Japan – Dancing on the Edge of Calamity

Duncan Cameron has asked me to post this contribution by Ken Courtis,  a recognized authority on Japan and world economics. A Canadian academic turned investment banker, he has been resident in Japan for many years.
On 09-11-26, at 19:30, Ken Courtis wrote:

The reality of Japan’s fiscal situation is as close to calamitous as any major economy has ever experienced, in peace time or during war. And it is set to become still more problematic.
The on-balance sheet central government gross debt is set to touch  200% of GNP within a matter of a few quarters. With the economy contracting and deflating, economic policy, indeed large parts of the country’s current economic structure are hurtling ever deeper into a complete cul de sac.
We do not have a good picture of the off-balance sheet obligations of the Japanese state, but it is significant. Earlier this decade, estimates based on data released by the Ministry of Finance seemed to indicate that off balance sheet claims on the state were then well in excess of 300% of GNP. In the meantime, the on-balance sheet debt continued to soar.
Debt, the wrong demographics, and deflation are the most poisonous of economic, political and social cocktails. In addition, Korean, Taiwanese, Chinese competitors are beginning to slice entire sectors off Japan’s global export market share.
For the moment, interest rates are ultra low, but imagine the economic and social tumult were government funding costs to rise, say to 2%, which is less than half the 50 yr average. With debt at 200% of GNP, that would mean that it would take 4% of GNP each year simply to service the debt. So if Japan were unable to grow at 4% annually, the debt would keep expanding. That means that Japan would be trapped in the jaws of a vicious debt trap.
Is there any potential for Japan to be growing at 4% real, year in, year out, anytime soon? And remember, I have used as an example, a 2% cost of funds. Plug a 4% cost of funds into the equation, and see how daunting the situation would be, and 4% is still less than the long-term -50 yrs– average cost of funds for Japan government paper.
There has been some discussion about the budget review which the new government has initiated. The only thing more urgent in this regard is a review of fiscal policy and of the country’s overall economic strategy, which is leading nowhere but to big trouble.
Should it become more broadly apparent that Japan is dancing on the lips of disaster, and the recent surge in CDS spreads indicate that at least some are becoming more than jittery, the knock-on effects would be dramatic indeed for a still extremely fragile global financial system, where we have seen in the last 24 months as a result of the worldwide combat to contain the wreckage of the US economy which was the Bush regime legacy to its successor, a surge in public sector debt of some 35% of world GDP!

Tied into this dynamic is the quasi totality of Japanese social policy, economic structure, indeed even its security position, and in particular its relations with America, and the parts of the world economy which will be generating growth in the decade to come. That growth is going to be led by China.
Kenneth S. Courtis


  • One thing the Japanese situation has demonstrated over the last 15 years is that it is the central bank that sets interest rates. The current crisis outside of Japan has reaffirmed this in spades, with Canada and the US, for example, adopting the same zero interest rate policy. Interest rates can remain at near zero indefinitely as long as the central bank so wishes. The debt trap scenario won’t happen.

    With respect to CDS spreads, Japan is sovereign in its own free floating currency. There is no reason for it to default on yen denominated debt. It can always produce more yen to pay it off so there is no default risk.

  • I put up two posts on Japan this past week. Krugman argued that they prematurely discontinued their monetary easing and that what caused the continued deterioration. That is fine I would suspect Krugman to argue as much given the size of dog he has in the present macroeconomic fight.

    But Japan is really much more interesting. As the graphs in my posts showed the Japanese government started with increasing fiscal expansion 5-6 years before adopting a low-zero interest rate target. Moreover, CPI just kept falling despite zero interest rates (LIBOR) and a 45 degree expansion in the growth of gross debt.

    I do not know of any highly accepted theory (HAT) which would have considered this a possibility.

    Keith writes:
    “Interest rates can remain at near zero indefinitely as long as the central bank so wishes.”

    And as long as there is no GDP growth to speak of. Surely 10 or more years of real interest rates around 2 % or less should have induced growth (particularly along side fiscal expansion). This is what is unsettling about the Japanese case.

    Is suspect Japan does not get much time by the profession because it does not provide safe harbour to the two main camps. I asked a CD Howe economist about this months back on this blog and he seemed thoroughly uninterested.

