Don't Shoot the Messenger

Japan’s Looming Singularity

by Claus Vistesen and Edward Hugh

According to Wikipedia, in complex analysis an essential singularity of a function is a “severe” singularity near which the function exhibits extreme behavior. The category essential singularity is a “left-over” or default group of singularities that are especially unmanageable: by definition they fit into neither of the other two categories of singularity that may be dealt with in some manner – removable singularities and poles.


No need to panic, a lot of analysts tell us, since far from being on the verge of some earth shattering event Japan  has invented the economic equivalent of a mechanical perpetual motion machine. Or as Nobel economist Paul Krugman put it recently, “while there is much shaking of heads about Japanese debt, the ill-effects if any of that debt are by no means obvious”. Maybe there is just one word missing here – yet.

This, however, will not be the viewpoint taken here. The rise and rise of Japanese debt is far from benign, and the dynamic, we are convinced, will at some point become unsustainable. Unfortunately by the time we reach that point it will be too late. Indeed, given that we agree with Krugman that the underlying cause of Japan’s malaise is demographic, after several decades of ultra-low fertility in all probability it already is too late. The root of the problem is, as he says – wait for it – that there is “a shortage of Japanese”.

Far from being like that woeful economist so tellingly characterised by Keynes, the one who through many travails and pages and pages of equations is only able to tell us that when the storm is long past the ocean is flat again, we feel we have more in common with the character so ably played by Mike Shannon in the Jeff Nichols’ film “Take Shelter” – “there’s a storm comin, one like none of you have ever seen before….”

If You Print Your Own Money, And You Run An External Surplus, How Can There Be a Problem?

Japan’s problem is benign, so the argument goes, since the country has an external surplus, and can print its own money. As a result there is a savings surplus, and no problem selling government debt, even at ridiculously low interest rates. And since the interest paid remains ridiculously low, then there is no problem servicing the debt, and if there ever was, why then the Bank of Japan could just buy even more of its own government bonds, effectively driving the interest rate even lower. In theory there is no good reason why it couldn’t even follow the lead being currently set in Germany, and push the rate into negative territory. Heck, the government would then be even earning income on its debt. It would be a good investment.

But somehow or other this view fails to convince. In particular it fails to get to grips with why Japan has gotten into this situation. It also doesn’t offer any kind of road-map for how the country could ever get back to the sort of monetary regime that was once widely considered to be “normal”. Or perhaps, in the world we now live in, as the US novelist Thomas Wolf once put it “you can look homeward angel” but in fact “you can never go home again”. Which is just a very poetic way of saying that time has an arrow, and that some processes are irrevocable and irreversible.

So, if this is what you were hoping for, then bad luck, since there is simply going to be no such thing as a return to normality for Japan. That being said, what we have to avoid at all costs is Japan becoming the “new normal”, the text book case of a society where the fundamental mismatch between declining demography and appeasing an ever older electorate with populist politics leads to complete dysfuncionality, a dysfunctionality which is then reiterated in one country after another. From this point of view it is fascinating to note just how fast Japan is getting towards “the end of the road”. Some investors have even been getting ahead of themselves and frantically shorting Japanese debt in the anticipation of future and continuing credit downgrades, without asking themselves the really awkward question – what happens to the country if it is eventually forced to default on its debt.

If on the other hand we are able to see that something is going on in Japan which is neither normal, nor desirable, nor sustainable, then we just might like to ask ourselves what then gets to happen next? Certainly there is nothing in conventional economic theory which can help us anticipate the answer, since this kind of end of the road point has not been foreseen, anywhere.

It’s equally fascinating that so few people are really talking about this development at the moment. The assumption that things can more or less go on and on is widespread both in and outside Japan. Despite the frequent references to “Japan’s lost decade”, the country has now lost not one, but two – what was it Oscar Wilde said, losing one child could be an accident, but losing two surely has to constitute negligence – and as things are shaping up we seem to be all set to have a third one in front of us, markets and weather permitting, always assuming the Japanese government remains able to finance its debt.

