A scenario for Japan’s public finances

A few days back there were rumblings of dissatisfaction from the market about Ministry of Finance projected issuance:

Japan’s Bonds Drop a 4th Day After 20-Year Auction Demand Cools – Bloomberg.com

It’s possible that the new government will have to limit its borrowing for “stimulus” spending, as the demand for additional JGB’s is limited.

It seems to me the scenario would work like this:

Ministry of Finance has to raise rates to sell enough debt

Yen spikes short term due to the interest rate differential, crushing exports more

Increased rates mean the increased interest cost can’t be covered by new issuance

BoJ prints yen to cover debt burden; yen collapses as the market flees rapidly devaluing currency

My theory about yen movement is based on the idea that a rise in rates would attract money to Japan short term, but that over time the size of the government debt burden and the higher interest payments would require yen printing.

I could be completely off base.

This just hit Bloomberg:  Japan’s Bond Futures Fall as Fujii Signals Debt Supply to Rise – Bloomberg.com

“Japanese bonds fell after Finance Minister Hirohisa Fujii said the government will likely use debt sales to meet a tax revenue shortfall, raising concern increased supply will overwhelm demand.”

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3 Comments »

  1. ille_vir said

    interesting stuff. nice blog.

  2. Rajesh said

    The Japanese are twenty years into a deflationary depression. The idea that the Central Bank is going to wake up one morning and suddenly think “We could just monetize the debt.” seems a little far-fetched. The more likely scenario is the higher (real) interest rates will cause a higher Yen; which would lower employment in exporting industries (who were the main source of what job growth there was for the last fifteen years); this would cause a fall in tax revenues; which would cause interest rates to go higher; which would drive the Yen even higher; etc.

    A deflationary currency spiral is a real possibility in Japan. As we saw in the aftermath of Lehman Brothers, once markets move; they can move much faster than officials can react; especially if officials believe that certain things could never happen.

  3. rosethorn said

    Rajesh,
    I agree that inertia is an important element of Japan’s economic policy. The question of how far the yen will rise is key and I think that it’s possible that the BoJ might take note of the FRB’s actions and act to devalue.

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