Japan's huge budget gamble will push up global interest rates

01/04/2010 10:30 am EST


Jim Jubak

Founder and Editor, JubakPicks.com

It’s a desperate gamble but Japan’s Democratic Party government, headed by Prime Minister Yukio Hatoyama, doesn’t have much choice.

To break the hold of deflation on the Japanese economy, the country has to spend money—lots of money—it doesn’t have to stimulate an economy that threatens to turn in a third straight year of negative growth in the fiscal 2011 year that begins in April  2010.

The government’s new budget calls for a record $1 trillion in spending for the fiscal year. But it’s not the size of the budget that’s so shocking. Government projections say that tax receipts next year will come to just $405 billion. For the first time since World War II Japan’s government will borrow more than it takes in from taxes.

That new borrowing—an estimated $485 billion—will bring the country’s total debt to $9.4 trillion by the end of fiscal 2011 in March 2011. That will be equal to 181% of the country’s GDP (gross domestic product) by March 2011. In other words Japan will owe almost two year’s worth of the activity of its entire economy.

How big is that debt burden? Let's look at a few comparisons.

Just for context, Greece—the country that all the credit rating companies are rushing to downgrade now--is projected to finish 2009 with debt equal to 112% of GDP. The United States, according to the International Monetary Fund (IMF) will finish 2011 with gross government debt equal to 98% of GDP. (Before you feel too smug about that remember that this ratio was at just 71% in 2008 and in Korea the ratio is at 35%.)

If you follow Japanese politics and economics, where the government proposes to spend its stimulus is shocking too. Japan has launched stimulus packages before in an effort to get its economy growing. The problem with those packages, I’d argue, was that they were too small and too focused on buying votes for the Liberal Democratic Party governments that ruled Japan in an almost uninterrupted string until their defeat by the Democratic Party of Japan in September’s election. Much of the stimulus money went to under-populated but politically influential rural districts where it was spent on infrastructure to nowhere. It’s hard to stimulate an economy if year after year the stimulus keeps being shoved into unproductive projects.

Now rather than building cultural resort villages in districts that tourists never visited or on road, water, and sewer infrastructure for industrial parks that never attracted any tenants, the Hatoyama government has proposed jump starting the consumer economy by increasing spending on welfare and education. The idea is that things like cutting or eliminating fees for public school education will free up money in household budgets that could go into consumer spending.

If the Hatoyama stimulus doesn’t work, of course, the country will wind up with an economy that’s going nowhere and a government debt that is massively higher.

For investors outside of Japan, the gamble means that the Japanese government will be issuing a truckload of new debt at the same time as the governments of the United States, the United Kingdom, Spain, Germany, and the rest of the developed world will be carting their own mountains of new debt to the bond market.

Sounds like a lot of upward pressure on interest rates, downward pressure on currencies such as the yen and the dollar, and increased demand for gold in 2010, no?
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