Yet at the moment there seems to be no danger of that. Japan has become flavour of the month among investors, following the continuing verbal interventions from prime minister Shinzo Abe. Against all odds, people are buying the story that an inflation target of 2% is attainable, and that the country can permanently devalue its currency by a sufficient amount to produce an ever larger trade surplus, despite the war of words that has already broken out about “currency wars”. Or perhaps it has become convenient to believe the impossible will be possible, simply to make money on short term trading positions. Given the quantity of long run uncertainty, this seems to be the main obsession of markets right now,  following the dictum of the 1960s philosophy made famous by Jack Trevor in the film “Live Now, Pay Later.”

A Country Growing Short Of People?

But let’s keep the debt issue for later and start with the demography – here Japan is certainly a real global leader, in this case for its advanced population ageing. Japan is not only an ageing society: It’s THE ageing society. Following decades of an ultra low birth rate and negligible immigration, it faces a steady decline in its working-age population and a rising dependency ratio for decades to come. There is no changing this now. Even some “miracle” reversal of the fertility problem would take decades to work through, so whatever happens next, things will get worse before they get better.

Japan’s population – in median age terms – is the oldest on the planet. Median age is around 45, and it will continue to rise. There is no real prospect of it coming back down again, since the process it is experiencing appears to be totally irreversible. Forecasts see the median age in Japan rising to more than 50 within the next two decades, and really here we are breaking totally unknown territory – no society in the whole of human history has ever been this old.

Given this prospect, it is natural to expect that the country should save heavily to make provision for the future–and it does. But a country with an ageing and declining workforce gets an additional problem, one of structural demand deficiency due to the changing balance between saving and borrowing. Investment opportunities in Japan are limited, so that businesses will not invest all those savings inside the country itself. The only surprising thing is that people are still surprised by this.

This demand deficiency results in a process we have come to call export dependency (leveraging the global rather than the local economy in the search for customers). Japan has now well passed the threshold at which the economy, as a modern market economy, can rely on domestic demand and domestically oriented investment to grow. The trouble is, that given its export sector cannot grow fast enough to keep pace with the contraction in private internal demand, the country has become increasingly dependent on large fiscal deficits to keep the ship right side up.

However contrary to the expectations of the classic life cycle model, the conclusion we have come to is that rapidly ageing societies will not, in the main, be characterised by aggregate dissaving but rather by the fight against it. In the context of international capital flows this means that rapidly ageing economies will be characterized by an external surplus and not, as theory would predict an external deficit. According to the said life cycle theory, savings by consumers should not affect total aggregate savings in the long run because savings today, by definition and through the idea of consumption smoothing, turns into consumption tomorrow. Yet this might be the wrong way to read the life cycle hypothesis: ageing may be associated with the propensity to run an external surplus and this may lead a country to a state of export dependency.

The conclusion we draw from the above is a simple one – if Japan is going to see a decline in working population over the next several decades (and possibly much longer, since so long as fertility remains below replacement rate each generation will be smaller than the previous one) and if this lies at the heart of the deficient domestic demand deflation problem, then it means the issue is a deep structural one which won’t be resolved by any kind of “kick start”, however large. The only consequence of having permanent fiscal injections will be not to give stimulus, but rather an accumulation of debt that will be increasingly harder for those smaller and poorer workforces to pay down in the future – especially if the process is associated with ongoing deflation.

To use an analogy – it isn’t simply a question of a planet which has slipped off or strayed from its orbit (or “good equilibrium”), and just needs a nudge to get it back on, what we have is a planet which has veered off onto a whole new trajectory, one which leads to who knows where. This situation was never contemplated by the founders of neoclassical theory, and yet, having started in Japan, the phenomenon is now extending itself steadily across all developed economies in one measure or another.

As long as Japan is the only guy in town facing this kind of problem, there is a simple solution – invest national savings abroad, in countries where populations are younger and still growing, and returns on capital are surely higher. These other nations should be able to pay back loans when they are richer and older, supplying some of the funds needed to meet Japan’s pension promises and other obligations.

Up to the arrival of the global financial crisis Japan played this game well because it was the only one playing it. The problem is that now every single OECD economy, one after another, will steadily be looking to do the same. So in similar fashion, those who urge a solution to Europe’s imbalances via an increase in German fiscal deficits to stimulate consumption miss the point: arguably what people in these societies need to do is save more, not less, and certainly when it comes to the public sector.

