Time Running Out for Yen and Japan

04/18/2011 12:18 pm EST


Gary Shilling

Columnist, Forbes

The financing of recovery from the recent disasters will hasten the day of reckoning for the heavily indebted government and its currency, writes Gary Shilling in INSIGHT.

Japan’s gross government debt last year was 226% of its gross domestic product, far and away the largest ratio of any G-7 country.

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Recently, Standard & Poor’s cut the Japanese government debt rating to AA-minus while Moody’s assigned a negative outlook to its Aa2 rating. At the same time, loans from Japanese banks have dropped precipitously since the early 1990s.

And now, on top of two decades of economic stagnation, comes the huge 9.0 Richter-scale earthquake and resulting tsunami.

Early estimates of destruction run around $200 billion, or 4% of Japan’s GDP. The economic disruptions and loss of nuclear-power generation may well drive the Japanese economy into yet another recession, a far cry from the 1.5% GDP growth the government forecast earlier for the fiscal year that started April 1.

Japan relies on nuclear reactors for 29% of its electricity generation, and 15 of her 54 nuclear power plants are now shut down.

Sure, rebuilding will create jobs and economic activity—but if that were the route to economic prosperity, everyone in the country should smash up each other’s car. Rebuilding simply takes things back to where they were, but at tremendous cost to the government, insurers, and those who lost property, income, and jobs—to say nothing of the sad loss of thousands of lives.

The earthquake and tsunami, then, will likely speed up the day when Japan’s trade and current account balances switch from positive to negative.

NEXT: How Japan's Deficit Could Nearly Double Overnight


How Japan's Deficit Could Nearly Double Overnight
Japanese government bonds (JGBs) are likely to sell off in anticipation of the higher yields needed to attract financing from abroad to cover current account deficits. The 1.24% yield on 10-year JGBs would need to jump 2.8 times to equal the ten-year Treasury yield, 2.7 times to match Germany’s and 4.4 times to equal the 5.5% yield on Australian ten-year bonds

The effects would devastating for Japan’s deficit and accumulating government debt, which has relatively low yields throughout the yield curve. Each one percentage point rise in the government's average borrowing cost will hike the deficit by about 7 trillion yen ($84.5 billion), or 15%.

The 4.4-fold increase in the ten-year JGB yield needed to bring it from 1.24% to Australia's 5.5% ten-year bond yield would push Japan's government deficit up 66%. Wow! A two-thirds increase in the deficit!

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The average maturity of Japanese government debt is six years and seven months. But 15% of that debt matures this year, 48% in the next five years and 75% in the next decade. And, as noted earlier, markets anticipate—so JGBs throughout the spectrum will probably plummet in price and leap in yield at the first sign of a current account deficit, maybe even beforehand.

It was probably the safe-haven appeal of Japan, with its serene culture and stable (if flat) economy, that fundamentally propelled the yen for two decades. But with the speeded-up train wreck, that safe-haven image will probably disappear. Ever-pessimistic Japanese consumers may retrench even further, intensifying the smash-up.

Then, those of us who’ve been waiting patiently for 20 years to sell the yen may have our turn in the sun. Perhaps the March 18 international intervention against the yen will be its turning point, just as the Plaza Accord to bash the buck marked its peak in September 1985.

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