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For several years, both Japanese government debt and bank debt have taken a beating from various credit rating agencies reporting sometimes astonishing weakness. However deservedly in some banks’ cases, it seems clear that some of this concern was overblown.
Certes we are seeing a rebound in the ratings of banks, with numerous upgrades happening in the last several weeks both for the national and regional banks. Bank lending appears to be down slightly on the number of loans year-to-year, but with the rebound in the economy, the quality of new loans should be higher. There is more money pumping into the system. The Deposit Insurance Corporation (DIC, www.dic.go.jp) is heaving a sigh of relief. Even at its worst, the DIC only went ¥4 trillion ($37 billion – for the rest of the article, we will reckon with 108 yen to the dollar) in the red, with payouts of ¥19 trillion ($175 billion), and ¥10 trillion ($92 billion) infused by the government. This was while the DIC provided unlimited deposit insurance coverage to depositors. Compare this to the mess that the United States had with its savings and loan crisis, which ended up soaking the taxpayer for $124 billion dollars according to the FDIC (www.fdic.gov) and another $29 billion from the thrift industry, with total payouts over $150 billion — but this does not take into account the far larger losses sustained by the larger depositors and other creditors who had uninsured losses. (Nor does it include the fact that Resolution Funding is still receiving money from the taxpayer &mdash the request for FY2004 is $1.7 billion.)
Despite this, the United States never lost a single notch from its credit rating, despite past and present vast budget deficits and massive trade deficits. Japan was punished with reductions in its credit rating for its own yen-denominated sovereign debt — this, to a country of which the vast majority of its debt is held in-country. Japan’s credit rating was famously lowered in 2002 by Moody’s to Aa2, less than Botswana’s credit rating. The then-head of the Ministry of Finance (MOF, www.mof.go.jp) Shiokawa roundly and rightly rejected this rating, as did the credit markets. Moody’s is currently rating Japan at A2, five levels below AAA, and has recently reiterated that it plans to keep its credit rating extraordinarily low.
What are the odds that Japan, which proudly has never defaulted on its obligations — even those denominated in other currencies (see, for instance, the June 30th speech at the Bank of England by the Bank of Japan's governor at www.boj.or.jp about Japan’s first foray into the international debt markets a century ago) — would start to do so on its yen-denominated bonds? Are the chances really greater than Botswana defaulting? If Japan, whose outstanding bonds total only ¥480 trillion ($4.4 trillion) and issued at extraordinarily favorable interest rates, with its massive savings and foreign debt holdings, deserves an A2, what does the U.S., with large foreign-held public debt, miniscule savings by the public, and vast trade and budget deficits, deserve?
This seems completely backwards; Japan had over $600 billion in U.S. bonds, and another $180 billion in cash as of March, 2004; the cash side represents a tripling of last year’s steady $60 billion, perhaps in part to let rates creep up a bit to stay on the right side of the yield curve. Assuming that the bonds average yield around 5%, Japan receives roughly $30 billion per year in interest payments from the U.S. government. (In point of fact, the budget listed ¥3.5 trillion, or $32.9 billion, in “non-tax revenues.” This non-tax revenue composes about 4.3% of all revenue.) Contrast this to the fact that Japan is only paying ¥8.7 trillion ($80 billion) in interest on its debt — the received interest on its U.S. bonds alone is around 35% of its yen interest paid out. Furthermore, Japan’s interest payments stay inside Japan, since virtually all of Japan’s debt is held by the Japanese (the Postal System alone owns a large fraction.) At the rate that Japan’s puddle of U.S. bonds is growing, it may well be the case that Japan will soon be able to pay most — perhaps all — of its internal interest payments simply from the foreign interest it receives.
Treating this as a simple spread situation, where one issues debt at a low rate and buys higher interest rate instruments, Japan is in ordinary commercial banking terms profiting on a good spread. Amazingly, it is able to do this by issuing debt rated at A2, and acquiring AAA-rated debt. While Japan is not a bank, it is already acting as one for the U.S. If Japan lets the yen go to its natural area around 90-95 yen to the dollar, it would stand to make quite a bit more on its U.S. bondholdings, though of course that would harm its exports. It is probably better trading strategy for Japan to stay the course, and continue to massively purchase relatively high interest U.S. bonds with the proceeds from selling its low interest bonds inside of Japan. If Japan went ahead and bulked out to $800 billion of U.S. bonds with its $180 billion dollar surplus, it would already be at 50% coverage &mdash and if it then let the dollar drop to 90, it would have 55% coverage.
While the credit rating agencies certainly have a point that holds in the general case that Japan’s debt to GDP ratio is a matter of some concern, the agencies seem to ignore the very special conditions that Japan operates under. Tokyo is the world’s greatest debt market. Japan owns enormous U.S. dollar bonds which it receives far higher interest than it pays on debt that it issues. It may well be able to pay all of its interest payments off of interest that it receives: the ballooning trade deficit of the U.S. with Japan augurs nothing else.