  • The value of houses and other assets lost as a result of the Japanese crash was three times GDP. It takes a huge amount of fiscal stimulus to make that up. Low interest rates are ineffective in that scenario. The government cut back on the stimulus prematurely as well.
    The US lost 1 time GDP and its fiscal stimulus is also too small.
    The mainstream has no answers for Japan so they ignore it. For example they believe deficits compete for loanable funds and cause a rise in interest rates, resulting in crowding out of investment. Japan demonstrated this is false. Deficits were huge and rates remained low because the central bank set them low. They also believe in “quantitative easing“ which is irrelevant.
    Try reading Richard Koo on this.

  • Hi Keith,

    Do you have a link for us or a citation?

    One interesting specificity of the Japanese case is declining population. I do not know how this connects to housing but I could imagine something out-loud. What I do know is that when population is scaled out Japanese productivity and GDP are not all that bad. In fact labour productivity has simply fallen in line with other advanced cap countries since the mid 90s. I will throw the graph up in another couple of days on my blog.

  • And on the stimulus thing I am not sure. When you say prematurely ended what do you mean: as in, what is your interpretation of the duration of fiscal stimulus in Japan?

  • It is not as if Ken Courtis has infra red vision and can see in the dark that he can pronounce that the dire(in his opinion) fiscal situation in Japan is about to get more problematic.

    Ever since Japan has made history by electing Democratic Party of Japan (DPJ) by overthrowing the uninterrupted rule of Liberal Party it has faced prejudice in the foreign media, perhaps because the DPJ is energetic and has vigour. What Ken has failed to mention that the economic policy in the past in Japan has been dictated by the Big Corporations (export oriented) , and not by the elected government or the finance department whereas the DPJ is working on changing all that. Here is a take by Karel van Wolferen, author of “The Enigma of Japanese Power” and his analysis has been important to the Democratic Party’s platform
    New Hope for Japan: Why I Think It Could Finally Start Acting Like a Real Democracy

    I don’t know what Ken means by Japan’s security position, because DPJ is confident on that issue. When in opposition they had repeatedly raised questions about the official version of the 9/11 events in the Diet. There are various media clips of this on youtube.
    The DPJ also made it clear during the campaign and after winning the election they are seeking friendlier relations with its neighbours like China, N&S Korea, Taiwan and also wants to re-examine the deal on US military bases and have the agreement which permits the US to store and deploy nuclear weapons in Okinawa scrapped. Instead it wants to redefine its relationship with US based traditionally on a subservient foreign policy to that of one of equal partnership and based on economic strength. It has also launched a fact-finding investigation to make public the past governments secret agreements which had eroded the public trust in government’s foreign policy.
    DPJ is also more focused on reviving the domestic economy and has offered incentives like subsidised child care to boost birth-rate.

    Furthermore Ken the GS alumni use of poetry for morbid purpose “Should it become more broadly apparent that Japan is dancing on the lips of disaster, ..” and the recent surge in CDS spreads indicate that at least some are becoming more than jittery, the knock-on effects would be dramatic indeed for a still extremely fragile global financial system”, is as inappropriate as a fat guy who takes off his shirt to sun while driving his convertible with the top down. Totally uncalled for.

    While Ken Courtis paints widening CDS a pending dooms scenario, Moody’s does not think Japan’s credit default swap spread signals a “turning point” in the finance ability of Japanese government bonds.

    The Times published a piece more suitable for a vampire flick than a financial analysis, the Japanese markets fall may be horrific but will be compensated by entertaining thriller. Perhaps I am the only one who is shocked, maybe because I did not know that sensationalism is integral to financial journalism.

    Here’s a trailer:


