Monday, August 13, 2012

Financial repression, Japanese style


For anyone who is interested in the Japanese economy, the recent paper by Takeo Hoshi and Takatoshi Ito is a must-read. Basically, it says that the days of Japan's seemingly infinite capacity to increase its national debt are numbered.

Everyone knows that Japan sustains its unprecedented national debt by borrowing money from its own people. The willingness of Japan's private sector to lend near-infinite amounts of money to the government at a pittance of an interest rate is legendary.

What Hoshi and Ito do is this: They assume that Japan's current government deficits, current GDP growth rates, and current savings rates will basically be maintained. Then they simply calculate the time when ALL of Japan's private wealth will be held in Japanese government bonds. Beyond that point, Japan will only be able to finance its deficits by borrowing money from foreigners, which of course will instantly push interest rates up to the point where Japan is forced to default. Under all of the scenarios, doomsday comes before 2023. Of course, that is making some very extreme assumptions, i.e. that government borrowing crowds out all other borrowing and that Japan's private sector demand for government bonds does not falter.

The upshot: Unless it balances its budget, Japan will start borrowing from foreigners in the next decade.

So there are three questions that follow, in my mind. The first is: Who is buying Japanese government bonds, and why? The second is: Why can't Japan balance its budget? The third is: "What will happen if Japan has to borrow from foreigners?" To answer these questions, I asked some Japanese econ professors what they thought. What follows is a distillation of facts that they gave me about the Japanese economy, some but not all of which can be verified by looking at official statistics.

On the question of "Who is buying Japanese government bonds, and why?", the answer appears to be: Pension funds, insurance companies, and regional banks. This answer is slightly different, though not hugely different, from the answer I gave when I blogged about the topic last year.

Japan's private individuals, who previously bought a lot of bonds with their non-pension savings, hold a lot of JGBs but are not buying any new ones. Partly, this is because Japan's household savings rate has dropped to near zero (which itself is partly due to rapid aging). Partly, it is because - all talk of "culture" to the side - people are just not that interested in holding such a low-yielding asset.

Japan's big banks and non-financial companies are similarly refusing to buy more JGBs. The Ministry of Finance, whose job it is to sell JGBs, had been leaning hard on big banks and companies to buy more of the bonds. However, the bureaucracy is not all-powerful (again, contrary to the stereotypes), and companies have basically said "No more!".

Pension funds and insurance companies, however, are a different story. The Ministry of Finance apparently has much more leverage over these guys, and basically forces pension funds to put households' savings in JGBs. But you may ask: Why don't workers demand that their funds invest in something higher-yielding? And here is what a professor told me:

In Japan, you can't do that!! In America, workers have a say in what asset classes their pensions go into. In Japan, this is apparently not the case. A 22-year-old entry-level worker, who really should have all of his money in global stocks, has absolutely no ability to stop his pension from putting all his money into low-yielding Japanese government bonds. Nor can he simply withdraw his pension early; apparently that is also not allowed in Japan. I am not 100% sure I believe that Japanese pensions work like this, but this is what people insist is true. If they are telling me something wrong, please let me know.

If true, this is "financial repression" at its worst. Japan's decrepit government is only keeping itself afloat by confiscating the savings of its hard-working populace. Some of these workers are staying in the office until late at night, only seeing their families one day a week, not even getting paid for the overtime...and their pensions are being confiscated by government pressure on fund managers.

So that answers that question. Next up is the question of why Japan can't balance its budget. I mainly outsource this answer to Yuriko Koike. Japan used to waste untold billions on pointless construction projects (concreting over every riverbed in the country, for example), but after a decade of cuts, that sort of thing now accounts for only about 5% of the budget.

The real problem is this: Japan has European-style health care with American levels of taxes. If you're going to pay for universal health care, you need high taxes, and Japan does not have them. With an aging population raising health care costs, Japan is going to have to either eliminate universal health care (ha!), or raise taxes a lot to balance the budget. Taxes have been raised, with the national sales tax recently going from 5% to 10%. But that change doesn't kick in til 2015, and won't put a particularly big dent in the deficit. Meanwhile, the tax hike was only popular because of the brave actions of a prime minister who will likely be fired as a result. Japan's populace, tired of working themselves to the bone and seeing their savings be stolen by pension funds, appear to be engaging in a full-fledged tax revolt.

So it seems unlikely that Japan will balance its budget. And Hoshi and Ito show that Japanese private investors, captive as they are, will soon have their backs broken by the sheer unbearable weight of government debt. So when Japan's government goes hat in hand to foreigners in the next decade, what will happen?

If Japan has to sell JGBs to rich countries, it's game over. No one will accept such low yields with such high default risk. The only investor who might buy the requisite amounts of JGBs is China. China, facing pressure from the U.S. to stop supporting exports by buying Treasuries, might turn to JGBs as an alternative mercantilist strategy. The idea would be to hold down the yuan against the yen, inducing Japan to buy a bunch of Chinese exports. This would be insanely expensive for China, but would give China de facto political power over one of its biggest geopolitical rivals.

So I see the following possible scenarios for Japan:

1. An early default, as pension funds escape government pressure and/or regional banks get spooked.

2. A default in 10 years, after Japan's private investors become totally tapped out.

3. A delayed default, but Japan becomes a client state of China in perpetuity, as China loans Japan's government the money it needs to stay afloat.

4. No default, as Japan carries out economic reforms, lets unproductive companies die, and experiences rapid productivity growth.

