Saturday, January 28, 2012

Will the U.S. be like Japan?

Japan is aging rapidly and is, already, one of the oldest countries in the world. The Japanese government is heavily in debt—more in debt than most European countries and the U.S. What can we learn from Japan?  Many pundits are fond to compare the U.S. to Japan, suggesting that the U.S. may enter an extended period of near zero interest rate coupled with zero growth.  Is that an optimistic or a pessimistic forecast?

If we examine the Japanese debt and demographics situation in more detail, we will see that the Japanese problem is very different from the European and the U.S. problem.  Instead, Japan provides a more relevant lesson to the Asian economies, like Taiwan, Singapore, Korea and China, which are all aging quickly as well.

The Japanese Debt Situation
The Japanese government debt level, which stands at 230% of its GDP or 12.5 Trillion USD, is one of the worst in the world. However, its corporate + household savings more than offset the government debt.  Most of the Japanese government debt is held by its own people.  Japan, as a country (public sector + private sector) owes external countries only about 2.4 Trillion USD, or just under 40% of its GDP, while running a 120 Billion USD trade surplus against the world and holding foreign currency and gold reserve of more than 1 Trillion USD. If we include Japanese foreign investments (stocks and other securities), Japan’s net investment position stands at positive 3 Trillion USD, or roughly 56% of its GDP.  Japan is a significant net global capital supplier.

By comparison, the US government and private sector combined has an external debt of 14.8 Trillion USD, which is just above 100% of its GDP.  It runs a 750 Billion USD trade deficit against the world and a reserve of 130 Billion USD. Its net investment position stands at negative 2.4 Trillion USD, or roughly -17% of its GDP.  Recent research shows that the U.S. external debt and its negative net investment position are both significantly understated, making the actual balance sheet health substantially worse.

From a net investment perspective, Japan is in a significantly better shape than the U.S. and most European countries.  Japanese government debt can be resolved without renegotiation with foreign governments. The government debt can be settle internally with its own people through higher implicit and explicit taxes (higher income and consumption taxes in combination with low interest rate and high inflation). Since the debt renegotiation will occur entirely as domestic wealth transfers, this will leave no appreciable impact on international trades. The European nations and, to a lesser extent, the U.S. do not have such a “pleasant” option.

The Japanese Households and their retirement planning
The Japanese households are probably one of the most sophisticated and responsible in terms of how they plan for retirement. They appear to have been particularly prudent in the face of aging global demographics.

The Japanese post war boomer households, seemingly aware of the reality that they will be retiring near the top of a demographics bust--where the population will be dominated by old and non-productive retirees--have saved enormously.  In 1980, there were nearly 6.5 working persons producing goods and services for every 1 retired Japanese person.  In 2030, there will be only 1.8 working persons producing goods and services for each retiree.  The massive shortfall in per capita production means a massive short fall in domestic goods and services available for domestic consumption.

As a people, the Japanese worked diligently and saved diligently, running large trade surpluses (consuming less than they produce) and acquiring foreign assets with their national savings. The assets that the Japanese households have built over time are meant to help them when they retire near 2025. The boomer’s savings will be used to purchase goods from foreign producers and to afford the higher cost for scarce domestic services, like assisted living and healthcare.

This may largely explain why regardless of how strong the Japanese economy grew or how high their per capita GDP was, the Japanese households always studiously saved. The Japanese households acted as if they were exceptionally aware of their looming demographics problem, even if the problem was decades away. With 266 Billion USD (56% of GDP) in net foreign investments, the Japanese households have a substantial claim to future global productions to buffer their own GDP decline associated with declining workforce.


Japanese Government Intervention
Many economists like to tell the joke that Japan has the world’s first rated workers, second rated bankers and third rated politicians. There seems to be some truth to that assessment. The high savings rate of the Japanese workers has been significantly offset by the huge and persistent Japan government deficit. The government’s fiscal imprudence has, over time, developed into one of the largest government debt in the world; only Zimbabwe has a higher government debt-to-GDP ratio. The government debt has eroded significantly the value of the retirement assets and the purchasing power of the Japanese savers.

In the last 20 years, the Japanese government has kept interest rate near 0%, which has resulted in zero interest income for the Japanese households on their trillions of dollars in savings. This is essentially a policy of transferring the workers’ wealth accumulation to subsidize out-of-control government spending. The consequence of this policy has meant that Japanese household must further reduce consumption and save even more aggressively.