    In the bloodcurdling programme notes, the Japanese bond market has a plot, a setting and a cast of characters that should logically guarantee a great horror show.
    There is the monstrous spectre of public debt –— a bogeyman that has swollen to nearly 200 per cent of GDP and which the IMF predicts could burgeon to 246 per cent within five years. There are the hapless Japanese villagers, too old and weak to fight the debt beast and no longer able to sate its hunger from their gold stashes. There is the spooky old castle of Japan itself — a rickety shadow of its former glory with crumbling walls and dark secrets………..
    Japan heads for financial horror story
    To start with, there is the question of whether gross debt to GDP ratio is deadly or even the right number to be looking at. Britain in the 1950s amassed gross debt above the 250 per cent mark and still managed to found the National Health Service. Looked at in terms of debt servicing costs, Japan is not especially more endangered than the US, UK, France or Germany.
    Secondly, Japan’s debt is almost entirely held by Japanese. That does not remove the risk that JGBs will lose their appeal and yields will rise, but it does mean that the Government knows precisely the kind of investor it is dealing with: all it has to do is what it has always done since 1989 and used the law to make every other investment — from property to the stockmarket — unappealing. CDS spreads too are a financial instrument used mainly by non-Japanese: given that 94 per cent of JGBs are held by Japanese, it is just possible that CDS spreads are not the most accurate predictor of JGB market behaviour.

    So the situation is not as scary as Ken Courtis would like us to believe. He also let some of the pertinent facts out. Understandable I suppose because he was laying the groundwork for propping up China at the expense of Japan. It is not as if there is a finite wealth in the world – one side must suffer for the other to prosper. Same old story – playing games and pitting neighbours against neighbours. Having said today (27 nov) the Yen made a 14 yr high to the US$ and the Japanese Finance Minister threatened to intervene. If the International Financiers can manipulate, he can play the arena too. Best wishes to Japan.

    Besides where would the world be without that “cool factor” of Japan?

  • Credit capitalism is my thesis.

    The question is how will all this debt be eventually dealt with? Will we have new mechanisms constructed. Eventually servicing the debt will potentially become a problem for many nations, that is unless we start growing and even then we may be within in the tangle of a gordian debt knot. Given the state of the international financial market and I would throw in Dubai as the latest example of the instability, how is it that policy makers can envision credit capitalism to continue crawling forward.

    It merely is a sign that chasing that which was actually existing capitalism, is only moving us downward in a spiral that has no solutions. Without severe regulation or new directions, we are dragging along a bottom that keeps sinking.

    JUst wait, the housing crisis will again rear is head in the USA, and then what, more trillion dollar bailouts? I think not, we are heading for the mother of all crashes- and yes the sky is falling.

    Unless!!! We have a new direction- and with that has got to be a new economy based upon the greening of the productive process and consumption.

    Why not allow debt a financed start, held and monitored at the international level. We need a bank for the greening and it need to be forgivable and it needs to be accessible- it needs to be focused and it needs to be filled with lots of power. I would say with all the international announcements in the last week or so that we are actually seeing some positive developments in a similar track as my international bank of greening.

  • Were did the Japanese get the funding to fight of its deflation and exploed its debt??? Which is of critical importance. I think the premise that deficits don’t lead to inflation/deflation is wrong just as equally as the premise that deficits lead to inflation/deflation is wrong. Looking for awnsers to inflation/deflation through prices, unemployment , deficit is foolhardy heroism of whatever cause they push because all of these are lagging idicators by various degrees .

    You can have all the stimulus you want, 0% rates if its paid for through surpluses, or taxation or borrowing. All creditor stimulus packages will have a effect and even then in Japans case, doesnt garantee succes, but debt fueld stimulus is a joke. In economics, stimulus spending ran aground on Robert Barro’s Ricardian equivalence theorem(Until his theorem is proven wrong). This theorem says that debt-financed spending can’t have any effect because people, seeing the higher future taxes that must pay off the debt, will simply save more. They will buy the new government debt and leave all spending decisions unaltered.

    However Inflation will win out in Japan too as there funding to fight of deflation is disappearing fast with a aging and declining population with a very depleted savings rate wont be able to hold back the loss in value much longer in a macro sense over the course of another ten years, the Japanese government will no longer be able to gobble up it citizens savings at the same pace as it once did in the 90’s when it cited a high teens rate.

    Japan 1990’s was 1930’s America, the similarities are numerous, High Saving rate, High production, even Japan took paige from FDR and funded everything domestically. However just like America experienced a prolonged depression. Its funny how the two times in history goverment employ, these huge measures, they didnt work. If it wasnt for WW2, the shifting of geo-polotical events and macroenconmic trendsAmerica might still be stuck in that rut if policy didnt change.