5. No default, as Japan's government ignores political pressure and raises taxes to European levels.

6. No default, as Japan's government ignores political pressure and eliminates universal health care.

7. Hyperinflation, as Japan's government pays off its debt by seigniorage.

(Actually, there is another scenario: Nightmare Socialism. Savings rates continue to rise, instead of falling as old people retire; more and more savings are hurled into JGBs, as the populace impoverishes itself to postpone default indefinitely. I didn't give this scenario a number because it's a little silly, and would represent an enormous and sustained reversal of many existing trends.)

I think Scenarios 1 and 2 are the most likely, though 5 is also possible. What do you think?

88 comments:

  1. Anonymous10:58 PM

    Couldn't they just print money? Or (almost the same thing) borrow infinitely from the BoJ?

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    Replies
    1. They could pay off the debt with seigniorage, leading to hyperinflation. I added that possibility.

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    2. Why would replacing risk-free, interest earning government liabilities (treasuries) with risk-free, non-interest-earning liabilities (reserves/cash) cause massive hyperinflation? Assuming the interest rate is already low, what effect does the seignorage have? seems like most people's balance sheet assets would stay roughly equal in value, or perhaps lose some interest income

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    3. Anonymous11:31 PM

      But their deficit right now is what, 4% of gdp? And they have hardly any inflation at all. Even if they finance the deficit entirely through seigniorage, that's not going to lead to hyperinflation. Some might even argue that 4% inflation is better than 0%.

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    4. Go take a look at the deficits of countries that experienced hyperinflation. Did the inflation rate correspond to the deficit as a percentage of GDP? ;)

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    5. Anonymous11:51 PM

      Countries that experienced hyperinflation also tended to experience a combination of major supply shocks combined with debt denominated in foreign currency. Neither of which is present in Japan.

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    6. Anonymous11:58 PM

      You need to read more about what hyperinflation is and what causes it. It's not *just* printing money- the countries that have experienced hyperinflation have been countries with external debts in other currencies.

      Wiemar Germany, Argentina, and Zimbabwe all owed debt in foreign currencies while having their economy destroyed by war. If you owe someone a bar of gold, inflating your own currency doesn't do anything. But if you owe your own country a dollar if your own currency, it does work and there's no reason it would spin out of control. It's not like, as soon as the government prints one yen, all the businesses in Japan will instantly lose their minds and double prices, although that is the scare story that right-wingers would like us to believe.

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    7. I think you might be confusing balance sheet monetary policy with seigniorage.

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    8. Balance sheet monetary policy is functionally retroactive seignorage. You're "paying off" existing debts with reserves that are created, as Bernanke says, by the marking up of accounts. If the CB directly monetized newly issued debt, you'd effectively have a system of ongoing deficit seignorage as the CB could roll over infinite treasuries. The internal accounts of the CB and Treasury don't affect prices in the real economy. So again, given that "paying off" the national debt is just an asset swap, with arguably deflationary impact in an already low-interest setting from further reducing seignorage, where's the hyperinflation coming from?

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    9. Sorry - "further reducing interest income"*

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    10. @Noah,

      What about a nice round of QE, generating a higher rate of growth until the employment/population ratio recovers to its full employment level, adjusting for the age-sex distribution, followed by raising taxes to pay for their Beveridge-style social welfare state? I haven't really ran any estimates, but do you think it could work?
      As far as I'm concerned, I think a QE- driven recovery of aggregate demand could make fiscal "consolidation" and possible structural reform more palatable.

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    11. Phil Koop8:30 AM

      According to Yuriko Koike, you have overlooked an important buyer of JGB's, as "balance sheet monetary policy" accounts for a significant fraction of new issuance. She says that the BoJ is already "now buying close to one-third of the JGBs issued each year."

      http://www.project-syndicate.org/commentary/japan-s-fiscal-crisis-comes-of-age-by-yuriko-koike.

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    12. Edmund4:19 PM

      In the spirit of your gentlemanly wager with Brad DeLong, make a bet with a functional finance type, MMTer - or, really, just a New Keynesian who doesn't care how the deficit is financed - about what's going to happen. You position will be some sort of default or hyperinflation, while his or her position will be no default and no hyperinflation.

      I'm pretty sure Warren Mosler will do it, and he's rich enough to give you nice stuff if you win.

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    13. Anonymous8:02 PM

      No chance Japan defaults. Hoshi's always struggled mightily with competent economic analysis, so I'm going to take the safe, opposite position of whatever story he's spinning.

      A little-known corollary to the argument that monetary policy is useless at the zero lower bound is that printing money and retiring debt is a free lunch. It will just reduce the amount of cash on banks balance sheets. If they print enough they'll have an economic recovery, at which point the debt problem takes care of itself.

      It's complete nonsense that Japan's yields are so low due to financial repression. That's just senseless. Japan's yields are so low b/c the economy is deeply depressed.

      Conservative japanese central bankers won't print money though, what'll happen is that japan will raise taxes and cut spending, and the result will be further stagnation -- or as you call it, proof of the solow model.

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  2. Really, there is a need for more and more progressive taxation -- people often think this is terrible because they don't realize the enormous positional externaltiies, how the blow is so so much less when your peers pay the same tax -- or those who are much wealthier than you are paying proportionately much more.

    But, I'd like to note too the option of tax-financed, deficit-free, stimulus, something I've noted before:

    We're concerned about government debt, and we're concerned about the great recession. Some people say the government can't deficit spend to stimulate because of high debt, and this is actually true in countries that can't borrow cheaply.