External demand and foreign asset income become crucial elements of growth for ageing societies, and if we end up with every developed country trying to export its way out of the mess it is surely not going to work! The first signs of this can already be seen in the Euro Area, where the sterling attempts of the countries on the periphery to escape from their trap through the ramping up of exports is simply leading to economic stagnation, since the core countries (largely net savers) are unable to take up the demand slack.

What makes the country different is that in Japan the cracks are starting to become visible. The positive external balance which is essentially the only source of growth for the economy is quickly evaporating. The trade balance is now well negative in large part because of the continuing need for energy imports (mainly LNG and oil) and this has started to drag the current account down. Even worse the income balance is also now falling lead the country to recently post its lowest current account surplus since 1985.

Seen in the light of the above, these recent trends in Japan’s external balance are deeply worrying.

To become even more worried, let’s get back to the debt.

A Balloon Which Just Grows And Grows

Amazingly, Japan is the only developed economy still expanding its annual budget deficit even though the economy is saddled with, by far, the biggest debt burden – gross government debt is now around 235% of GDP. Now many make light of Japan’s economic growth problem since with the 15 to 65 population falling, output per worker is not performing badly. As Paul Krugman so cogently puts it, “you can argue that demographically adjusted, the whole tale of Japanese stagnation is a myth.” You could, that is, if it weren’t for the growing debt. Simply thinking about GDP per member of the active population is very misleading, since what you need to thing about is the elderly dependency ratio, how many people, that is, each member of that steadily shrinking workforce has to support. This is where the real action is.

Evidently a large chunk of this growing debt problem is demographically related. In fact, since the early 2000s, Japan’s non-social security spending has been reasonably well contained and, at about 16% of GDP in 2010, it was the lowest among G-20 advanced economies. Meanwhile, social security costs have risen steadily due to the steady attrition from population aging. Social security spending rose by 60% between 1990 and 2010, accounting for about half of consolidated government expenditures in 2010. Moreover, a sustained increase in the old-age dependency ratio has implied larger social security payments supported by a shrinking pool of workers, and again this has rapidly deteriorated the social security balance.

As long as the interest rate is close to zero, even sky-high debt seems to be fine. But, as the IMF puts it: “Should JGB yields rise from current levels, Japanese debt could quickly become unsustainable. Recent events in other advanced economies have underscored how quickly market sentiment toward sovereigns with unsustainable fiscal imbalances can shift.”

And the IMF draws a scenario, in which a wrong combination of circumstances at an inopportune moment in time could easily send Japan spiralling to where Italy and Portugal are now: “Market concerns about fiscal sustainability could result in a sudden spike in the risk premium on JGBs, without a contemporaneous increase in private demand. Once confidence in sustainability erodes, authorities could face an adverse feedback loop between rising yields, falling market confidence, a more vulnerable financial system, diminishing fiscal policy space and a contracting real economy”.

We’re just now seeing the beginning of this scenario. The average rate of maturity on JGBs is being pushed down due to investors buying the short end in combination with the purchasing program from the BOJ. Where have we seen this before … oh yes, the eurozone periphery. You try to see what yield Japan would need to pay for for a MARKET based 10y or 30y issuance of a decent size. Our best guess is way, way above its nominal growth and herein of course lies the problem. Japan ran a 10% deficit last year and there are no signs of consolidation in 2013. Meanwhile the current account surplus is starting to play the vanishing man act.

Japan will run out of sufficient savings to buy the whole issue of JGBs by 2016, but the possibilities are the market will respond sooner. If the Japanese government continues to issue debt, the Japanese economy is going to run out of savings to buy the new debt. The share of government debt to total currency and deposits will soon reach close to 100%. At this point of the endgame, there is no way out for Japan: either the central bank or foreigners must take up the bid, or Japan must begin to sell off foreign assets. Markets will price in the endgame before it happens…. then it will be game over!

What does game over mean?

How does a country accept its fate of having no other chance of growing other than simply growing old?

