Skip to comments.Warning: The World's Third-Largest Economy Could Crash Soon
Posted on 11/16/2012 9:26:28 AM PST by Kaslin
In the summer of 2010, a little-noted milestone took place. China passed Japan to become the world's second-largest economy. Now, Japan needs to keep an eye on the rear-view mirror. Germany and Brazil are gaining ground and may overtake the Asian country in coming decades as well.
Japan's steady decline -- relative to other economies -- can be attributed to a pair of factors: A rapidly-aging population and a too-strong currency. These two factors are crimping demand for goods and services at home, as well as foreign demand for exports.
This isn't a new story. The Japanese economy has barely budged in the past two decades after a 40-year spurt of strong growth. Though the economic weakness has been mild, helping the country maintain full employment, cracks have begun to emerge and the pace of economic erosion may soon accelerate.
Problem is, this is not just worrisome for Japan, but also its neighbors in Asia, along with the United States and key European trade partners. That's why investors need to stay abreast of events in Japan.
Short sellers have been surely aware of the troubles in the Asian country. In just the two weeks ended Oct. 31, the short interest in the iShares MSCI Japan Index fund (NYSE: EWJ), has doubled in size, to a whopping 19 million shares.
Debt and trade: worrisome signs
To see why short sellers are piling on, you need only look at Japan's balance sheet and its cash flow statement. On the balance sheet, you'll find a country with a staggering amount of debt. Here in the United States, our national debt is now more than 100% of gross domestic product (GDP). In Italy, that figure has risen to 120% while in Greece, it's up to 160%. Japan's debt-to-GDP: roughly 230%. Japan's government debt is now larger than all 17 Euro member nations combined.
Even if Japan's economy doubled in size while debt stayed constant, it would still have one of the highest relative debt loads in the world. Trouble is, Japan's economy will not be doubling in our lifetime. In fact, it's not clear that Japan's economy will grow much at all in coming years: Japan's economy generated 537 trillion yen of economic activity in 2005. That figure in 2011: stuck at 537 trillion yen. China's economy grew nearly 50% during that time. For further context, Japan's inflation-adjusted economic size is the same size as it was -- back in 1993. The fact that Japan's population is expected to shrink in coming years will make it even harder for GDP to grow.
Indeed, it looks as if Japan's economy may actually be shrinking, as a too-strong currency -- coupled with a trade spat with China -- is crimping the export sector. Japan's government just announced the economy shrank at a 3.5% annualized rate in the third quarter (compared with the second quarter).
Simple math implies that a smaller economy means an even higher debt-to-GDP ratio. Of course, the government has begun to think about stimulus programs to fire up the economy, but with such high levels of debt already in place, further borrowings run real risks: What happens if global investors get spooked and become less comfortable buying Japanese bonds at ultra-low rates? Simply put, Japan's staggering debt load would look even worse if interest rates (and expenses) sharply increase.
To avert catastrophe, the Japanese government has proposed a series of tax hikes, especially in the form of sales taxes. But those hikes would be cancelled if the economy slumps, as now appears to be the case. As it stands, fully 40% of the proposed 2013 Japanese budget will need to be funded with debt.
Japan's greatest strength has always been its massive export-oriented industrial sector. But that pillar of strength is now weakening. Exports fell 10% in September from a year ago, while machinery orders and industrial production also showed big drops in September.
As is the case with companies, a country can also shore up its balance sheet (and pay down debt) by showing positive cash flows. And surely enough, a solid base of exports has enabled Japan to generate consistent trade surpluses that have brought cash in the door. Moreover, Japanese culture has been that of notorious savers. In the 1990s, many companies saved 44% of their earnings, depositing the funds in low-interest accounts that gave those companies essentially free money. In effect, a persistent trade surplus and a high savings rate have been able to offset rising fiscal deficits.
First off, Japanese citizens are no longer big savers: They now save just 2% of their income. And trade surpluses now look like a thing of the past as China takes over as "the world's factory." In the first six months of fiscal 2013 (which ends next March), Japan generated a $40.6 billion trade deficit and is headed for its largest annual deficit on record. That rising deficit is not just due to falling exports. Japan's imports are rising, especially in the area of energy supplies as the country steps back form nuclear power.
To be sure, Japan's demise has been anticipated for quite some time, but the country has managed to tread water for nearly decades. Yet the key factors holding up the economy indeed appear to be finally eroding, and Japan is now emerging as one of the world's leading trouble spots.