    So, you could raise taxes, especially on wealthier people with a high propensity to save, and then the government spends, invests, the money. We're worried that people aren't spending enough; this makes the money get spent. You tax a dollar from someone with, say, a 90% propensity to save; their spending goes down by 10 cents, and the government spends the whole thing, $1.00, hopefully on high return public investment. Private spending goes down by 10 cents, government spending goes up by $1.00, so total spending goes up by 90 cents, with not one cent added to the debt.

    It's sad that this is so rarely considered; the spending always has to be deficit, because the right's billionaire financed propaganda machine has convinced so many that tax increases are always terrible for the economy, short or long term. You wonder if there might be some advantageous way to sell this politically, especially in European countries where rapacious billionaires don't have such a death grip.

    Robert Shiller, wrote in 2010:

    It has long been known that Keynesian economic stimulus does not require deficit spending. Under certain idealized assumptions, a concept known as the “balanced-budget multiplier theorem” states that national income is raised, dollar for dollar, with any increase in government expenditure on goods and services that is matched by a tax increase.

    At: http://www.nytimes.com/2010/12/26/business/26view.html

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    Replies
    1. Of course, big structural reforms, finally really utilizing their women, and expanding and improving higher education, could really boost GDP long term.

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    2. @Serlin,

      I like the points you made, here.

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    3. Conservatives only believe in Ricardian Equivalence when talking about middle class tax cuts, but it is the wealthy who actually behave roughly the way Ricardian Equivalence assumes; it is the wealthiest who spend out of savings rather than income, and it is the wealthy who will buy the treasury bonds the government needs to sell when it decides not to tax them.

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  3. In America, workers have a say.. with what they save themselves, yes, with defined contribution plans, yes though they may have limited choices, with defined benefit plans, rarely. Most defined benefit plans are company/financial institution managed and only provide what options they choose to provide and only vest near retirement.

    High deficits are the choice of having a low inflation rate.

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  4. Anonymous12:24 AM

    According to one argument, if a debt scare produces robust NGDP growth expectations, then, simultaneously, those same NGDP growth expectations will also take care of the debt scare. Therefore the BOJ need only to promise to finance public deficits until NGDP reaches a certain level, and then fine tune its actions to keep it on trend. Your scenario #7, rather than a dire outcome, represents a step down a relatively low-risk optimal path.

    Sound right?

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    Replies
    1. According to one argument, if a debt scare produces robust NGDP growth expectations, then, simultaneously, those same NGDP growth expectations will also take care of the debt scare.

      I don't think that works. For the NGDP expectatons to remove the debt scare you need people to be forward-looking, but if they are forward-looking, then there won't be a debt scare in the first place. There is no rational expectations equilibrium outcome where you can get this effect.

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  5. Anonymous12:48 AM

    BOJ buys new bonds, refunds interest to treasury. Not hyperinflation - but finally inflation instead of deflation. Which, btw, will cause their debt to gdp to fall. Countries never pay back their debt - they inflate it away.

    Also, Italy faced a similar position in the 90s - and learned quickly you cannot default if you control your own currency and have a floating exchange rate:

    http://www.warrenmosler.com/post/583336524/why-us-solvency-is-not-an-issue

    So i chose 8) japan will continue to pay its debt.

    -SM

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  6. You fail to mention the key assumption in the paper: that interest rates on government debt equal or exceed the growth rate of the Japanese economy. But this hasn't been the case in Japan for many years now, has it? If you adopt the more realistic assumption that Japanese interest & growth rates stay at their recent levels, I think Japan can indeed continue running deficits forever.

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    1. But this hasn't been the case in Japan for many years now, has it?

      Nope. The annualized real growth rate in Japan over the last 10 or 15 years has been lower than the annualized real interest rate on Japanese government bonds. The same is true if you only go up until 2010 (excluding the earthquake).

      In some individual years, the growth rate was above the real interest rate. But there's no sign that that pattern will dominate going forward.

      Also, the authors' analysis does not depend critically on the assumption you mention. Even if GDP grows above the interest rate, government debt growth can still exceed the growth in total net private wealth. Check out their model and verify this for yourself.

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    2. By the way, when I said "Nope", I meant "I believe you are incorrect on two counts, check both the data and the model".

      Also, I'm pretty sure that if you were right, then debt service payments would shrink as a percentage of tax revenues. However, that has not been the case; debt service payments are currently over 50% of tax revenues, up quite a bit from where that ratio stood 10 or 15 years ago.

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    3. Well, empirically you may be right -- Japanese growth rates have been very low. But it's still the case that they explicitly assume that interest rates must at least equal growth rates, even though there are many historical examples of countries where g > r for long periods. If we assume a 2 percent real growth rate for Japan going forward, and interest rates at their current near-zero levels, then a primary deficit of around 5 percent of GDP should be sustainable forever. (2 percent growth plus 0 percent interest plus 5 percent primary deficit = debt/GDP converging to 250%.) It is true that recently Japanese primary deficits have been larger than 5 percent, but then there has been a global recession.

      The question is not whether debt service payments are rising, but whether they are rising without limit or converging to a finite value. My point is that with very low interest rates and moderately positive interest rates, even fairly high primary deficits will result in the ratios of debt to GDO and interest payments to taxes converging to finite values -- the definition of sustainability.

      The conclusion that Japan *must* achieve a primary surplus or default depends on r > g, which -- you are right -- may be true for recent years, but shouldn't be assumed to be a fact of nature.

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    4. I'm not sure, but I think that empirically you may be confusing the Japanese federal funds rate (called the "overnight call rate") with the interest rate on JGBs. The former is at zero, but the latter has been between 1 and 2 percent since 2000.

