Japan’s Debt level… and perhaps why the figures are wrong

So we again greet another week of crisis, political deadlocks and CDS complications… When is 2012 going to start? Come to think of it 2011 wasn’t that different to 2010… oh my.

A cursory glance at this Daily Telegraph Article on the state of the UK drew my attention to the new McKinsey Global Institute on Debt and Deleveraging. I thought I would do my check on the Debt figures for my favourite economies: Japan and South Korea (yes China I love you too but for some reason McKinsey don’t list you… talk to them) More specifically a certain chart shown below

Please note all copyright goes to McKinsey Global Institute and the graph is from page 5.

Now according to this government debt has increased to about 225% of GDP, the majority of which prior to the Tohoku Earthquake was composed of social security expenditure. According to Kyle Bass of Hayman Capital management along with many other doom-sayers who have an annual rally call on Japan defaulting this model is unsustainable.  Furthermore Bass has highlighted that due to a low rate of immigration and the fact that Japanese government debt is already higher than that of domestic household savings, Japan will be forced to seek foreign buyers that will demand a higher interest rate. This coupled with debt servicing costs (now 50% of the last Fiscal Budget) means that Japan has a high incidence of default.

Now why do I say that this maybe incorrect? I might add that I am by no means stating that  Japan hasn’t got a problem, rather the economic situation is

I would like to point out a often forgotten paper by Broda and Weinstein called ‘Happy News from the Dismal Science: Reassessing Japanese Fiscal Policy and Sustainability’ that was published in December 2004. A quote is perhaps best:

For example, in a consolidated accounting system, if the social security tax raises one hundred yen of revenue and rest of the government spends one hundred yen, the debt of the government would equal zero. In Japanese system, however, this transfer of say, one hundred yen, often involves the purchase of a bond or the creation of a government deposit account. Hence, the same transfer would involve the general account borrowing from the social security system, which creates a liability for the general account of one hundred yen, and the social security system obtaining an asset (i.e a deposit in the government) worth 100 yen. In both accounting systems, the financial implications to the aggregate public sector are identical, but the accounting practices would make the balance sheets look quite different. (p.12)

Of course the kicker: ‘the consolidated government debt would be zero, but the unconsolidated accounts would show a gross Japanese government debt of one hundred yen.‘ This of course forgets any accounts held by the Bank of Japan.

Furthermore, a source of mine who worked for a would-be up and coming Diet member who was tasked with revitalising the social security system revealed that the vast majority of social security spending was consumed just by keeping track of people as there is no standardised social security number system unlike the UK/US/other mature economy. There is a lot of efficiency improvements that would decrease the costs. The idea that the government has no room to manoeuvre is false.

Government debt in Japan is the 2nd cheapest in the world after Switzerland and despite the most recent earthquake at present it is less than 100 Yen to the Dollar and Euro. In fact in a recent bond auction:

A Y2.5tn auction of one-year Japanese bills on Tuesday attracted bids valued at more than six times the amount on offer, the highest ratio since July 2005, according to Japan’s finance ministry. A Y5.5tn auction of three-month bills on Wednesday was more than 10 times subscribed.

More than 6 times? Add to this that Japan has not yet fully privatised Japan Post, has a stake of 50% in Japan Tobacco, $1 Trillion of foreign exchange reserves and a low rate of inflation if not deflation which has maintained if not increased the value of the debt held by individuals (as opposed to UK/US debt which is being inflated away) and other assets in the form of waste management etc it seems as though the Ministry of Finance can hold on for a bit longer. Well, at least until gets all its double-entry accounts up and ready.

Although Mr Bass’s comments on debt servicing are certainly worthy of attention and Japan’s fiscal health is still not sound, the problem I hope has been demonstrated to be not as big as we think. Any thoughts?