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Home > Blogs > Anthony Harrington > Is Japan at the tipping point? Not if China can help it

Is Japan at the tipping point? Not if China can help it

Finance Blogger: Anthony Harrington Anthony Harrington

Back in early August I wrote a blog post which highlighted Edward Chancellor’s excellent account of the global sovereign debt crisis. In recent weeks something happened that made me revisit Chancellor’s paper. In August, Japan, astonished at the amount of Japanese government bonds (JGBs) China was amassing asked China to explain its actions.

More specifically, the Japanese Finance Minister, Yoshihiko Noda, demanded talks with China over its sudden appetite for the yen, pointing out that it was creating an unfair pricing advantage for Chinese goods over Japanese goods. It is also causing major Japanese exporters to think seriously about relocating more of their manufacturing facilities to China, which would get them out of the problems created by manufacturing in a strong currency zone, while simultaneously giving them access to the benefits of China’s yuan, which is managed by the Chinese government in a manner that allows it to continue to be moderately undervalued, at least in US eyes.

There is no doubt that Japan is struggling with a currency that is hitting a 15-year high against the dollar, thus weakening the country’s attempts to boost exports as a way of achieving some forward momentum for its stagnant economy. Having China soak up JGBs creates further demand for the yen and is not helping. The relevance of this to Chancellor’s paper will take a moment to explain, but the point has some interest, I hope.

In his paper, Chancellor, amongst other things, picks up Reinhart and Rogoff’s point that whether or not a state will default is inherently unpredictable and argues that there are usually tipping points that will trigger a sovereign debt default, even if these are only discovered with hindsight. In considering the case of Japan as a potential defaulter, Chancellor has an intriguing graph of Japanese savings, which starts in the top left hand corner in the 1960s at about 20% of income, and wanders down to the bottom right hand corner, ending at about 3% in 2010—a classic diminishing graph, in other words.

The point here is that Japan’s huge public deficit has been funded in the past largely by Japanese savers. However, the Japanese population is ageing and as people age, their capacity for saving and their interest in saving tends to diminish for obvious reasons and the chart reflects this.

The inverse correlation between savings and age is not a universal law, of course. Some people are obsessive about improving the pot that they intend to hand on to the next generation, using it perhaps as a kind of proxy for immortality. But it does seem to Chancellor to suggest that a tipping point for Japan’s ability to continue to fund its huge deficit could be at hand. A drop in Japanese savings rates from 20% to 3% does indeed suggest that local demand for government debt is drying up. Does this create a tipping point? Not really, not if other sources of debt can be found, which brings us to the China issue.

Why is China engaged in a record yen-buying spree? The obvious answer is as a way of diversifying at least a small fraction of its massive surplus of US dollars. However, obvious is not always right. China holds around 3% of its surplus in JGBs, according to the first ever fulsome disclosure of its foreign holdings by the Chinese Central Bank (source: Daily Telegraph). Also, according to a very recent comment by a central bank official, China doesn’t plan to add significantly to its JGB stocks in the immediate future out of concern that the strong yen might be about to weaken, leaving it with a depreciating asset (it already has more than enough of assets with that characteristic!) My guess is that since it has occurred to Japanese auto manufacturers that it would be a good idea to relocate some factories to China to escape the strong yen, Chinese central bankers and the top Party hierarchy are also likely to have predicted this outcome. Forcing the yen up to drive Japanese factories to China would look like a very sweet play… Long term it probably wouldn’t be bad for the Japanese auto industry either.

By way of a rider to this blog, it is worth pointing out that this whole China yen-buying spree saga is proof positive of Chancellor’s key point in his paper, namely that it is fiendishly difficult to predict sovereign debt defaults…

Further reading on currency risks and Japan

Tags: China , default , deflation , government bonds , Japan , savings rates , sovereign debt , tipping point
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  1. Anonymous Comment says:
    Wed Jun 20 15:10:32 BST 2012

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  2. AnthonyHarrington says:
    Wed Sep 15 10:46:38 BST 2010

    In a splendid demonstration of Sods Law, on the very day this blog was posted, Japan chose to intervene massively to take the pressure off the yen/dollar pair, causing the yen to weaken slightly and to briefly to move above 85 yen to the dollar. What does this mean for JGBs? Rod Davidson, head of fixed income at Alliance Trust Asset Management points out that while there has been a rally around JGBs on the back of this intervention, we can expect the authorities in Japan to move to neutralise the intervention's impact on the bond market through a programme of buying JGBs. Davidson points out too that one of the interesting features of Japan's yield curve is that it was the only developed market that did not set new lows for 10 year yields in the recent burst of activity. They went as low as 90 basis points, but didn't get anywhere near their 60 basis point lows. They could make their way lower in the near term and that would simply be a by-product of the intervention... Already, however, there is some market scepticism that Japan can keep the yen from rallying strongly in the medium term, no matter how much it wants to protect its exporters... Anthony Harrington

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