There is an interesting article in the Economist this week about Japan and its high level of government debt.   This got me thinking…

I’ve been negative on Japan for years mostly because of the negative population growth and more recently, appreciating Yen.  Yet… the high level of public debt makes me even more pessimistic. I am no fx expert (actually I think fx is one of the more complicated markets out there especially when you’re trying to make money in the short term) but it is pretty clear that a strong Yen is bad for Japan or any country that likes to make things and sell them to others.  So, the Yen gets stronger and the price of a Sony TV or  DVD player either goes up…or the profit margin for the Japanese company making it goes down.  Not too complicated.  

Over the past few years, prices in Japan have been flat or even declining.   Money has been basically free for years as the government tries to encourage people to invest and grow the economy.   The big downside to all this is that it has prevented companies from raising prices and, thus, making more profits. Deflation also discourages consumers from spending. Aside from the more recent US-initiated global collapse, this is why the Japanese stock market has underperformed for years.   Anytime a CPI reading came out that showed even a slight increase in prices, the market got a boost as investors thought (and prayed) that the deflationary malaise had finally come to an end.  With all this free money around, the Government has had an incentive to spend money too and they have running up the largest gross government debt as a % of GDP in the developed world.  People here in the US are worried about a 60-80% debt to GDP ratio while in Japan, the figure is already 175% and excpected to top 250% by 2014.  Yikes!     Currently 20% of the government budget is used to finance this debt which is manageable, but, what happens if interest rates go up?   You see where i’m going with this?  Imagine a scenario in which interest rates go up and the government has to increase taxes to keep up with the debt payments.   This is scary: higher taxes, declining population resulting in lower government revenues, and a  higher Yen to boot.  Again, I am no macro economist or a Japan expert but these are strong headwinds. 

Image from the Economist website.

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