      Theoretically you're right, but check out the model in Hoshi and Ito's paper. It does not predict if or when Japan will be forced to default. It predicts when Japan will have to borrow from foreigners. If you take a look at their model, you'll see that that happens whether or not rg.

      And when Japan has to borrow from foreigners, it is quite likely that interest rates will rise. If Japan is forced to default (or engage in austerity, or use seigniorage), it will be because of a rise in interest rates.

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    5. I'm not confusing them. The 10-year rate is below 1 percent, around 0.8. The nominal bill rate (3 months?) is less than 0.1. So g > r by a good margin currently, a possibility that Hoshi and Ito simply rule out a priori. Now, again, you are right that this has not been true in Japan over any recent extended period, given extremely low growth and deflation. But it clearly belongs on any reasonable list of things that could happen in the future.

      As for their model, it depends on the numbers. Yes, with a sufficiently large primary deficit, you can still reach the point at which all the private sector's savings are held in the form of government debt, if the primary deficits are large enough. But g > r creates a great deal more space for positive deficits forever with debt-GDP ratio converging to a level that the Japanese private sector has historically been willing to hold.

      If Japan had to borrow abroad, interest rates might rise. But the example of the US should at least raise some doubts, no? Wealth holders' demand for safe assets seems to be a more important factor in sovereign rates now than the textbook stuff.

      Japan actually does have a problem right now -- low growth and deflation. Suggesting they stop trying to fix that problem in order to worry about a problem they very emphatically don't have -- insufficient demand for public debt -- strikes me as about as unhelpful as similar austerian arguments everywhere else.

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    6. Now, again, you are right that this has not been true in Japan over any recent extended period, given extremely low growth and deflation. But it clearly belongs on any reasonable list of things that could happen in the future.

      Well, maybe, but it would be of marginal help as long as primary deficits are big, and it would seem to be crazy to count on it happening when setting policy.

      If Japan had to borrow abroad, interest rates might rise. But the example of the US should at least raise some doubts, no? Wealth holders' demand for safe assets seems to be a more important factor in sovereign rates now than the textbook stuff.

      OK, maybe that will continue forever. I wouldn't bet on it. Neither would most Keynesians I know. The thing about deficit-financed stimulus is that it is temporary - you basically bet that the interest rate environment will not change until after the stimulus is done. But counting on this sort of thing indefinitely is a different animal entirely.

      Japan actually does have a problem right now -- low growth and deflation. Suggesting they stop trying to fix that problem in order to worry about a problem they very emphatically don't have -- insufficient demand for public debt -- strikes me as about as unhelpful as similar austerian arguments everywhere else.

      It seems to me that Japan should attack the aggregate demand problem with QE. That would be helpful for both the economy AND the debt.

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    7. I agree that some form of QE would be a good idea in Japan.

      When you say it would help with the debt, do you mean just insofar as it produced faster growth, or is there some way that unconventional monetary policy can relax the debt constraint even with given growth?

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    8. What "debt constraint" are we talking about here? The "ceiling" in the Hoshi/Ito paper? Because I don't know that there's actually any constraint on the amount of debt a government can hold.

      Are you asking if stagflation would be better than deflationary stagnation? I don't think it would be much different, if at all, from a welfare standpoint. But I guess it's a hard call...

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  7. also, could the BOJ not institute an IOR program,sterilizing any increase in the monetary base due to seinourage?

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    1. Edmund4:21 PM

      I see absolutely no reason why they couldn't.

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  8. JW Mason - I think this paper by Jamie Galbraith makes that very point w/r/t the US: http://www.levyinstitute.org/publications/?docid=1379

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  9. Or-

    Yes, it does. But lots of other people have pointed this out as well, going back to the early 1980s at least. (Which is why it's so silly of the Hoshi-Ito paper to simply assume that interest rates must exceed growth rates.) I discuss these issues and link to some other relevant papers in some posts on my blog.

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  10. Japan's decrepit government is only keeping itself afloat by confiscating the savings of its hard-working populace. Some of these workers are staying in the office until late at night, only seeing their families one day a week, not even getting paid for the overtime...and their pensions are being confiscated by government pressure on fund managers.

    This is really egregious bullshit. Japan's "decrepit" government maintains a level of public services and infrastructure that puts the US to shame. On a whole raft of social indicators -- from life expectancy to educational outcomes to crime rates to the distribution of income, Japan looks much better than the US. And, oh cry me a river for the "confiscation" of financial wealth. Japan also has a relatively low tax burden compared with most other rich countries. I see no ethical reason why financing public goods through compulsory savings is somehow morally inferior to financing them through taxation. Indeed, there is no clear line where one starts and the other ends -- look at US Social Security. Are you going to next tell us about the poor hard-working Americans whose savings are being expropriated by forced saving in the "low-yielding" Social Security trust fund?

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    1. This is really egregious bullshit.

      UR MOM

      I see no ethical reason why financing public goods through compulsory savings is somehow morally inferior to financing them through taxation.

      Well, if you don't care about progressivity, then I agree with you. But rich Japanese people don't depend on their pensions. Middle class and poor people do.

      Are you going to next tell us about the poor hard-working Americans whose savings are being expropriated by forced saving in the "low-yielding" Social Security trust fund?

      Well, no, because Social Security is not going to default and leave people who paid into the system in penurious old age. Unlike Japanese pension funds.

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    2. OK, egregious bullshit was unnecessary. I apologize for that.

      I would be interested to know how holdings of Japanese government bonds are actually distributed across incomes. In the US, government debt is overwhelmingly held by financial institutions, which means ultimately by the rich.

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    3. In Japan, a lot of pension funds hold JGBs, and a lot of individual savings are in JGBs...

