An end to corporate hoarding in Japan (Archived)
In 2014 investors enjoyed a welcome break from several years of fretting about ‘mountainous’ public debt in the mature economies. The United States was spared another nail-biting showdown over the debt ceiling, a Congressional limit on the amount the federal government can borrow. On the periphery of the euro zone, worry about painfully high spreads on sovereign debt gave way to wonder at surprisingly low yields on the same paper.
With luck, this calm on either side of the Atlantic will continue in 2015. In the year ahead, the most interesting sovereign-bond market may lie not in the US or Europe but in the country with the highest public debt ratio of them all: Japan.
Which one is Japan? G7 governments' net interest payments (2014F)
Japan’s gross government debt exceeds 1 quadrillion yen, a number most people have to look up in the dictionary. By the end of 2014 its public liabilities amounted to almost 230% of its GDP, according to the OECD’s calculations. Given these mind-boggling numbers, most people assume Japan’s economy is already buckling under the weight of a punishing interest burden. Presented with a chart showing the government’s net interest payments in each of the G7 countries (Canada, France, Germany, Italy, Japan, UK and the US), many people assume Japan is the first or second economy on the left, handing out big chunks of its annual income to its creditors.
But this assumption is wrong. Japan’s interest burden is surprisingly light. It is in fact the sixth economy on the chart, with net interest payments amounting to only about 1% of GDP in 2014, according to the OECD’s projections. That is a lower percentage than the US or even Germany pay on their significantly lower debts.
G7 governments' net interest payments (2014)
To put these figures in concrete terms, Japan’s government is paying the equivalent of four days’ worth of national income in net interest on debts that are equivalent to 838 days’ worth.
How is this possible? First, quite a lot hangs on that small word ‘net’. Japan’s net government debt is much less frightening than the gross figure that is commonly reported. Japan’s government and social-security fund hold over ¥400 trillion in financial assets, according to Japan’s Cabinet Office. Therefore its net public debt will be about 143% of GDP by the end of 2014, not 230%.
The other big reason why Japan’s interest payments are so light is, of course, because interest rates are so low. The yield on a 10-year Japanese government bond (JGB) was less than 0.5% in November 2014, according to Thomson Reuters. These low yields reflect the central bank’s efforts to reflate the economy through minimal interest rates and maximal asset-buying. The Bank of Japan already owned over a fifth of outstanding JGBs by October 2014, according to its figures, when it surprised markets by saying it would buy government paper at a still faster rate. If it maintains its pace of buying into 2016, it may end up owning about 40% of the government’s bonds, according to calculations by Capital Economics.
Japan’s monetary policy is lax but what lies behind the looseness of its monetary policy? The Bank of Japan’s extraordinary easing is part of a longstanding effort to encourage borrowing and spending in an economy that persistently does the opposite. Japan’s corporations are chronically reluctant to spend as much as they earn. It is this propensity to hoard that allows Japan’s government to borrow so cheaply and also obliges it to borrow so much.
In a healthy economy, the corporate sector is a net borrower from the rest of the economy. It makes use of the funds households wish to save, ploughing these resources into new factories, machinery, equipment and research. That is how an economy makes progress. But corporate Japan is a peculiar exception. Each year since 1998, it has run a financial surplus rather than a deficit: it has consistently spent less than it earned, using the remainder to repay past debts and accumulate financial assets.
By mid-2014, private non-financial corporations were sitting on ¥229 trillion in cash alone, according to the official flow-of-funds statistics. For any individual company, building up cash buffers and accumulating financial assets might make perfect sense. But such financial retentiveness makes no sense for the corporate sector as a whole. Companies are supposed to create the real, physical assets on which financial claims can be issued. If companies are all buying bonds, who is left to issue them? If companies are all hoarding deposits in the banks, whom are the banks supposed to lend to?
These persistent financial surpluses represent a drain on demand, reinforcing Japan’s deflationary tendencies and deflation in turn encourages firms to hoard nominal assets, rather than building real ones. Since the corporate sector refuses to borrow and spend, the government has been forced to do so instead. Its deficits mirror and offset corporate surpluses. From the 1998 fiscal year to the 2013 fiscal year, these corporate surpluses added up to a cumulative ¥311 trillion, or over 60% of Japan’s 2014 GDP, according to the official flow-of-funds statistics. Without them, Japan’s net public debt might now be about 80% of GDP not over 140%. Corporate thrift makes government deficits sustainable, it also makes them necessary.
But throughout 2015 that may begin to change. Now prices have started rising again, albeit weakly, financial assets make less attractive stores of value. The reflation of the economy and the revival of demand will encourage firms to increase their capital outlays and they will face other pressures on their cash-flow also. Workers are demanding higher wages and big institutional investors, such as the Government Pension Investment Fund, are paying closer attention to dividends, buybacks and returns on equity. Both trends will eat into the financial surpluses that firms are accustomed to hoarding.
It is already possible to spot some statistical straws in the wind. According to the latest official flow-of-funds figures published in September, the financial surplus of Japan’s non-financial corporations turned into a ¥6.3 trillion deficit in the second quarter of 2014. Private non-financial corporations reduced their holdings of currency and deposits by ¥3.47 trillion and their holdings of central-government bonds by ¥1.66 trillion.
This second-quarter deficit is suggestive, but not conclusive. These numbers can be volatile. In the past, Japan’s firms have run the occasional quarterly deficit, only to return to surplus for the rest of the year. It must also be remembered that the second quarter of 2014 was a peculiar one, disrupted by the April hike in Japan’s consumption tax. Nonetheless, the pronounced deficit in April-June, the biggest since 2008, might be a harbinger of things to come. Firms may begin losing their appetite for cash and government bonds in favor of higher wage payments, bigger dividend payouts and bolder capital outlays. If so, their altered appetite will increase demand in Japan’s struggling economy, reviving growth and tax revenues. For the government, it will become harder to sell its bonds, but also less necessary to issue them.
The result may be a long-awaited increase in Japan’s government bond yields. If so, the increase will not reflect a heightened risk of default. It will instead reflect heightened demands on corporate revenues. An increase in Japan’s bond yields, I believe, will be a sign of success not a signal for alarm.