The Greece of Asia

Japan's Growing Sovereign Debt Time Bomb

The eyes of the financial world are on Greece and other heavily indebted euro-zone
countries. But Japan is in even worse shape. The country's debt load is immense and
growing, to the point that a quarter of its budget goes to servicing it. The government
in Tokyo has done little to change things.
By Anne Seith
Photos

Today's Tokyo has become a permanent mecca of consumption, its boroughs seemingly
divided according to target markets. The city's Sugamo district, for example, is
dominated by the elderly. Escalators in the subway station there go extra slow, while the
stores along the Jizo Dori shopping street offer items such as canes, anti-aging cream and
tea for sore joints. The Hurajuku neighborhood, on the other hand, is teeming with
fashionistas made up to look like Manga characters.

This world of glitter, however, is but an illusion. For years, the world's third-largest
economy has been unapologetically living on borrowed cash, more so than any other
country in the world. In recent decades, Japanese governments have piled up debts
worth some €11 trillion ($14.6 trillion). This corresponds to 230 percent of annual gross
domestic product, a debt level that is far higher than Greece's 165 percent.
Such profligate spending has turned Japan into a ticking time bomb -- and an example
that Europe can learn from as it seeks to tackle its own sovereign debt crisis. Japan, the
postwar economic miracle, has never managed to recover from the stock market crash
and real estate crisis that convulsed the country in the 1990s. The government had to bail
out banks; insurance companies went bust. Since then, annual growth rates have often
been paltry and tax revenues don't even cover half of government expenditures. Indeed,
the country has gotten trapped in an inescapable spiral of deficit spending.
The fact that this tragedy has been playing out in relative obscurity can be attributed to
a bizarre phenomenon: In contrast to the debt-ridden economies in the euro zone,
Japan continues to pay hardly any interest on what it borrows. While Greece has
recently had to cough up interest at double-digit rates, for example, the comparable figure
for Japan has been a mere 0.75 percent. Even Germany, the euro zone's healthiest
economy, has to pay more.

Endless Amount of Money

The reason is simple: Unlike countries in the euro zone, Japan borrows most of its money
from its own people. Domestic banks and insurers have purchased 95 percent of the
country's sovereign debt using the savings deposits of the general population. What's
more, the Japanese are apparently so convinced that their country will be able to pay off
its debts one day that they continue to lend their government a seemingly endless amount
of money.
Experts warn that this system cannot go on for much longer. Takatoshi Ito, an economics
professor at the University of Tokyo, says for example that Japan could become the "next
Greece" if its government doesn't change course; the money, he says, will eventually run
out. Ito and a colleague have calculated that even if the Japanese people invested all of
their assets in sovereign bonds, it would only be enough to cover 12 years of state
expenditures.
But who is supposed to come to Japan's rescue once that point has been reached? "If
Japan is forced to go looking for investors abroad, a debt crisis will be unavoidable," says
Jörg Krämer, the chief economist of Commerzbank, Germany's second-largest bank.