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  11. @Noah,

    Right on. Furthermore, taxes are levied in a systematic and uniform manner, even if there are problems of horizontal and vertical equity, caused by deductions, credits, exemptions, etc.

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  12. Blue Aurora4:36 AM

    My dad, who spends time on stock markets, told me this hunch back in June, Noah Smith. I hope that you and him are wrong on this. But speaking of deficit finance, were you aware that J.M. Keynes was opposed to it?

    Dr. Michael Emmett Brady cites Volume XXVII of the CWJMK and correspondence with James Meade that indicate that Keynes opposed deficit finance.

    But that issue aside, what is your opinion of Modern Monetary Theory? I personally think that it's Chartalism being taken too seriously by some people who think it's a panacea, but I need to familiarize myself with the literature on Modern Monetary Theory.

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  13. the idler of march5:19 AM

    I work with Japanese pension schemes and the answer to the financial repression question you’ve been given is partially correct – the massive government-run public pension plan (the GPIF) has little independence and is run as a pseudo-sovereign-wealth fund. It is laden down to the waterline with JGBs – something like a 65% allocation. Japanese corporate schemes have no such pressures and usually hold about 25% or less JGBs, often for liability duration-matching.

    The Japanese private sector has been on a disinvesting trend ever since the bubble burst, so banks and pensions put their money into JGBs by default, since the private sector doesn’t want to borrow. Even then there aren’t enough JGBs – banks have a lot of money sitting in reserves – about 40% of Japanese GDP if I recall correctly. Given the deficit is (medium-term average) about 5%, that will keep yields low for some time to come.

    I don’t like to be unkind to academic output but that study is starting from a totally faulty premise. Private savings and public savings can sit side-by-side – money is credit, and as long as borrower and lender are both willing (they are) then the money supply will just expand to accommodate both. When they say ‘all private savings end up in JGBs’ what money supply measure are they even thinking of? (here I go knocking the paper without even reading it). Japan follows Basel regulations so there is a zero-weighting for banks lending to their own government. Whilst you have fractional reserve banking, there is no such thing as ‘all household savings’ – ie the figure is not in any sense rigid. If you assume that ‘all potential household savings’ = M0 x 1/reserve requirement (I don’t, but I use it as a useful simplification) then you’re way, way away from hitting that barrier right now.

    Incidentally, if the private sector is disinvesting and the public sector is not investing to an equivalent amount, then you have contraction of the money supply and Fisher-ian debt-deflation, which is considerably worse than merely a growing government budget deficit.

    Whilst I’m at it – the assumption that foreigners are going to somehow unilaterally demand higher yields – if you own yen, then you own the currency of an economy where the only outlet for your investment is the government. The corporate bond market is almost non-existent, and the equity market is an ongoing disaster zone. You don’t have some weird extra foreigner power to find investment outlets that don’t exist. You can affect the currency value by selling your \, but not the interest rate itself.

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    1. A. All this is pretty close to my post of a year ago. But what I was told this time is that corporate pension funds are also investing more in JGBs under pressure from the MOF. Not true?

      B. My main question about corporate pension plans was: Are employees allowed a say in the asset mix?

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    2. the idler of march5:57 AM

      A. Not that I've ever heard. The MOF might have some kind of elaborate Edo-era hostage system whereby the eldest sons of the trustees are forced to live in the HQ, but I don't think so. Most corporate sponsors are looking to further disinvest from JGBs, but can't find much else that they like.

      B. 95% of pension money is still DB, so no they are not (understandable since the company picks up the buck if they squander it on distant mineral-filled asteroids or whatever else pickles their fancy). If it's a DC scheme, then they usually are.

      I looked at that paper and the error is in the assumption that total household savings growth = money supply growth; it doesn't, in a fractional reserve banking system. Even if we were in a full reserve banking system, you'd need to include corporate assets as well, which are hefty.

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    ReplyDelete
  15. Governments that print their own currency don't default, they create inflation (which in reality is the same thing). Bottom line: the kind of taxes Japan needs is inflation. Not #7, but maybe a healthy 2-3% inflation.

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  16. Anonymous8:41 AM

    Noah wrote: "The real problem is this: Japan has European-style health care with American levels of taxes. If you're going to pay for universal health care, you need high taxes, and Japan does not have them."

    And not going to get them. Among the "six burdens" that have become Keidanren talking points is the high corporate tax. I suspect we'll be hearing about corporate tax reform soon now that Noda has taken the consumption tax bullet.

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    1. Corporate tax cuts would be fine if paid for with consumption and/or progressive income tax hikes. In fact better than fine; great.

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    2. Anonymous12:25 AM

      So in a country with excess savings and a lack of demand, reducing it further with consumption taxes and increasing savings with corporate tax cuts would be a good thing for the economy?

      -SM

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    3. What is the argument for corporate taxes being harmful? I mean, about any tax can be argued to be harmful yet they are necessary, so what is the argument for singling out the corporate tax as especially bad? It has no harmful incentive effects; how a company does to maximize profits is the same whether it gets to keep 100% or 85% of those profits. The economy has not been constrained by a shortage of investment dollars for a long time; if there are returns to be had it is easier than ever to get loans at low interest rates. And anyway the total fraction of the economy dedicated to investment isn't going to increase, unless you believe the middle class is full of people who'd rather put their money in the stock market rather than their day-to-day needs if only returns were a little higher? Is the idea to get a shift of capital away from small businesses to corporations? Seriously, what is this supposed to accomplish?

