Q: For all the dire warnings about Japan’s impending fiscal disaster, however, Japanese government bonds have not crashed yet. Nor has there been any panic in the market. Why is that?
A: That’s true. But that could happen at any time. Japan’s public debt load, as a ratio against gross domestic product, is bigger than that of the crisis-stricken Greece or Italy. Actually, there is no convincing explanation why Japan is not experiencing a financial panic at this moment.
Fiscal rehabilitation doesn’t mean that the government pays off all its debt. It means bringing government debt as share of GDP down to a certain level, to a level where debt no longer keeps growing indefinitely.
Q: But the fact is, the government is facing a tough political battle in its attempt to raise the consumption tax rate to 10 percent.
A: Politicians, bureaucrats and voters all tend to put greater importance on the present--immediate elections and immediate profits--than on the future. This may point to the limitations of democracy. So it is necessary to set up an organization staffed by experts that works on plans to push the nation toward a better fiscal future from a neutral position without being influenced by political motives.
In Britain, for instance, there are various organizations whose politically neutral status is guaranteed within the government and Parliament. Japan should also create such an organization (for fiscal reform). It could, for instance, make estimates concerning the nation’s fiscal conditions for the next 50 and 100 years for the sake of broad public debate on related issues. It is necessary to change the current situation where ministries and agencies independently publish estimates that serve their own interests and agendas.
Q: That may be a good idea, but it doesn’t appear to have a good chance of becoming reality given the current state of the Diet, does it?
A: I think the government should make the maximum possible effort to restore fiscal health through steps like a tax hike and cuts in social security spending. But the government also needs to take measures to mitigate the damage of a possible fiscal collapse in case its efforts for fiscal rehabilitation fail.
Q: What kind of measures should the government take?
A: It should set up a public-private fund to buy huge amounts of foreign assets (foreign-currency-denominated assets). The fund would also cover the foreign exchange risk for private-sector companies that purchase foreign assets.
Q: Why would such a fund help mitigate the damage of a fiscal collapse?
A: If the fund buys foreign assets while the yen is strong, it would reap foreign exchange gains on these assets when government bond prices plunge, causing the yen to weaken against other currencies. The yen weakens when, for instance, its exchange rate rises to 100 yen per dollar from 80 yen. In that case, each dollar you have generates 20 yen in foreign exchange gain. As the fund’s foreign-currency-denominated assets generate such exchange profits (if government bond prices fall sharply), the financial position of the whole government sector would improve (under such a situation).
At the same time, such a fund would also be able to help Japanese exporters suffering from a strong yen because it would sell yen to buy foreign assets and thereby curb the yen’s strength. As a result, the government’s tax revenue would increase to help improve its fiscal health. So this scheme would delay Japan’s fiscal collapse and allow the government to buy time to take necessary measures to fix its finances. If a fiscal collapse occurs and causes the yen to fall too sharply, the fund would be able to stem the slide by selling its foreign assets to buy yen.
Q: If the government is also involved in the fund’s purchases of foreign-currency-denominated assets, wouldn’t it be criticized by other countries as a form of government intervention in the currency market?
A: The fund could dodge such criticism by buying, for instance, European Union bonds to be issued as part of Europe’s efforts to solve the debt crisis. Japan’s massive purchases of EU bonds through the fund as a way to support Europe’s efforts to defuse the debt crisis would have a far greater diplomatic impact than simply offering up a small amount of money as a mere diplomatic gesture. And such a move would not be criticized as currency market intervention.
Considering the total amount of Japanese government bonds outstanding, it would be desirable for Japan’s public and private sectors to hold several hundreds to one thousand trillion yen of foreign assets in total (as a preparation for a fiscal collapse). The fund I propose would serve as a catalyst for the policy. This is not an unrealistic proposal, given that Japan already has some 600 trillion yen worth of foreign assets.