Asahi newspaper said MUFG has drawn up a contingency plan that flags 2016 as the time when yields on JGBs could surge if the current account falls into deficit. As the chart shows, Japanese investors hold about 95% of government bonds. But a fast ageing population also means a growing number of elderly Japanese will be running down on their savings. And increasing pension cost ticking like a time bomb under the future public debt. So we could indeed have a serious problem of funding once Japan is forced to tap the international investor. And I think Japan will not be capable of pulling this trick @ 1% funding cost.
“Banzai” is a traditional Japanese exclamation meaning “(May the empire live) 10,000 years”. Kamikaze pilots used to shout this after finishing their farewell sake ritual and climbing on board of their airplane for their final divine mission. And yes, strangely enough, they wore helmets. But it didn’t serve them in the end. And when you are a JGB holder 5 or 10 years from now, my guess is that a helmet will be of no use to you either.
A more in depth IMF study on the subject of Japanese government bonds can be found at