      I suppose if you're going to pick a harmless tax to pit it against to make the corporate tax look bad, a more progressive income tax is a good choice, but anything you do to make it easier to turn money you already have into more money is going to worsen the inequality you're trying to solve with progressive taxation.

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    4. What is the argument for corporate taxes being harmful?

      It's a lit easier to discourage investment than to discourage working, consuming, or owning property.

      Delete
    5. It's difficult to change consumption through incentive effects, but quite easy to do so through budget effects. Anything that negatively impacts consumption reduces the incentive to invest as surely as a corporate income tax would, and when you consider that it is impossible for a corporate income tax to make a profitable company unprofitable but a consumption tax can, I just don't see any way a consumption tax is better than a corporate income tax. As for income taxes, on low-to-middle income tax payers, these will affect consumption, and therefore they will discourage investment.

      Noah, you don't spend much time arguing that any sorts of taxes are harmful, and you certainly didn't put much effort into this argument. There's a reason for that. But it's usually not hard to make a reasonable sounding economic argument for any tax that it is harmful. Given the importance of taxes to a functioning government and economy, I'm not keen to just concede the harm of the taxes most hated by those who hate taxes the most. And I haven't seen a convincing argument for eliminating corporate taxes. Can you show me with graphs and numerical examples how a corporate income tax is harmful in ways a consumption tax isn't?

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  17. Anonymous12:58 PM

    Noah,it seems to me that one first needs to look at the problem which has been the low annualized real growth rate in Japan since 1990, assuming the data is accurate.

    What is your take on that situation?

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    Replies
    1. That's a topic for another blog post!

      Delete
  18. Anonymous2:53 PM

    I have a partial solution: One would be to nationalize certain industries (electricity anyone?) and use their dividends for debt reduction. You could do this in combination with corporate tax cuts (or elimination?), which could stimulate investment and growth, which would be partially captured by rising revenues for new SOEs.

    The only complication I can see is whether or not the dividends would be high enough to cover interest payments on new debt from purchasing these companies as well as having some left over for deficit reduction.

    Another thing would be to start imposing taxes with less deadweight losses (and even gains) like land taxes, pollution taxes, alcohol and cigarette, etc. and lowering or removing other kinds.

    ReplyDelete
  19. Is higher inflation but not hyperinflation decreasing the value of the debt over time a possibility?

    ReplyDelete
    Replies
    1. Yes. That would postpone default. If QE helped to restore growth as well as creating inflation, it would be excellent.

      Delete
  20. Anonymous3:55 PM

    European-style healthcare is still much cheaper than America's unwieldy hybrid. I don't think the government will abandon universal healthcare, but they could limit what procedures they'll fund.

    Anyway, while healthcare is a major expense, there are also other social expenses such as pensions. The eligibility age for pension payouts is gradually being raised to 65. Interestingly mandatory retirement at 60 for government employees will still continue. Instead the government is planning to rehire employees at a lower salary and keep them until they reach 65. A similar practice seems to be widespread in the private sector, with many businesses retiring workers as early as 55 and then rehiring them, though often only as part timers.

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  21. So, in sum, the Government of Japan is stealing the returns of its youth, in order to keep taxes low to stay in power, so as to provide universal healthcare, which is mainly spent on the older generation that most of those in power are part of.

    Wow! Now I totally get this cheesy Japanese B movie I watched a while back. In it these greedy old plutocrats create clones, in order to harvest their organs and gain immortality. Meanwhile, the rest of society is a wasteland and the survivors are being hunted by the plutocrats robot army. But, the youthful clones rebel, kill all the plutocrats, and set about destroying the robot army. Did I mention that the youths had superhuman strength? If I think of the name of the movie I will post it. I want to see it again after reading this post.

    I have been having some thoughts about how that, as society progresses, the older generation sucks up more and more resources. In tribal times, once you got too old you went out into the wilderness to die. A couple hundred years ago, only the wealthy could expect to be well cared for in their old age. This past century, we got Social Security and Medicare. As a result, the proportion of GDP spent on the older generation has dramatically increased (this is a reasoned guess, but I'm sure there is research on this). Imagine if someone figures out pseudo-immortality, like depicted in that movie. This will likely require a shit ton of societies resources, and it will mean that the average life span (for the rich) will approach infinity. That surly will break SS and Medicare.

    Of course, before this happens, the younger generations will likely revolt. At first, non violently, by refusing to pay into the pension system. And if they can't refuse directly then they will refuse by not working within the system. Then, the powers that be will try a return to slavery, which will precipitate the first War of the Over-Lapping Generations.

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    Replies
    1. Anonymous8:10 PM

      You need to relax. The future increases in productivity, even with more retiree per worker, will ensure that both can be wealthier in the future.

      Dean Baker:

      "The implication [of a declining population] is that the increase in the ratio of retirees to workers will impose a devastating burden on the working population.

      Those who know arithmetic don't share such concerns. Productivity growth in Japan has averaged almost 2.0 percent annually over the last two decades. At this rate, output per worker hour will be nearly 170 percent higher in 50 years.

      This means that if retirees consume 80 percent as much as active workers, and the ratio of workers to retirees fall from 2.5 today to 1.8 in 50 years, then consumption per worker and per retiree can increase by 120 percent over this period, assuming no reduction in hours worked.

      In fact, this would understate the actual gain in living standards since there will be fewer children to support and there will also be gains in living standards associated with less crowding."

      -SM

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    2. To those who know arithmetic:
      How does what you wrote above contradict doc's statement that the proportion of GDP allocated from the young to the old will continue to rise? Moreover, you are ignoring the impact of health care costs for the elderly, which are rising faster than GDP.

