curious story from ft.com
Bond mystery set in Japan
How is it possible for the yield on the 10-year benchmark Japanese government bond to be just 1.87 per cent?
The laws of economics appear once again to have been suspended in Japan. After all, since August 1992 the government has announced 10 stimulus packages worth ¾120,000bn (œ737bn) - equivalent to 24 per cent of Japan's gross domestic product. Not everything announced is actually spent, of course, but the impact of this fiscal profligacy on Japan's gross debt has nonetheless been devastating.
By the end of this financial year, the government's gross liabilities are expected to reach a staggering ¾600,000bn - equivalent to 125 per cent of GDP. In 1990, the figure was less than 60 per cent.
Japan will, therefore, have the dubious distinction of being the most highly indebted member of the Organisation for Economic Co-operation and Development. Hence, Moody's, the credit rating agency, downgraded Japan's sovereign debt.
Yet the markets appear unconcerned. True, the yield has risen from its low in September last year of 0.655 per cent, when investors were implying that not only was the Japanese government the most creditworthy in the world but the most creditworthy in the history of the world.
But even at its current rate, the markets appear to be saying that Japanese debt has the lowest risk of default of any sovereign debt.
One argument put forward is that the gross figure does not reflect the true position, because it ignores the state's assets, such as those in the social security system. If these are included, net debt is about 45 per cent, the lowest in the OECD.
There are two problems here. First, it is far from clear that the social security system is properly funded - and it may face significant liabilities. Second, many of the assets held by the government - particularly land - are worth much less than their book value. Another argument is that the market can cope with all this additional supply because of strong demand.
To international investors, a yield of 1.87 per cent may not sound much; but for domestic investors, confronted with deposit rates of 0.3 per cent and consumer price deflation of 1.3 per cent, it looks princely.
Simply put, there is nowhere else for Japanese investors to place their money other than JGBs. They certainly dare not risk their savings in foreign deposits while the yen remains so volatile.
As was shown on Friday, the 5 per cent annual return on a dollar account can be wiped out in a single day. The potential greater return is simply not worth the risk.
Finally, when private investors are unable to take up the slack, there are always quasi-governmental institutions ready to purchase excess supply. And if that does not work, so the argument goes, the Bank of Japan will be induced to buy. The government, say the bond market bulls, cannot afford to let the bond market crash.
This looks complacent. Even net debt is on an explosive and unsustainable trajectory. The current rate of about 45 per cent of GDP compares with just 4 per cent in 1992.
All this might seem academic to international investors: after all, non-domestic investors hold much less than 10 per cent of outstanding JGBs.
Understandably, they have been put off by the low yield. Instead they have been consistent buyers of Japanese equities. (Alas, their timidity has cost them dear: the return on JGBs in the past decade has been a little more than 100 per cent, while that on Japanese equities has been negative.)
The trouble is that international investors cannot ignore the implications of a rise in long-term interest rates. Japanese equities would be hard hit. Much of Japan's corporate sector is heavily indebted and would struggle to deal with higher rates.
The JGB market looks less like a mystery than an accident waiting to happen. The question is timing.
Historically, governments can continue down unsustainable fiscal routes for some time until market discipline is exerted. But the later such discipline is applied, the more painful the reckoning. |