How does a country accept its fate of seeing its private savings evaporate? How can a country get along with the discovery that what was seen as a secure source of private wealth and old-age provision, national government bonds, just dematerializes?

Of course, each country is different, especially if it goes through a heavy crisis. And, at least, over the years the Japanese built up a strong net external investment position which leaves the current account strongly positive despite the negative goods trade balance due to the high income flow from investments abroad. This is very different from Italy and Portugal, countries which have long run both trade and current account deficits and have very poor net external investment positions. But these external assets and the internal savings are distributed differently, and in case of heavy losses on the domestic side – will the Japanese Gerard Depardieus and those leading global companies with large foreign assets still be happy to pay the surcharge needed for elderly care of all those elderly people that lost their savings because they trusted the government?

Or Japanese young people, will they still be prepared to stay and work in a country which may well have some of the highest income tax rates on the planet?

No matter how Japan will act in its battle to survive the endgame, it is going to provide us with a fascinating experiment to follow because whether it succeeds or not will tell us a lot about our own future, and of how the rest of the OECD will cope with the rapidly ageing societies they have in their own back yards.

19 Responses to “Japan’s Looming Singularity”

Ed Dolan EdDolanFebruary 12th, 2013 at 5:56 pm

While reading this, I was just wondering, why couldn't Japan solve its sectoral imbalance problem by taxing saving of the young to support the old? When I got to the end, I guess I see that the answer is this:

"Will the Japanese Gerard Depardieus and those leading global companies with large foreign assets still be happy to pay the surcharge needed for elderly care of all those elderly people that lost their savings because they trusted the government? Or Japanese young people, will they still be prepared to stay and work in a country which may well have some of the highest income tax rates on the planet?"

DiranMFebruary 13th, 2013 at 7:58 am

Boy that thought would sent Obama spinning with his panaceas about taxes solving spending problems!!! Most politicos cannot conceive of people protecting their assets and labor by leaving with their feet. Was not this a central point by Ayn Rand that politicos just do not want to hear….. What happens if productive people just go on strike? Even worse is Japan where they go to the grave and there is no replacement….

SYLFebruary 19th, 2013 at 9:44 am

Is that selective reading of an amazingly detailed and wonderful – though worrisome – analysis? The problem is "Will the Japanese Gerard Depardieus and those leading global companies with large foreign assets still be happy to pay the surcharge needed for elderly care of all those elderly people that lost their savings because they trusted the government? Or Japanese young people, will they still be prepared to stay and work in a country which may well have some of the highest income tax rates on the planet?" The "Gerard Depardieus" of the world somehow think that they "deserve" to pay lower taxes on the money they earned through their trickeries on the backs of innocence of masses under the disguise of "fair trade " and other such phrases. The government "made by the people" (not manipulated by by the "Girard Depardieus" of the world through lobbyist and other strong arming means) has absolute right to extract the revenue and recover the taxes from such people – case in point – Mitt Romneys of the world. The far right in the US has blamed the liberal wing for too long of income redistribution- while creating its own income redistribution by trying to concentrate the wealth in the hands of the few. Somehow, using pervert isolationist and egoistic logic of Ayn Rand's poetic language doesn't negate the fact that we all are part of the "whole" and everyone for is his or her own can only go so far before the interest of the "whole" will subdue the greed. The question is if Romneys and Depardieus are willing to join in gladly or kicking and screaming.

DiranMFebruary 19th, 2013 at 10:42 am

As the Texan said, assumptions can make an ass out of you and me. Romney and Depardieu really have nothing in common. Romney is not looking to change his tax venue. Of course, any normal human being would react sharply if a politico – like an Obama or Hollande, who never held a normal productive job in their lives or produced anything of value in goods and services – suddenly decided to walk away with a large part of their money that they actually earned by real work. Ayn Rand makes the cogent point that Obamas or Hollandes are using other peoples money for their own political purposes. This is always couched in terms of the common good to avoid backlash but in the end, certain people benefit and others suffer by their political power. More likely than not such Politicos are more likely to benefit themselves and their donors with rent seeking government schemes than the common guy on the street, who is just a pawn in the game. If the Producers, however, revolt and disappear, then the Obamas and Hollandes are dead because there is no more money for their political ambitions and schemes.

