Japan Slowly Awakening to Debt Situation

From Reuters over the weekend, we find an article on Japan’s worsening debt situation (seemingly confirming Hugh Hendry’s arguments here). Here’s a snippet (emphasis added):

“It’s scary when you think what could happen if there’s triple-selling of bonds, stocks and the yen. The chance of this happening is bigger than markets think,” says a senior official.

Leaning back in a leather sofa in his office, the official appears relaxed, but the way he wastes no time answering questions about a debt meltdown, suggests it is an all too familiar topic.

The official, like many others interviewed by Reuters, declined to be named because of the sensitivity of the subject and his alarm over Japan’s $10 trillion-plus debt overhang has yet to be reflected in public debate or action. But these officials would be the ones pulling the levers in the command center if Japan were to be hit by a debt crisis.

The government borrows more than it raises in taxes, and its debt pile amounts to two years’ worth of Japan’s economic output, the highest debt-to-GDP ratio in the world.

It costs Japan half of the country’s tax income just to service its debt. Each year, Japan’s debt level increases by more than the combined gross domestic product of Greece and Portugal.

The article also notes a return of investor appetite for risky assets as a potential tipping point:

Fund managers say such scenarios remain hypothetical as long as global investors shun risks and the Japanese lack attractive alternatives to big-scale holdings of yen-denominated government debt.

A resolution of Europe’s debt crisis and return of risk appetite combined with a lasting reversal of the yen’s upward trend and a return of carry trade using the yen to fund investments in higher-yielding assets could change that.

Farley says the emergence of government debt of new economic powers such as China or Brazil as safe high-grade investment could also allow Japanese investors to diversify away from JGBs, though he expects such a change would be gradual.

Tokyo technocrats worry that the psychological impact of Japan losing its long-cherished status as a top capital exporter could produce an explosive mix if combined with a sense of policy paralysis and better alternatives elsewhere.

“The worst-case scenario, or capital flight, would become reality if the Japanese start feeling that Japan will go into steady decline and they will find no reason to keep their assets at home.”

How would you invest in order to take advantage of this (assuming you are not able to access the CDS market like Mr. Hendry)? 

Read the full article here.


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Talk to Frank about Japan

  • Neil Patel

    We could be reaching a tipping point. In terms of how to invest in this outcome – look for asymmetric ways to gain exposure to JGBs or the Yen.