    Japan market was probably more pricier than the US market in the year 2000 or in the year 2007. Also, the real estate market was in “bonker’s land” in Japan. The one good thing about Japan after 1990, when the recession hit and a no-growth period began, is that the typical household nor citezen never suffered very badly, for the simple reason that prices for assets, things like golf course memberships, nightclubs, housing prices, etc., all went down. So, their paycheques didn’t rise any more but didnt decrease either stayed at the same level, and everything fell in price – we had deflation. So the typical household actually increased its standard of living.

    What does all this lingo mean? I am not saying deflation Japan-style is the only possible outcome. In a sense, I highly doubt it will occur. Commonsense dictactes No two disasters are ever exactly alike and the biggest differrential between the US, ( I use the US as example since any crisis there affects us) Canada and Japan is that they have savings and we don’t. Their budget deficits were also the result of one-off governmental fiscal policies moves unliky to keep re-occuring, whereas our impending crisises are due to structural flaws with our entitlement systems.

    In the US even Canada a little, the problem is that the household sector is terribly indebted. That wasn’t the case in Japan. In Japan, the banks sector was indebted and the corporate and real estate companies were overleveraged too, but not the household sector. The household sector in Japan still had a 12% savings rate when the crisis began. In the US, the household sector had stopped saving out of current income throughout the 1990s.

    In 1990s, the saving rate was nine percent(US); then it went to zero. Now, the savings rate will have to go up. The US and again somewhat levereged Canadian household sector will realize that savings out of illusory asset price gains, like stocks and real estate, are not permanent; and therefore, if we want to have money for retirement, we have to save money from current income which can never happen with artificially low rates. Rising rates And that has, of course, a negative short-term impact on the economy.

    But if everyone can loan to the US government and the Canadian goverment at 6-7%, tour stock markets will collapse since people can get solid returns with ‘no risk’ in US treasuries or Canadian bonds, and the cost of borrowing for corporations and individuals will be unbearable. However for this scenario to play out the world has to be dumb enough to lend the US every dollar it needs, which with increasingly upset creditors is difficult at best.

    Inflation is a serious problem for Canada, thanks to our neighbor, how can our currency rise despite the fact we have 1% rates (LIBOR)?.

    Well my explanation stems from inflation, the USD. The falling USD is driving currencies higher which can be interprted as inflation in the system if you treat a nation currency just like any other commodity, end result our CAD is getting expensive, and not just the currencies but many different asset classes and global markets. From commodities, stocks, equities gold, metals, wheat, argiculture eventually this will all rise to a unnacceptable pont. What makes this worse too is the unemployed this resccession around will still be unemployed, (US) will find prices to high and for everything in years to come. Will my kid have to get a job in highschool because of prices continually rising incremently, if prices rise in my lifetime like they have for my grandomother at the same pace or even sub par, doesnt look good for future generations. I thinking long term to my death what will prices be????(I have been thinking about it alot since my granma is ill and has one foot out the door) I want to head that off as much as possible. Capping prices has never worked in history so I know there can be a no time, prices will just stop and not go higher.

    Im actually optomistic as whatever damage we take, we’ll come out less depandant on the US markets, as the saying goes, dont put all your egges in one basket, Americans less the 5% world pop were not placed on this green earth to simply to consume imported goods. We will consume more, and exports less; all nations will. A shift in global consumption patterns will take place. I think this Christmas season will prove that the world is able to consume at faster rate the the US, this mainly because we have exports and savings build up to spend, unlike our southern counterparts who blew all the money they borrow on consumption, where are the factories, healthcare, education investment they could have been making before the crisis??? The money was blown, gone, and now they have a goverment with the selfimposed titile consumer of last resort which kinda scares me. I need a Paul Vockler.

  • “Just wait, the housing crisis will again rear is head in the USA, and then what, more trillion dollar bailouts? I think not, we are heading for the mother of all crashes- and yes the sky is falling.” – Paul Tulloch

    This remains to be seen I do not think the FED will stand their and watch the industries it just bailed out, wither and collapse, under the renewed housing crisis. It will inject and inject and we will never see 800, or 900 lows on the S&P ever again.

    Too many mortgage holders vote and are you ready for quasi-trillion dollar bailouts you ready for that? and Yes the sky is falling in year or two or more from now when everyone looks to the FED to raise rates and they dont because on gonging problem is housing sector and labor markets and low inflation(cough) will warrant exceptionally low rates for an extended period.

