Governments are unsinkable? Not really…
By Daniel at 18 December, 2009, 2:31 am
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The global economic recovery has been built on one single assumption: Governments are unsinkable. As long as governments can borrow money then they can stimulate the economy through monetary and fiscal policy. The flaw in this line of thinking is the same flaw that sunk the Titanic… Nothing is unsinkable.
Over the last fortnight, the global financial markets have experienced the first signs of icebergs in the water. The de facto default by Dubai and the downgrade of Greek sovereign debt both serve as warnings of what may be to come. So far, the markets have navigated the icebergs surprisingly well. The primary reason for the deft navigation was the relative size of the icebergs.
However, Q3 GDP in Japan was revised sharply lower from 4.8% to 1.3% annualized. Moreover, the GDP deflator (a measure of inflation) printed at -0.5%, implying deflation in the Japanese economy. The response to deflation and a weak GDP has been fiscal stimulus and quantitative easing.
While this two pronged approach has been the preferred prescription written by central bankers to combat the economic crisis, Japan poses some special risks. The amount of new debt needed to finance these measures will now exceed the amount of tax revenues the government will collect.
Additionally, Japanese debt as a percentage of GDP is already the highest in the developed world and is approaching 250% of GDP. Japan needs GDP growth of 3% a year to halt the climb in debt as a percentage of GDP. Adding more debt, while GDP falls has placed Japan on a dangerous course.
In 2010, the Japanese government will need to issue an additional ¥53 trillion in government debt. At the same time tax revenues are expected to drop from ¥46 trillion to ¥37 trillion.
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“1. A nation with egregiously bad economic policies, no innovation, declining and aging population, dangerous dependence on energy and mineral imports, declining global competitiveness and influence and a steadily worsening worker to dependence ratio cannot grow. There are simply no engines to propel the economy. This means Japan cannot grow out its massive debt
2. The Japanese people will have to accept an inexorably declining material quality of life, the end of conventional retirement for reasonably healthy people, lower levels of health care for most, the re-emergence of extended families, and a less magnificent infrastructure as a consequence of national decline.
3. A sense of national, civic and personal honor may yet motivate the Japanese to avoid default by substantially reducing Big Govt spending: the Japanese may be willing to do what is necessary for social cohesion and cultural reasons what they simply will not do for economic and financial reasons: but this requires that the Japanese people accept the fearful reality of their situation and reset both self image and expectations. Perhaps they will: true character is not revealed except under great stress “
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