The man tasked with averting this disaster has his office in a building that looks like a
fortress compared to the glass-and-steel skyscrapers surrounding it. The walls of the
Bank of Japan, the country's central bank in Tokyo, are made of heavy, gray stone
decorated with thick columns and gables.
Yet the impression of an impregnable fortress is misleading. The bank's 63-year-old
governor, Masaaki Shirakawa -- a thin man with neatly parted hair -- no longer adheres to
the disciplined monetary polices his Western counterparts preach. Instead, Shirakawa
keeps the money printers going to stimulate the economy. Since 2011, his bank has
launched emergency programs with a total volume of around €900 billion. In comparison,
the euro bailout funds jointly financed by the euro zone's 17 member states only add up
to €700 billion.
Carefully Weighing Each Word
For some time now, Japanese banks have been able to borrow money from the central
bank at interest rates close to zero. By following this policy, Shirakawa is doing exactly
what a number of European politicians -- and particularly ones from cash-strapped
Southern European countries -- have been asking the European Central Bank
(ECB) to do: He is financing the Japanese government. He denies doing so, and the
method he uses are circuitous, but it amounts to the same thing.
So far, though, his strategy has done little to help. "At the moment," Shirakawa admits,
"the effect of our monetary policy in stimulating economic growth is very limited." The
cheap money is stuck in the banks rather than flowing into the real economy. "The
money is there, liquidity is abundant, interest rates are very low -- and, still, firms do not
make use of accommodative financial conditions," Shirakawa adds. "The return on
investment is too low."
Shirakawa is sitting stiffly in a black leather chair with a straightened back and crossed
legs. He carefully weighs each word.
The chief central banker, though planning to retire this spring, is currently under massive
pressure. The government of newly elected Prime Minister Shinzo Abe, a conservative,
recently made clear that it expects Shirakawa to print even more money. Abe's
inauguration took place on Boxing Day.
The prime minister wants to launch a massive new €91 billion ($120 billion) economic
stimulus program, refuelling the Japanese economy with public investments in the
construction sector. At the same time, Abe wants Shirakawa to pump unlimited cash
into the economy. If the central banker is unwilling to go along with those plans,
Abe has warned he is prepared to change the law and place the central bank under
government control.
It's the kind of idea economists have little regard for. "That would be tantamount to
the driver of a car steering towards a wall and putting the pedal to the metal one more
time before impact," economist Krämer says dryly. Klaus-Jürgen Gern, an Asia expert at
the Kiel Institute for the World Economy, speaks of "pure helplessness".
Election Gift?
Central bank chief Shirakawa himself seems unsure of the best way to respond. Four days
after Abe's electoral victory, the central banker apparently caved and increased his
emergency sovereign bond and securities buying program by a further €90 billion.
Observers described it as a Christmas present for the imperious election winner.
Still, it also appears that Shirakawa is likewise aware that he may just be throwing good
money after bad -- even if, according to Japanese tradition, he hides the concession
behind prim courtesies.
Money is only a means with which "to buy time," he says. "It can alleviate the pain.
But the government has to implement reforms too."
That may be, but every political effort that has been made in recent decades to activate
the overregulated economy has failed. In the retail sector, for example, proceedings
have become hopelessly old-fashioned. The industry has slept through many IT
revolutions because the country seeks to "preserve as many jobs as possible through
extreme state regulation," says Martin Schulz, who has worked since 2000 at the Tokyo-
based Fujitsu Research Institute.
It even appears that election victor Abe may be planning to scrap his predecessor's plan to
increase the value-added tax (the VAT sales tax) in several steps, from 5 to 10 percent.
One thing is sure, warns central banker Shirakawa, "If we don't deliver fiscal reform, then
the yield on Japanese government bonds will rise."
'A Real Problem'
Were that to happen, it would be tantamount to pulling a card directly from the center of
a house of cards. Fully one-quarter of the government's overall budget currently goes
toward servicing debt. Were Tokyo forced to pay higher interest rates, it's mountain of
debt would grow even more rapidly.
One additional "potential risk," is the "amount of holdings of Japanese government bonds
within the banking sector," as central bank chief Shirakawa politely notes. If long-term
interest rates were to rise considerably, it could affect the stability of the sector.
That, at the very latest, would mark the point at which the crisis could spill across Japan's
borders. In Germany, financial institutions like Mitsubishi UFJ may not be widely
known, but they are still internationally networked mega-institutions that have the
potential to destabilize the entire finance community.
Predicting the potential effects of the Japanese debt crisis is extremely difficult. But
researcher Schulz is convinced that there won't be any "major crash." Out of self-
preservation, he says, it is unlikely that large holders of Japanese bonds, such as domestic
banks, would shed those bonds very quickly. Such a move would severely damage faith
in Japanese debt and, by extension, in the banks that hold that debt. Instead, he predicts
"many small crises" in the coming years. He and other economists further believe that
there is plenty of room to raise taxes as a countermeasure; taxes in Japan remain
relatively low.

Nevertheless, warns Commerzbank economist Krämer, one shouldn't give short shrift to
the potential dangers of the Japanese debt crisis. "The psychological effect could be the
most dangerous one," he says. What would happen, for example, were investors to
suddenly lose faith in other heavily indebted countries such as the US.
"Japan remains one of the world's biggest industrial nations, and the yen is an important
currency for international monetary transactions," says Asia expert Gern. "If everything
were to spin out of control, then the world would have a real problem."