  • I think this quote is appropriate for the article.

    Henry Morgenthau, Jr. was FDR’s Secretary of the Treasury from 1934-1945.
    Blum, “From The Morgenthau Diaries — Years of Urgency 1938-1941” at pp. 24-25 The portions ommitted by Folsom are in brackets: We have tried spending money. We are spending more money than we have ever spent before and it does not work. And I have just none interest, and if I am wrong . . . somebody else can have my job. I want to see this country prosperous. I want to see people get a job, I want to see people get enough to eat. We have never made good on our promises. . . . [We have said we would give everybody a job that wanted it. We have never taken care of the people . . . . there are four million that don’t have that much income. We have never done anything for them . . . We have never begun to tax the people in this country the way they should be . . . . People who have it should pay. . . . It’s never a good year to have a tax bill, but I think it’s a darn good year to begin to balance the budget. . . . the biggest deterrent of all . . . is that the country does not know when the end is in sight and this unbalancing of the budget . . . that’s what frightens people.] I say after eight years of this administration we have just as much unemployment as when we started . . . . And an enormous debt to boot!

    Neither did the New Deal or Japan stimuli ever fix the problem. Said shortly before Americans entering the WW2. Which kinda solved unemployment by itself and not administrative policies.

  • Inject and inject- I just am not sure that is possible. How far can they inject- run more deficit and still assure the world that the USD can be the reserve currency. I simply don’t think the world has any exchange mechanism in place- potentially regionally we are safe but not globally.

    There is a breaking point where the US deficits and total debt versus the role of the US dollar in international exchange will be breached.

    As this article is suggesting- this devaluation of America is dangerous to everybody else.

    The problem I see though, when will required thinking needed to right side it all enter the solution space? When indeed, we had a small window that was open a few months back, and it cost so much to get that small window open, but we failed to get much in the way of change embedded on Wall Street or the other financial sectors.

    We are global for sure, and we are now potentially witnessing some further dominoes falling broke flat on the floor, bankrupt, bloated, over leveraged on a rotted infrastructure in a financial wasteland of last gasps as the ticker tape slows to a stop- every solid debt melting globally into the air! And we are rapidly closing in on meltdown again.

  • Seems as though many are echoing the above sentiments in some kind of global rethink of the economic state of the financial markets..

    couple of links



  • Japanese govt is working on a supplemental budget which could top 2.7 trillion yen($31billion) in an effort to bolster the economy. And the central bank is poised to intervene to maintain financial market stability.

    DPJ is not worried, they are forging ahead with the social programs. There is no wavering from the domestic or foreign policy promised during the elections.

    They’re Ninja’s!!

  • ( I do know, that this is the exact same post for another article but I was writing my comment for this article when I got sidetracked and wrote this comment as if both articles were one)

    At Paul T, & author.

    Real GDP, The FED, HR1207 in the US will affect Canada. Would you support HR1207 type bill which scored a victory in the house for our central bank???

    The author taps on one of my points or yours from the recent article on Japan. Real GDP is not improving as we would theoretically like as we blame this on how the funds are used, then ask the question will the funds ever be used correctly with HR1207 looming? then inflation becomes a bigger concern, when I would traditionally be a deflationist.

    Real GDP is worse in the united states given how they calculate a lot of contributions from workers overseas in their statistics, and what the official number doesn’t do. Give any hope for a winding down of stimulus measures, a reduced central bank balance sheet with traditional CB assets you would expect to find, and meaningful rise rates that would happen in the third quarter of 2010, nor do I expect 2011. If the US was still a creditor and had surpluses, or savings, or production to build on from, I would be a deflation hawk.

    I do not think their recovery is sustainable, I don’t even think ours is, and if that’s the case. The real economy in America is hurting like never before. Even jobs losses are not what they appear to be, because the 10% unemployment figure the highest since 1983 included part time workers who were looking for full time and those seasonally adjusted workers who are no longer looking, which is still counted by the united states but is referred to by labor statistics as U6, to compare apples to apples then comparing apples to oranges. Lets be fair you would use the 1983 unemployment and compare it to the U6. That measure – which includes the part-timers — is at 17.5 percent. So if you throw the unemployed into the statistics, as the U6 does, that nation’s job problems are worse than the 10.2 percent U3 rate suggests.

