QUESTION: Hello Martin
There are a few writers who speculate the the yen will be the first currency to fall (because Japan has been tied into QE and flat interest rates for decades already, and their manufacturing is suffering). How do you think the currency situation will play out for Japan?
thank you
best wishes
M
ANSWER: This is the classic example of people who keep touting fiat and money supply as if it was the beginning and end to everything. I have stated that ALL money is fiat even when a government fixes the price of gold for they are dictating its value. The floating exchange rate has its advantages. It is truly the check against government for money is simply the expression of confidence in the total productivity of a nation. It is not gold – it is the people.
Japan rose to the 2nd largest economy with a tiny island, no gold, and no resources. It did so proving Adam Smith was correct based upon the total productivity of its people. Inflation does not correlate to money supply. If it did, then ALL commodities would be higher today. Inflation is a matter of confidence and as long as people know someone else will freely accept whatever money might be at that moment, then they will accept it as well. Disturb that confidence and you get inflation all the way up the scale to hyperinflation, which also involves the collapse in confidence in banks and people spending everything as fast as they get it – the opposite of deflationary hoarding.
Interest Rates are also a reflection of INFLATION. You would never lend money with a rate of return BELOW the purchasing power of money at the time you expect a return. Therefore, rates have been flat in Japan because of the massive deflation that is also the hallmark of hoarding (savings).
To understand Japan we must look at the whole picture. The key lies in capital flows. Here we can see the outflow of yen where Japan became the largest holder of US debt until the 1987 Crash. The G5 morons stood up and said they wanted to see the dollar down by 40% for trade. The Japanese panicked and sold US assets taking their money home. That set the stage for the bubble peak in 1989 two years later.
The Current Account surplus has been instrumental in Japanese economics. Japan is running a current account surplus – attracting capital inflows into Japan and such inflows can be used by the private sector or buy government bonds and equity. Japan does not rely on external financing of its public sector debt. A high percentage of Japanese public sector debt is held domestically. In fact, some 70% is held by the Bank of Japan itself. Most of the remaining balance is held by Japanese trust and investment funds.
Consequently, despite a temporary inflow after the Euro debt crisis, foreign sector holdings of of medium- to long-term Japanese government securities remained distinctly below 7%. This in part was driven also by capital controls. One could not even issue a note in Japanese yen without approval first from the Ministry of Finance.
Now, let us look at this perspective in contrast with Europe. The European periphery countries like Spain, Greece and Italy were also running current account deficits and had a greater reliance on external financing of domestic debt than Japan. This was the initial belief that Euroland replaced credit risk. Here is a list of the top 10 nations who has public and private debt held by non-residents.
| Rank | Country | External Debt | PerCapita | %GDP |
| 1 | United States | 17,997,889,181,468 | 58,437 | 106 |
| 2 | United Kingdom | 9,590,995,000,000 | 160,158 | 406 |
| 3 | Germany | 5,546,869,000,000 | 68720 | 145 |
| 4 | France | 5,750,152,000,000 | 86317 | 222 |
| 5 | China | 3,000,000,000,000 | 2220.57 | 37.5 |
| 6 | Japan | 2,861,488,000,000 | 24000 | 60 |
| 7 | Netherlands | 2,526,895,000,000 | 226503 | 316 |
| 8 | Luxembourg | 3,472,282,000,000 | 3696467 | 3443 |
| 9 | Italy | 2,651,413,000,000 | 43621 | 124 |
| 10 | Spain | 2,305,648,000,000 | 52045 | 167 |
The typical snake-oil salesman’s analysis focuses on the debt size and assumes it is fiat and therefore the dollar has to collapse. Now look closer. Why is the debt crisis starting in Europe rather than Japan? Japan’s externally held debt places it in the rank of number six, whereas its total debt to GDP puts it in first place among all nations. Now look even closer. Here is the external debt as a percentage of GDP where we can see that Japan is the LOWEST of the top ten countries coming in at just 60%. Therefore its debt is primarily domestic not external.
Now turn to the per capita column. Low and behold, Britain is the worst and Germany, France, Netherlands, Luxembourg all exceed the USA and Italy as well as Spain are not far behind the USA. The problem, no European country has a viable economy to service this level of debt. The average German pays more than 50% of total income to taxes at least 33% more than the average American. Europe is a basket-case for socialism.
There are far too many charlatans distorting facts usually to sell something be it gold or some newsletter filled with nonsense and poor research if you can even call it that. Sorry, but the Japanese private sector (both household and corporate) have a large appetite for buying government bonds (hoarding) for they have traditionally believed in government. For you see, once upon a time the Emperor was seen as appointed by God and thus was the “Son of Heaven”. You cannot argue with God. China had the same philosophy known as tiānmìng (Madate of Heaven). If an emperor was overthrown, this was seen as God’s will. Therefore, instinctively, there is a different sort of confidence in government that dominates Japan compared to the West.
Consequently, this concept of the “Son of Heaven” created a culture where people have listened to government, which is starting to decline with the younger generation. Nonetheless, this belief has created domestic savings rates that are relatively high by global standards (hoarding) which in itself is deflationary. People and firms have spare cash to buy bonds and lend the government money.
Cost of debt servicing Japanese debt has been minimal in recent years and this is the risk Japan faces in the future. Interest rates and bond yields in Japan are very low. (10 year bond yield is 0.5%) Therefore, the interest payments on the debt are relatively low. If interest rates in Japan were to rise, the cost of servicing the national debt would then explode rising much higher than anyone will suspect. With rates so low, debt interest payments account form a substantial amount of total government spending reaching about 15% of GDP.
With Japan in a deflationary spiral, inflation and interest rates have both been very low. The Bank of Japan is able to monetize part of the debt without causing inflation because of the depressed state of the economy. The 70% of government debt is held by the Bank of Japan, does not impact the economy at this stage when in the West pension funds are in danger from holding way too much government debt.
So our analysis looking at every asset class and debt class leaving no stone unturned, places Japan second in line to Europe. The crisis that will tip Japan over will be when rates rise externally. That will transfer risk to the Bank of Japan.
