Conclusion: From a secular perspective, Japan’s economy continues to implode. The acceleration of that implosion towards the Keynesian endgame is arguably the largest TAIL risk to the global economy.
Position: Bearish on Japanese Equities; Bearish on the Japanese yen; Bullish on Japanese CDS.
This morning, Standard & Poor’s came out with yet another lagging downgrade that seems to have caught the US financial media’s attention. By cutting Japan’s credit rating to AA-, Standard & Poor’s reminded us all what we already knew:
Japan’s economy is imploding in slow motion. Slowly, but surely, Japan is reaching the Keynesian endgame.
For the sake of not making too much of a deal about a late downgrade, we’ll spare you with the details on why we feel this way. Please refer to our 4Q10 Key Macro Theme of Japan’s Jugular for the work behind our implicit downgrade of Japan’s credit, currency and equity market. The presentation, originally published on October 5th, can be accessed here:
Replay Podcast (starts around 9th minute): https://www.hedgeye.com/feed_items/9746
[To access the podcast, you may have to copy/paste the link into the URL of your browser.]
Slides (12-34): http://docs.hedgeye.com/Q4%202010%20THEMES.pdf
Two alarming datapoints that hit our screens over the past couple of weeks were Japan’s widening central government budget deficit and subsequent burgeoning debt issuance. According to the Japan’s Finance Ministry, Japan’s budget deficit is forecast to grow to ¥51.8 trillion yen (~$630B) in FY13 and ¥54.2 trillion yen (~$660) in FY14. [For reference, FY13 starts April 1, 2012.]
When put into the context of a ratio, Japan could be running a PIIGS-like ~11%-12% deficit to GDP in a little over a year. Looking closer to this upcoming fiscal year, which begins on April 1st, Japan’s relentless acceleration in deficit spending has Japan’s Finance Ministry upping its projected debt burden +5.8% YoY to 997.7 trillion yen, or roughly 215-220% of GDP.
Japan bulls point to the fact 90% of Japanese government debt is financed through its domestic population of savers, making it less likely to experience a dangerous back up in yields or default. As we’ve shown in the aforementioned presentation, that tailwind is rotating on the margin towards becoming a headwind as a result of unfavorable demographics. We saw signs of this trend starting last year, with Japan’s largest pension funds selling assets and joining the global search for yield to meet payout obligations.
This will only accelerate over the next 20-30 years, with the next ten likely being a real wake up call for global investors. Currently, the ratio of retirees to working-age Japanese is equal to 35.5%. In just ten years time, that ratio will be equal to 48%. In a society notorious for luxurious pension packages, going from a 3-to-1 base in potential contributors to a near 2-to-1 base in a matter of just ten years means the domestic demand for JGBs bulls consistently refer to will decline by nearly 1/3rd.
All told, we foresee a major supply/demand imbalance for Japanese government debt and, in our opinion, this imbalance is one of the largest long-term TAIL risks to the global economy. But don’t take our word for it:
“The financial state of our nation is becoming increasingly severe. Fiscal management that depends excessively on bond issuance is becoming too difficult.” – Japan’s Finance Minister Yoshihiko Noda, January 24, 2011
“The government must fix its finances to avoid a debt crisis that could trigger a global depression.” – Japan’s Vice Finance Minister Fumihiko Igarashi, January 2011
Obviously, we think it pays to pay attention here.