Risks to Consider: Upside risks are few. Japan possesses a considerable base of assets and could start conducting fire sales to raise funds, but that creates further long-term weakness as many of these assets (such as real estate) are cash flow producers.
Action to Take --> Short sellers are anticipating an imminent crisis for Japan. They note that the current Japanese Prime Minister is getting a great deal of resistance with his fiscal plans (and if history is any guide, won't be in that position for very long anyway). If the government enters a phase of paralysis, right at a time when vital action is needed to boost the economy and reassure global bond markets, then events could spiral out of control.
In the interim, you may want to hedge your global market exposure by joining forces with the short sellers and target the iShares MSCJ Japan ETF.
Anyone remember how terrified we were supposed to be that the Jappers were going to own us?
The USA will still be #1 in 2015?
Fukishima alone could Bankrupt Japan.
It's also interesting that the chart is from CNNMoney and they already project serious US GDP growth throughout Obama's second term!
Perhaps if the US is lucky, we will suffer the same economic fate as Japan's. Slow but steady decline that will prevent total collapse.
What's wrong with collapsing and rebooting, at least in comparison? This would get all the layabouts off the dole, and blow up the government bureaucracy.
Actually.. Japan has been GAINING in worth ($) .. since Barry has been illegally elected (twice)..
The value of the YEN has doubled, since I have been here.. the value was 144 yen to the $ when I got here in 1998.
Now, it is pretty much averaging @ 78 yen to $1.
The difficult position this puts me in, is that I want the yen to be higher value... but I don’t want to see the USA economy to collapse.. and to make it more difficult.. the Japanese WANT the yen to be weak compared to the $$.. (export sales)..
It would also negate your worries about all the cash you have saved. It will be sacrificed to the god of monetary stimulus (which just prolongs the decline much like Japan).
Tax hikes. Tax hikes. Every government on the earth thinks that if you steal every dime the public has that they can fix the problems. Problem is, they would just spend this on waste as well without fixing the real problems.
Japan is simply currently winning in the race to inflate everyone else’s currency. The export of inflation is pretty simple, the Japanese banks buy higher yield instruments abroad. After the boom in such buying, they all scramble out causing a bust with a general ratcheting of inflation of the other currency each cycle.
Because of their national industrial policy, that wisely pushed analog Hi-def TV.
Lester Thurow, you magnificent idiot.
I haven't cared much about saving cash, because I've been betting on hyperinflation for about 15 years. I'm also expecting inflation to pay off my mortgage. OK, we have a 401K, but I'm not counting on it saving us. I'm expecting to work until I croak.
Maybe our fellow citizens aren't that stupid. They've been buying guns by the armload.
You have it totally backwards.. Japan WANTS a weak yen.. It has been pissing them off for 4 years now that they can’t mess with the value...
The weaker yen gives them more export value; especially in the (ex) USSR countries.. The Japanese govt. here LOVED a weak Yen (I was on the opposite side... I pay Child Support)..
It is all too complex for the simple voter/person to understand..
“Japan’s steady decline ...can be attributed to a pair of factors: A rapidly-aging population and ... “
People in Japan age faster?
I know that and so does everyone else. What happens is people carry trade Japan's ridiculously low rates to other higher rate markets hoping that the yen will fall and they will buy more yen when they cash the foreign securities.
It never works, the carry trade rapidly unwinds (crashing those foreign markets) and the yen shoots up. It's a stupid policy and Japan has been doing since the early 90's It is one of the big reasons for the worldwide booms and busts since then. Since the late 90's we have been doing the same thing off and on.
Anyway, it's how they export inflation and never inflate themselves.
I’m about the same. I have put away into the 401k but the extra cash gets turned into true mattress money (think very heavy uncomfortable mattress). It doesn’t help the economy but there are a lot of people doing it.
Perhaps it has merely maintained status quo as the dollar slipped to 50% of it's value.
I agree there.. and Japan is totally selfish about their position..
I'm not sure about Germany and Brazil, but I'm pretty sure that rear view mirror must have Korea in its sights.
They're taking away Japans electronic edge, tourists, and even "J"-pop has turned into "K"
Oh the humanity!
Borrowing 40% of their annual budget? What an economic baskate case!
At least we’re not like that in the US - we don’t have an annual budget...