    Then we Dubai, for the markets to treat this as a blip, when it was more serious then people think, makes me wonder. Then but of course with so much global liquidity and low rates globally, the markets can only go up without capital or price controls, there are no capped limits to liquidity, if we mess up now we issue more new dollars later, this cycle doesn’t need to necessarily stop, and unlike Japan, America must fund this debt globally or monetize because unlike Japan doesn’t have the surpluses or the savings or production to fund and service their debt domestically.

    The Federal Reserve signaling it would rather risk leaving rates too low than choke off any emerging recovery, will leave rate 0% effectively for most of 2010 if not all. This is causing its international role into question, and I can easily see a new reserve currency in my lifetime, with the fiscal risk the FED has took on. Our Central bank has none of the fiscal risks that the FED does. The US central bank has responded by monetary and fiscal relief.

    In Canada I’m unclear how this will all effect us. as we have never had the states not come back robustly. When a major problem to my research is the US, I don’t see the necessary changes their and year from now or two or more when the FOMC release their minutes on interest rates, the only thing I can see that would reign in long term and short term borrowing cots is a revolt in the treasury market, something like the Suez canal crisis developed or even less trivial and US creditors put the foot down. Or wide of US debt default.

    The FED may still surprise me, if they unlock Paul Vockler Monetary tightening, which was who it took last time the USD reserve status was last called into the light with a president Ronald Reagen who protected the central bank independence.

    Now we have democratic president and congress, who’s about to legislate HR1207 which hampers the feds monetary Independence and rises the scope for public intervention and how many voters would scream bloody murder if rates even inch up not to mention politicians by different colors.

    Already the FED publicity is unusually high for me to be comfortable. I think it politically impossible for the FED to stop injecting money, the only difference will be how the money is used? That doesn’t satisfy international creditors. There is public rage all right but none of that rage yells for a reduction in money. That rage want its own bailout blanc cheque. Why give Wall street everything, and Main street nothing, as long as that perception remains intact with HR1207, I dont see good times.

    Also the trend that globally sales, I mentioned previously will outperform the Us is coming to fruition and need months of more data to clearly establish this trend but I throwing my cards down.

    “The surge in [recent] imports reflects Canadian domestic demand that is stronger than in the U.S.,” said Yanick Desnoyers, assistant chief economist at Montreal-based National Bank Financial and went on to say “The Bank of Canada will focus on domestic demand, not the GDP number.” Given his firm was amongst the earliest to predict Canada’s economy would resume growing in the third quarter.

    The strong Canadian dollar isnt all bad. On the flip-side the most innovative technology to equipment is cheaper and is indicated by recent imports. 25-per-cent rise in automobile and parts, reflecting the emergence of General Motors and Chrysler from bankruptcy protection, a 10% gain in purchases of machinery and equipment, and a 5% increase in industrial goods. I expect this is not just taking place in Canada but all around the world in various degrees.

    This Christmas the global shift in consumption patterns will be more evident, but that is really just clear hope. Hope that’s is however seemingly becoming reality.

    p.s. Too anyone making any investment or decisions based off the states, Just read HR1207 (it is a extremely important document which has garnished Americans distrust over the bailouts and acting as a vent for that rage and regulates the FED not the Banks) then think about everything, the unprecedented actions, etc the FED has done. I would worry or at least change 5% of my net worth to include the possibility of a currency crises. The US FED is becoming to politicized, and the politicians loves this because then they dont have to fund wars or welfare through savings, production, or surpluses, or taxation.

    They just run up the record breaking debt. Why not when your debt is the most liquid and safe in the world. If I see tightening from the FED, my normals senses should return too me and I will say I over reacted but its better then not being prepared.

    However that small window that opened up in 2008 will return in greater force because of the current solutions (cough). Good or bad that’s up to your point of view.

  • Federal Reserve Transparency Act of 2009 – Repeals the authority of the Comptroller General to carry out an onsite examination of an open insured bank or bank holding company only if the appropriate federal regulatory agency has consented in writing. (Retains the authority of the Comptroller General to audit a federal agency.) Directs the Comptroller General to complete, before the end of 2010, an audit of the Board of Governors of the Federal Reserve System and of the federal reserve banks, followed by a detailed report to Congress.

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