A growing number of economists and financial experts are now warning that Japan is headed toward a fiscal catastrophe. Their apocalyptic warnings, which might have been seen as scaremongering a while ago, are now getting some serious attention these days, perhaps because of the sovereign debt crisis in Europe. The shelves of bookstores are overflowing with titles containing two words--crisis and Japan.
But what does a nation’s fiscal collapse exactly mean? What can Japan do to avoid its fiscal doomsday? In a recent interview with The Asahi Shimbun, Keiichiro Kobayashi, a professor at Tokyo’s Hitotsubashi University and leading voice warning about Japan’s towering public debt, discussed these and other related issues. Excerpts from the interview follow.
* * *
Question: There are growing concerns about Japan’s deteriorating fiscal health. What is your diagnosis?
Answer: Now, Japan is in a situation where it can no longer pay back its excessive debt with tax revenue alone and must keep piling on new debt to pay off old debt. In other words, its debt is snowballing. Actually, however, prices of Japanese government bonds, or the government’s IOUs, will tumble before a fiscal collapse or the government’s default on its debt.
A: When, for some reason, people start thinking that the Japanese government may be unable to pay back its debt, they decide to cash in--meaning sell off--the Japanese government bonds they hold before their prices fall. The price of any product sinks when there are more sellers than buyers. That’s true for government bonds as well.
Government bond prices would crash if the number of people trying to sell them surges. We don’t know what will trigger such a wave of selling. It could be the debt crisis in Europe and it could be the political situation in Japan.
Q: What kind of problems would the collapse of government bond prices cause?
A: Interest rates would shoot up, triggering inflation. Higher interest rates would increase the debt burden on borrowers, and inflation would erode the real value of savings. Since such a situation would also erode confidence in the Japanese currency, the yen would fall sharply against other major currencies.
Q: Why would tumbling government bond prices cause inflation?
A: There are various theories to explain that. One says that massive selling of Japanese government bonds would eventually force the Bank of Japan to buy a large amount of bonds by printing money. That would increase the money supply and thereby cause inflation.
Q: That would cause big problems for the people.
A: In addition, banks could start tightening up their lending standards and cutting off credit lines. That happened after Japan’s economic bubble burst in the early 1990s. At that time, banks saw their loans to businesses sour. For banks, loans are assets. Many Japanese banks now hold government bonds as assets. This time, this type of assets would depreciate. If banks begin to shut off lines of new credit and call in loans, businesses would find it difficult to get the money they need. The economy would then slip into serious recession.
Q: Some people say economic recovery or inflation would enable the government to wiggle out of its fiscal hole without raising a tax or cutting its spending. Is that true?
A: According to an estimate by Kazumasa Oguro, an associate professor at Hitotsubashi University, fiscal rehabilitation through natural tax revenue growth is possible only if Japan’s per capita real economic growth rises to 3.7 percent or the annual inflation rate surges to 14 percent. Such fast economic growth is impossible (for today’s Japan), and such steep inflation would ruin many people’s lives.
Q: Are you saying the only way to fix Japan’s state finances is through tax increase and spending cuts?
A: That’s right. And these policy measures must be taken quickly. The government’s debt keeps growing. Putting off the actions needed for fiscal rehabilitation would only make the process even more painful. Several years ago, it was said that raising the consumption tax rate to 15 percent would put the nation’s fiscal house in order. Now, some economists say the rate needs to be raised above 30 percent to cure Japan’s fiscal ills. I believe a consumption tax hike to 25 percent would do the trick if it is combined with a sharp reduction in social security spending.