SYLFebruary 19th, 2013 at 1:46 pm

Let us look at your underlying assumption that comes across from the comment: Somehow, a politician or social servent such as Obama, does not produce anything of value since he has never held a real job. The fallacy of "Texan cowboy capitalism" is that somehow, the entrepreneur creates more value in goods and services than a social servent would in serving the society. Not everything (health, education, art to name a few) purely by transactional value. By that measure, Gandhi, Mother Theresa were just the "takers" as esteemed Romeny would have us believe. I would like yo to consider a simple possibility that an entrepreneur is externalizing the cost to the society and internalizing the profits – the probability that such an entrepreneur will pay in for externalizing the costs is almost negligible (e.g. Romney, BP, and many others). I hope the producers (that includes me – an entrepreneur with two small businesses – one the US and one Europe) must realize that when we create the presumptive value, we re-deposit something to compensate for the externalized costs (e.g. CO2 emissions, hoarding of resources) – unfortunately the greed gets in the way.

There has to be a balance between "Creation (maker) – Consumption (taker) – Conservation (the tree hugger)". This constant war between business, politics, societal strata (not to mention religion) is driven by greed, hunger for power and domination and fear.

We as humans are condemned to evolve or so it seems (may be I should take some classes in creationism – I guess – 😉 ) If we together do not realize this, the great debate will degenerate into a strife which takes its own course over which we have very little control besides being just an observer. It is not too late to see the other side of the coin of capitalism and make a course correction. It would be for "common good!"

DiranMFebruary 19th, 2013 at 5:51 pm

Let's face it that the Obamas and Hollandes can only fulful their promises with other people's money and generally speaking, they have no track record in creating wealth, but a pretty good record in destroying wealth over time like the majority of politicos as opposed to those who actually work for a living. In bankrupt, scorched earth countries like Greece after years of socialism. Its political class has become a virtual aristocracy, but left millions in marginal economic circumstances despite all their empty rhetoric of social justice to keep themselves in power. Young Greeks are now voting with their feet to leave for a better future where they can get a decent job and keep a fair share of what they earn. Such has been the result of many socialist gulags in the past. Debt ridden Greece has no future: tremendous loss of human resources, ageing shrinking population and huge taxes on anything that moves…. As George Soros said, the Euro utopia is now becoming a nightmare for millions. The EU (and Greek) elite, however, still wine and dine, whilst the EU share of world trade is declining and is rapidly becoming poorer with their policies.

DiranMFebruary 19th, 2013 at 10:43 am

When you get to bankrupt, burned out cases like Greece after 38 years of socialist rhetoric and a poltical class now resemble an aristocracy, yes – young people will vote by their feet and chose to emigrate for a better future, So did some many others, fleeing from various socialist gulags for a chance to get back control of their lives from ideologue politicos living lavishly off the fat of the land.

jamesFebruary 20th, 2013 at 2:03 pm

You are just using this demographic crisis as a justification of your anti-right diatribe. It is morally wrong to force one generation to pay for everyone else and then claim its 'fair'. This is classic scialism disguised as a bogus concern for the general welfare. What you want to do is create a nanny state with no incentive so try to learn not to blame those who have been successful. Many (not all) successful people are that way due to hard work, not exploiting the masses like your Marxist / Alinsky masters taught you.

David WishartFebruary 12th, 2013 at 6:54 pm

What if Japan monetized its debt as it comes due, and stopped the process of compounding interest payments? This would flood the banks with even more reserves, driving interest rates to zero. Given rates are already low and nobody in Japan is interested in borrowing from private banks, it wouldn't lead to an inflationary private sector borrowing binge. If inflation started to become a problem because people tried to continue saving in a foreign currency, start selling bonds again. My favored approach would be to expand investment in mechanizing the economy further so that less labor (since the labor pool is shrinking) is needed to provide the goods and services the elderly will demand with their social security checks.