      Delete
    3. Thanks CA. Not to mention that I can change those numbers slightly and blow the system up.

      Delete
    4. Richard1:08 PM

      Doc:

      You skipped over the entire agricultural era, when, in most societies, elders had a lot of power (in part because, having lived through many seasons, they had a lot of wisdom about dealing with rare weather conditions, and since most of society was illiterate, wisdom had to be passed down orally).

      Delete
  22. Anonymous7:47 PM

    You don't know what a liquidity trap is, do you?

    Back in the 1980s, yields on Japanese debt was much higher than today. Is the difference that financial repression started in 1992, or is the difference that Japan slid into a deflationary trap?

    ReplyDelete
    Replies
    1. You don't know what a liquidity trap is, do you?

      No, what is it? Do tell...

      Back in the 1980s, yields on Japanese debt was much higher than today. Is the difference that financial repression started in 1992, or is the difference that Japan slid into a deflationary trap?

      The difference in what?

      The financial repression, from what I hear, started pretty recently, maybe in the last 5 years.

      Delete
  23. Anonymous8:05 PM

    Half a dozen people have pointed out japan has a central bank: no response forthcoming. I guess they didn't teach this in post grad?

    -SM

    ReplyDelete
    Replies
    1. I see you're not a regular Noahpinion reader... ;)

      Delete
    2. Anonymous12:18 AM

      Commenter or reader? I do not comment often, but this one was pretty laughable. I mean, we all know that because japan has their own currency, it's literally impossible for them to default on their debt unless they forget how to print yen. Do you expect this to happen?

      In which case, the only concern is inflation. But as several of us have pointed out, A) inflation would be helpful to them now (raises for the people, lower debt/gdp) and B) the central bank could purchase government bonds, and refund the interest to the government - if inflation occurred, they could use other means to reduce the money supply such as the reserve requirement (china does this). There is no reason to assume hyper-inflation.

      So, it's neither guaranteed that they will have to sell debt to foreigners - because they have a central bank - or they will default - because they have a printing press. (5) is the only possibility of the ones you list unless they intentionally want to destroy their economy.

      PS. Clue me in if there's something you have to do to get a response...some rules on this blog or something...

      -SM

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    3. Your whole analysis is based on the assumption that private investment will remain anemical for decades to come. If that changes, and eventually it will as existing capital depreciates, the post will not be at all laughable. Contrary to old-Keynesian doctrine, there is such a thing as a long-run. And in that long-run, data show that money growth and inflation are highly correlated.

      Delete
  24. @SM,

    I'm not sure that I'd go with a "countries with their own currencies can't default" argument. Let's just say, they have some options. Russia defaulted a few times, most memorably in 1918, 1991 and 1998.

    Devaluation can help and so can inflation (to some extent, the opposite sides of the same coin). I'm thinking that Paul Krugman's discussion ages ago about the flip side of credibility (credibly promising to deliver inflation) could be a serious problem for the BOJ, which has delivered, shall we say, too much price stability. How can such a central bank promise inflation, deliver it, and keep delivering until there's a recovery strong enough that the Japanese govt can raise taxes without depressing the economy below full employment?

    ReplyDelete
    Replies
    1. Anonymous11:09 AM

      Russia was borrowing in dollars ("original sin") -- Japan is borrowing in yen, which they can print.

      When you borrow in a foreign currency, of course you can be forced into default -- it's risky. You can't print foreign currency... European countries now all have debts in currencies they can't print. Difference may seem subtle, but it's crucial.

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    2. Anonymous12:31 AM

      Thank you anon.

      Again, a country that owns its own printing presses can not default on their government debt if it is denominated in their currency, and they have a floating exchange rate. Sure, they could A) peg their yen to another currency and default (argentina), B) borrow in another currency and default (russia), or C) intentionally default instead of doing the obvious thing (Republicans attempt last year).

      So, unless BOJ is run by people as stupid as modern republicans, there is no chance of a default - certainly they cannot be forced to default.

      Now, wouldn't the BOJ buying government debt until inflation reaches the target solve both these problems? They could be reducing the burden of the debt and deliver inflation. I do not know why they do not do this.

      -SM

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    3. Anonymous3:53 AM

      Anonymous. Russia might have been borrowing in hard currency in 1918 and 91 but in 98 the default was on *Russian denominated* debt. Which was why all the top tier talent who piled into it were so embarrassed by that default.

      [but i generally agree with ya'll. real countries dont default, they just re-write contracts]

      Delete
    4. SM,

      I understood what you meant, but it wouldn't be so clear to everyone. That being said, I find it hard to decide whether default or hyperinflation is the better choice, but my instincts say default with a currency devaluation might be a good policy mix, if there are no reasonable alternatives.

      Delete
  25. None of the above. No default, No hyperinflation.

    I don't understand how any of the above are likely outcomes unless N.S. believes the debt is a real debt, rather than a nominal debt. I understand the argument that we can sometimes pretend government debt is a real debt because the CB is doing its job and maintaining price stability. But why would anyone apply this reasoning to Japan?

    The debt is a nominal debt, not a real debt. Inflation is not default on nominal debt. BOJs problem is that nominal rates should be below zero but cannot go that low. Deflation is the problem. The debt earns too high a return, which is why there is an insatiable demand to hold it.

    That creates an environment in which the state is one of the few willing borrowers. Of course private borrowing is shrinking while public borrowing is increasing. Look at the Nikkei. That would be pretty much the expected result of having excessively high real interest rates.

    My hope is that Japanse public sector debt keeps rising faster than the decline in private wealth until the interest rates are not excessively high, at which point the private sector will borrow more and there will be sufficient inflation to reduce the Debt/GDP ratio to whatever people want. The value of equity increases and the value of debt shrinks, as a share of GDP. Things go back to normal.