While low interest rate and excess government spending are classic Keynesian stimulus policy tools, neither has proven effective, in Japan, at inducing more private sector consumption or real investments or at creating subsequent GDP growth. Instead, the Japanese households have had to engage in one of the most aggressive savings programs in the developed world due to the need to combat their government’s persistent low interest rate monetary policy and a spendthrift fiscal policy.

And it comes full circle
Have we saved enough for our future retirement, which unfortunately will occur at a time of worsening demographics and therefore reduced availability of domestic goods and services? Has the deterioration of government finances created a black hole in the national balance sheet that the household sector cannot offset, regardless of how much the household de-leverage and save? Are we prepared to face the reality that our standard of living, in the future, must decline substantially because we have not saved enough to offset our demographics trend but have, in fact, overspent to exacerbate the problem? Are we prepared to ship our scarce domestic production to the Japanese and Chinese consumers near the boomer retirement peak in 2025? Are our boomers ready to delay retirement to work for the Japanese and Chinese retiring boomers over the next few decades in the same way that they have worked for us, in their prime, in the previous decades?

by jason c hsu

24 comments:

Larry Kornman said...

Jason, Thank you for your analysis. i love your break down of facts and comparison across borders. Can you factor in immigration? Japan is known for being much more insular and resistant to immigration. If the US opened its doors and brought in 50 million or 100 million immigrants how does that effect the equation? or perhaps the question should be how many immigrants over what time frame does it take to effect the equation. Any thoughts. Thank you.

Anonymous said...

Thank you as well. I would like to second Larry's comment. I lived in Tokyo for several years as an expat. My biggest two observations was the complete lack of immigration and the overall difficult and minimal standard of living for hard working Japanese. The zero interest rate seemed to me to really reck havoc on the equation in the long term and this I see as a greater parallel to Japan. Not to mention the strength of our lobbyist in diminishing the quality of the US government for the greater good, for that of the smaller special interest groups.

jason c hsu said...

I think the U.S. would do itself a world of good by allowing and encouraging more immigration. For the longest time, some of the most highly educated and hardworking people clamor to come to this country. We benefited tremendously from immigration.

We should not be worried about immigrants taking American jobs! Make immigrants Americans and this would just be semantics. The high unemployment we face right now is not our real problem. Our real problem will hit when we have 0% unemployment--when every 65 year old person must work to provide care to a 75 year old.

Anonymous said...

The Japanese government debt level, which stands at 230% of its GDP or 12.5 Trillion USD...Japan’s net investment position stands at positive 266 Billion USD, or roughly 56% of its GDP...

12.5t/230% = 5.43t
266b/56% = 475b
I get different GDP numbers from the two stats. Am I missing something?

jason c hsu said...

Thank you to the anonymous reader above. My mistake. I meant to say about 266 Trillion Yen or 3 Trillion USD.

Steve Browne said...

ISTM that both the Japanese and Chinese models depend on the populace accepting a sustained financial repression - I wonder what the opportunity cost is of these countries savings being expropriated by their respective governments? If your average Japanese saver had bought some sort of diversified global portfolio instead of putting their money in gov bonds where would their wealth be today - would the tax base have expanded sufficiently that the debt levels would be lower? Similarly, what is (or will be) the opp cost of the CCP's control over the savings of Chinese citizens?

Anonymous said...

Jason, I think the US has a "pleasant" option too. Since all of its debt is all denominated in USD, it can all be inflated away. In fact, I think there isn't any other option. The US will never be able to achieve an emerging country rate of growth to keep up with with its debt obligations.

Compare Medicare Supplemental said...

That's a very interesting point of discussion. The economies of these two countries are propelled by different factors so it is really hard to compare.

Lena Harris said...

I believe that US will not come to a point that it will have more debt than most of the countries in Europe. The US will be able to contain its increasing debt problem from its vast resources. It is blessed with so much manpower and natural reserves.

debt settlement by wites & kapetan

andieclark said...

I talked to a foreclosure attorney in NY and I realized how much debt US has from other countries. It's more than I could imagine but still we're very strong.Same with Japan, I think both countries may vary with their debts, but what's important is that they are still sustainable countries.

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