DiranMFebruary 13th, 2013 at 8:01 am

Brilliant article, Ed! Euroweenie policie makers will surely close their ears. They got everything solved with a big economic turnaround by the end of the year for their beloved Eurozone. No worries about double digit unemployment or massive youth emigration from the deflationary gulags that they have created in the EZ periphery. Then their backstop is Germany, but is Germany really that strong financially to carry the system? I do not think so…. The Swabian housewife is a strange place for hope.

cantuesoFebruary 13th, 2013 at 9:33 am

(I have not yet read all)
Quote: "….. a steady decline in its working-age population and a rising dependency ratio for decades to come. There is no changing this now."

What if they sponsored immigration for young foreigners, people between 25 and 30 or younger (I'd let you do the maths)?

Anyway, this has ben great reading. I never read longish texts all in one sitting. Or, as Machado said:

Despacito y buena letra:
el hacer las cosas bien
importa más que el hacerlas.

Joaquin MontesFebruary 19th, 2013 at 9:39 am

Excelent post. In few years we all be asking ourselves why we didn't see this coming before, as with the Great Recession. So many obvious points, so many points easy to forecast well in advance: demographics, debt trends, external balances, declining interest rates. And still, this is the first time I see this issue treated as a very big problem. As it is.

ErikwimFebruary 19th, 2013 at 11:12 am

This passage "Yet this might be the wrong way to read the life cycle hypothesis: ageing may be associated with the propensity to run an external surplus and this may lead a country to a state of export dependency." and a little further "These other nations should be able to pay back loans when they are richer and older, supplying some of the funds needed to meet Japan’s pension promises and other obligations." seem to contradict each other. If the first statement is true, there will only be a need for Japan to need those foreign funds when it's population starts growing again. While ageing it will keep accumulating foreign assets.

SpikeFebruary 19th, 2013 at 4:08 pm

Fascinating article, which strikes close to home as my brother is a 'gaijin' professor with a family in Japan. But it feels somehow sort of ad-hoc. I have trouble believing forecasts by humans using intuition – even educated intuition – to predict the behavior of a complex system operating in an unfamiliar regime. I'd find this a lot more convincing with some graphs generated by a simulation.

SichFebruary 19th, 2013 at 7:32 pm

Will the trade balance swing back to positive when the nuclear reactors are turned back on? If so, then how much further would the JCB be able to expand their balance sheet without causing a crises of confidence?

Digmen1February 19th, 2013 at 11:17 pm

May the Japanese have it right ?
With automation and globalization a country does not need so many people.
The rest of the world is worried about youth unemployment – so Japan should have hardly any of that.
Over time the old people will die off.
Japan still makes and exports a lot of stuff which the world wants, which countries like Greece and Spain etc do not.

The world needs less people
Go and sort out Uganda and its projected 90 million people. Who will fed them ?

I am more worried about the US economy and its huge debt. And is disappearing middle class.

BenMarch 19th, 2013 at 8:01 am

I moved to Malaysia 4 years ago to retire. I have been amazed by how many young Japanese people I have met and know in S.E.Asia. Ones who have left Japan. Many move to Malaysia,Thailand,Laos etc. where they can live very cheap, go back to work a seasonal job in Japan for 3,4 months and then get out. I asked one young woman recently, "where will you go if you move out from Malaysia.?" Her answer, anyplace is OK with me, as long as its not Japan." Everything I hear from everyone who is Japanese is always very negative. I have been very surprised at this, talk to young Japanese and almost all say this. What will happen to the country if it is getting really old but most of the young people are all leaving or want to leave? Doesn't look good!

AssetApril 6th, 2013 at 2:55 pm

The banksters did not envision a population decrease in their fractional money system, they sold to the politicians, nor did they envision globalization or tech killing jobs. The banks have made fortunes in the markets, and move on to the next population to exploit. The populations figure out its expensive to feed, house, and educate children with inflation created by the banks, and it would be good to spend less and have fewer offspring. These banks have helped create wonderful things, and the host country does well until development slows.

Japan should have told the the world they would not print and created a gov hedge fund. Then they could have watched the yen go up and up, this would allow for the purchase of real producing assets cheaply. (they could have bought Hawaii at a huge discount, or oil sands). Then trash the yen and collect the currency fall. America should have done the same in the crash of 09, buy real assets that produce, to pay expenses.