    Reductions in deficits in and of themselves don't help, although structural reforms that might reduce savings demands or increase investment demand would help a lot.

    ReplyDelete
  26. Anonymous12:30 PM

    What about

    8. Normal high inflation (3%-5% range).

    What prevents that from being tried, or from working?

    ReplyDelete
    Replies
    1. Anonymous9:36 AM

      A 3 - 5% inflation rate would increase the yield on JGBs, seeing as the reason they are so low now is because of zero inflation/deflation allows for positive real returns. This pushes bond prices down to a point where it would be difficult for banks/insurance companies/pension funds to absorb the losses. The IMF working paper "Assessing the Risks to the Japanese Government Bond Market" by Waikei Raphael Lam and Kiichi Tokuoka cites estimates from the BOJ that a 100 basis point in yields will correspond to a 10 percent hit in major banks' tier 1 capital and more than 30 percent of regional banks' tier 1 capital. Inflation/interest rates can increase 300 basis points without a meltdown in the banking sector mandating government recapitalization.

      Delete
    2. Anonymous9:38 AM

      "Inflation/interest rates can increase 300 basis points"

      Sorry, this should read "can't"

      Delete
  27. Anonymous5:10 PM

    7. Hyperinflation, as Japan's government pays off its debt by seigniorage.

    Sigh. Why are so many economists blind to the middle ground between 2% inflation and "hyperinflation" (whatever that is, as most are too lazy to specify what level of inflation is "hyper" in their minds)?

    ReplyDelete
  28. A nice summary of the research on the relationship between budget deficits, seignorage, and inflation can be found here:
    http://www.phil.frb.org/research-and-data/publications/business-review/2005/q3/Q3_05_Sill.pdf

    ReplyDelete
  29. Anonymous5:05 PM

    This is a TERRIBLE paper.

    If you assume that savings will drop as a percentage of GDP (and therefore by definition an expenditure increase), you cannot assume constant GDP growth because you have just assumed a growth rate increase.

    ReplyDelete
    Replies
    1. Anonymous5:13 PM

      That's not what the paper assumes at all.

      "A more reasonable assumption may be that GDP per working-age population rather than GDP itself will grow at a constant rate."

      Delete
  30. A simple question: why can't the government pay debt with 3-4% inflation. government can print money and buy their own debt .. thanks to QE for clarifying this stuff... so the only limit is inflation if you have debt in your own currency... of course hyperinflation could happen, but it is normally rare in a economy with productive capital (that is, if you disocunt countries after a great war, or countires whose dictator decides to destroy its own country A la Haiti or Zimba.. ok you see my point)

    So, the basic question is.. can a QE-forever pay down debt while keeping inflation below 5%? The paper you sent us to does not address this point.. I would like to check your numbers...but it surely seems 5% inflation would be more than enough... Japan can have as much debt as it wants as long as it does not destroy its own productive capital and takes QE to the limit...

    Do you agree?

    ReplyDelete
  31. Hi, Im a moron when it comes to Macroeconomics and need your assistance.
    I see on a recent Bloomberg video http://www.bloomberg.com/video/japan-may-take-china-to-be-biggest-u-s-creditor-kDrqTQcZQSCjgxdxz6vV3w.html How can Japan buy US Treasury Bonds (US$1.2 trillion) when their own government debt is at 220% of GDP. The only answer I can come up with is that the Bank of Japan (BOJ) is just printing money out of nothing. That should cause the yen the devalue - but it hasn't. I feel like a moron because the only answer I can come up with is not logical - that the global financial system is a big ponzi scheme paying back previous creditors with new creditors that get their money out of thin air. If you own the money prining press this can continue indefinately, (agreeing with Bororo comments). Please, in very basic terms, can you explain this to me - what is the real situation is? At the moment nothing seems right to me.

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  32. Noah,
    I made some comments the other day and they disappeared. Am I for some reason banned? What exactly have I done? Or was it a temporary blip.
    Here I suggested that maybe raising death duties is a way out of the bind. Since most of the bonds are held by the aging they could just be repatriated when the owners don't need them any more.

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  33. Anonymous7:43 PM

    Japanes health care expenses are less than 9 % of GDP. Which is fairly standard for a UHC system. In America, non-UHC runs at 18 % of GDP.

    With its low taxes, America is running a system twice as expensive as UHC. Japan also has an exceptional level of control over its health care expenses, since the government is much more involved in price-setting than in the rest of the world.

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  34. Anonymous8:16 PM

    Japan health care costs are low even by universal health care standards (which is saying something!)
    Of course, they will increase as the elderly fraction of the population increases, but as they are starting from a point of such exceptionally low costs and first-class results...

    http://www.rawstory.com/rs/2012/05/03/u-s-health-care-spending-highest-japan-lowest-study/

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  35. Anonymous8:47 AM

    It's so simple, and it amazes me that Noah and others don't understand. If you have a player in the market that has unlimited capacity to buy and sell government "debt" (central bank), then that player controls the market for government "debt". And it's ridiculous to think that the japanese govt will ever struggle to find buyers. The reserves used to purchase govt "debt" can't go anywhere other than the Japanese banking system, the BoJ, or the govt reserve account. And what does the govt do when it gets reserves from a debt issue? Puts them right back into the banking system. There will ALWAYS be buyers of JGBs, at the prices decided by the BoJ. Ultimately, commercial banks will always buy govt debt as a way of earning better return than holding reserves.

    ReplyDelete