What is more, to the extent that these policies are successful in generating higher nominal GDP growth, they create a problem for Tokyo in how it decides to set domestic interest rates. Japan has never really resolved the overinvestment orgy of the 1980s. Instead of writing down bad debt it effectively transferred much of it to the government balance sheet, and now this huge debt burden is itself becoming, I think, a constraint on the success of policies designed by Tokyo to spur growth.
The argument for why there hasn’t been a Japanese sovereign debt crisis are pretty well known and are also a large part of why Pettis thinks Tokyo is so eager to engage in polices that force up the Japanese savings rate — as Citi put it recently “so long as the current account is in surplus, the marginal purchaser of new JGBs issued by the sovereign can always be a domestic buyer.” The Bank of Japan now aggressively included.
That’s why the problem most people foresee is that Japan’s current account turns negative. From Citi’s Buiter and Rahbari:
As Japan continues to age rapidly, its household saving rate will continue to decline. It is possible, but not likely, in our view, that the corporate saving rate will continue to rise to offset this…
At the point where Japan becomes a persistent current account deficit country, the marginal purchaser of newly issued Japanese securities is less likely to be a domestic investor. It is quite plausible that yields on Japanese securities, including but not limited to Japanese government bonds, could rise quickly and sharply once the marginal purchaser is a foreigner.
Frankly, while that only underlines scepticism about how realistic a longer-term current account surplus is, we lack the tools to balance the ongoing demographic shift with Japan’s desire to generate growth by structurally forcing up its savings — or to put it another way, growing at the expense of its trading partners who might fight back anyway — and it doesn’t seem too silly to cover one’s bases here.
(This might also be a good place to point towards Citi’s aside on the current account and the exchange rate on p38 of their note. In summary: “The notion that any sharp depreciation of the real exchange rate, regardless of what causes it, is necessarily accompanied by an increase in the trade balance surplus or current account surplus is theoretically suspect… even the data don’t speak clearly – they barely whisper.”)
That said, we should push on and note that Pettis is increasingly wary of Japan’s nominal interest rate and worries that as it rises debt servicing is going to get a lot more difficult as “the real cost of servicing the debt during each payment period consists [then] of interest plus some real principal.”