By Financial Post
Last week, Bloomberg reported in depth on Japan’s miraculous diminishing debt load. Turns out, despite a steady rise in government borrowing, the burden of repayment is diminished because the buyer of 90 per cent of that debt is the Bank of Japan.
This has serious implications for Canadian investors, yet the full significance has not yet been thoroughly unpacked by media. My bet is most analysts and economists are aghast at this admission by a G7 government that debt could just be summarily forgiven. It suggests the notion of liability in credit does not apply to government, or its associated (yet private, to varying degree) central banks.
But it’s really quite simple.
The single most important rule upon which our global debt-driven economic growth equation is dependent is that debt is repaid. If it isn’t, assets are confiscated. Just like if you don’t keep up with the mortgage payments on your house, you lose it. But what happens when the biggest creditor is also the debtor? The entire debtor/creditor relationship is rendered nonsensical.
The size of the debt any one nation can undertake is directly related to its ability to repay any proposed amount over time. Its ability to repay its debt, in turn, is derived from the consensus of markets that demand a higher rate of interest the closer a debtor gets to defaulting. The debt limit is reached when no one will lend, because even at the highest rate of interest, the chance of default is greater. Or when the debtor misses a payment.
This works well in a world ostensibly governed by free markets, and when the rules are universally applied.
The workability of the institution breaks down when a different set of rules are seen to apply to governments versus those that apply to everyone else.
The fact that Japan has essentially monetized most of its debt by taking it 90 per cent out of private hands, where it can be forgiven, as is now the expressed endgame coming from the BOJ, is exactly the scenario that any developed nation can confidently expect, thanks to this BOJ precedent.
Does this mean that we could, theoretically, default on our debts and obligations in the expectation that they could be monetized by exchanging them for zero interest perpetual bonds, and ultimately “written off” as the BOJ is proposing? Are we not — at least, aren’t the citizens of Japan — in a position to sue for constitutional harmony in the application of laws governing debt in society equally with government?
The obvious answer is “no,” but the only qualifier as to why that makes sense is that there are indeed different sets of rules for government versus private institutions. But hang on a sec… aren’t central banks private institutions? In the case of the BOJ, it is partially a public company — thus the trading symbol TYO:8301.
Imagine all central banks purchasing all the debt of the governments who have bestowed their respective monopolies on printing money? The emperor, indeed, is naked.
Might this explain how unsustainable debt loads as a portion of GDP in the developed world continue to be cast in the light of unconventional monetary policy as opposed to farce? Economists will dismiss this perspective as simplistic, but the math speaks for itself.
Japan risks, according to Bloomberg, causing borrowing costs to soar, credibility destruction for the BOJ, and currency purchasing power destruction.
But what is the significance for Canadian investors?
The Bank of Japan is the canary in the coal mine, in many respects, for the rest of the developed world’s economies. One might argue that its staggering debt-to-GDP ratio of 201+ per cent is only possible if Japan defaulted, a domino effect would likely catalyze a crisis of truly global proportions. The appearance of stability is more important than stability.
So Japan now overtly monetizing its debt through the BOJ is likely to signal that the limits of Keynesian economic stimulus have been reached, and a broad reset of the financial system globally may be nearing. That bodes well for commodity-based economies, as interest will flood into tangible assets away from sovereign debt derivatives and all the stocks that debt has subsidized for the last seven years.
On the downside, the economic turmoil that would likely accompany such a reset would also have tremendously negative connotations for Canadian manufacturers and exporters, as the Canadian dollar in this scenario would appreciate dramatically.