By Prakarsh Jain
1,000,000,000,000,000 yen?
Well, confusion would set in, counting the number of zeros. They are 15 in all, post the 1. A quadrillion yen is approximately 10.5 trillion US dollars. To compare with some other economies, it is an amount, which is larger than the combined economy of Germany, France, and the United Kingdom. What is this figure we are talking of? It is the astounding amount of debt, Japan holds today, and I am sure, it is hard to even get our mind around it.
Government debt to GDP ratio in Japan will reach 250 per cent this year, and they are currently spending about 50 per cent of all central government tax revenue only on debt servicing. Believably, there are two ways out of this overwhelming debt trap for the country. Either the country defaults or they try to inflate the debt. Currently if we observe, they have chosen the second option, which is trying to inflate the debt away. Abenomics has initiated the greatest quantitative easing experiment that a major industrialized nation has attempted since the days of the Weimar Republic. If we look at the plan, over the next two years, Bank of Japan plans to zap 60 trillion yen into existence out of the thin air and use it to buy government bonds. What we can conclude by this is, by the time this program is over, monetary base in Japan will be doubled. However, authorities in Japan are desperate. They are aware of the fact that the Japanese debt bomb could set off global panic at any point in time, and therefore they are trying to find a way out that will not cause pain that is expected.
Tactlessly, the only way that this bizarre quantitative easing program will work is if investors in Japanese bonds act irrationally. The only way that Japan has been able to pile up this debt in the first place is because they have been able to borrow enormous money at super low interest rates. As of now, yield on 10-year Japanese bonds is sitting at an absurdly low 0.75%. Nevertheless, even with such ridiculously low interest rates, the central government of Japan is still spending about half of all tax revenue on debt service. If interest rates go up, the game is over.
Now that the Japanese government has announced that it plans to double the monetary base, it would not be rational for investors not to demand higher rate of returns on government debt. Why would investor want to loan money to the government for less than one per cent when the purchasing power could probably be halved over the coming years?
Incredibly, this is exactly what the Japan government is counting on. They are counting on being able to print up the money and thereon monetize the debt; they would also be successful in keeping the yields on Japanese bonds at insanely low levels. To the shock of humankind, it is actually working now. Investors in Japanese bonds are behaving irrationally.
However, if that changes, we could potentially be looking at the greatest Asian economic crisis of all time and there are sharp minds out there, who believe that is exactly what is going to happen. Founder of Hayman Capital, has been alarming about Japan for a long time. He has correctly predicted the subprime mortgage meltdown, and in the process, has made hundreds of millions of dollars. Now he believes that the next major crash is going to be in Japan.
Japanese banks in general have 1000% of their tangible assets invested in Japanese Government Bonds, which are the most negatively convex instrument. Assume for instance that a bank holds a 10-year bond yielding 75 basis points. Now imagine, a 100 basis point move. Think about the psychology and the financial implications. Think about the solvency of a nation, which currently spends half of its central government tax revenues on debt service. We cannot look at this as a simple question. This is a multivariate equation. If rates even rise by a percentage point, it would start to stampede towards the exit that nobody in the world would be able to control.
Japan is not the only “bomb” that could potentially go off in Asia. The major problem exists in China. In China, the big problem is the stunning growth of private domestic debt. The total amount of credit in China has risen from approximately 10 trillion dollars in 2008 to 25 trillion dollars today. To compare, that increase is roughly equivalent to the entire U.S. commercial banking. There is simply too much debt in the world today. It has never been the same before. Many in media insist that this party can go on indefinitely. That is what they said about the housing bubble too, and we know what eventually happened.
The truth is that every financial bubble bursts, and this debt bubble on global level will be no exception.
Prakarsh Jain is a graduate from Jai Hind College, Mumbai and a Chartered Accountant. In full-strength to continue his passion for studying, he moved on to take up Masters of Global Business in Investment Banking & Wealth Management from S P Jain School of Global Management.In addition, he also acted as a delegate at the World Islamic Banking Conference: Asia Summit. Email ID: prakarshjain@gmail.com