Tuesday, August 4, 2009

Japan's leverage on the rise

Worried about rising federal budget deficit? Concerned about government debt spiraling out of control? Thinking there may not be enough buyers for all the new debt? Well it turns out that one can go on a spending spree and just keep selling more debt - for years. Japan has been trying to spend their way out of a prolonged recession (and deflation) since the early 90s. They tried raising taxes, but all that got them was even slower growth and more debt. Investors continue to gobble up that debt - 40-year bonds are yielding under 2%! The chart below compares Japan's debt levels to the rest of the world (it's almost double the OECD average).

The country is now leveraged at nearly 2 x GDP. Japan effectively transferred the leverage that existed on tremendously overvalued real estate in the 80s from the banking sector onto the government's balance sheet. Sounds familiar?

So who is going to pay all this Japanese government debt back? Of course it's the next generation. There are going to be more young people cranking out a larger GDP - they should be able to handle all that debt, right? Not really. The chart below shows how skewed Japan's population will become.

The percentage of young people is dropping, leaving increasingly higher debt burden per working individual. And even small GDP declines will increase the country's overall leverage, making it harder to roll the debt. As the population ages, bonds held by individuals will be converted to cash, forcing the government to look externally for buyers. At some point the growing leverage will come back to haunt Japan's government and it's people.
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