The common perception as to why the Japanese economy is challenged is centred on the low or no growth the country has achieved since its heyday during the 1980s.
Growth rates did struggle initially after this period, but Japan has grown in real (inflation-adjusted) terms at a similar level to many key European countries – including the UK – over the past decade.
The real issue is debt. As with any debt, interest needs to be paid and buyers of debt issued have to be found. In spite of being the first country to have the ultra-low bond yields that are now so prevalent across the global financial markets, more than 15 per cent of Japanese tax revenue goes on paying the interest on the accumulated government debt every year.
Interestingly, this statistic is not dissimilar to the equivalent one for the US in spite of Japanese 10-year bond yields being materially lower. The reason for this is the sheer magnitude of Japanese government debt which, as a proportion of GDP, is clearly the highest among the larger and more economically developed countries of the world.
So why is Japan the biggest economic experiment in the world?
Simply because without very careful economic management it could be the first major and significant economy to face a debt default threat of this generation. This is no Greece – a country whose GDP is a per cent or so of the eurozone’s GDP; no, this is the only Asian country that even has the remotest chance today of looking the Chinese economy square in the face. So this matters.
So Japan is faced with a careful economic management challenge or ‘experiment’. It has to stop its debt levels rising and the only way it can do this is by running a national budget that is much closer to balance, using inflation to reduce debts in today’s money terms or by defaulting.
As far as I can see the Japanese authorities are undertaking the first two in order to avoid the third.
In early November, the country’s central bank ramped up its quantitative easing (QE) programme. So why is this so different from a whole range of other countries that have used the QE policy to underpin and boost local economies?
The difference is the sheer size now of the Bank of Japan’s balance sheet compared to other major global central banks. Try 50 per cent plus of the country’s GDP versus nearer 20 per cent for the Federal Reserve, Bank of England or the European Central Bank. That’s an economy much closer to the edge and a big reason why the yen is sliding on the global foreign exchange markets.
And the reason for this? First, it is the extreme efforts being put in to generate a local, underlying rate of inflation of roughly 2 per cent to help inflate away some of the debt. Second, it is a policy that is trying to offset the impact of the now delayed hike in taxation levels.
