Friday, 13 November 2015

The Economist says Japan’s high debt might make it “insolvent”. Sigh.

The Economist trotts out the old myth that a country that issues its own currency can go insolvent because of a relatively high national debt. As they put it “As more Japanese workers retire, domestic saving is falling and spending on the old soaring. Even a modest rise in borrowing costs could bring insolvency.”

I’ve demolished this sort of nonsense several times over the years. So what do I do apart from demolish it yet again? Darned if I know. So here goes.

First, the point about “spending on the old soaring” is only of marginal relevance. If that spending increase does take place, then it helps solve the problem which the Economist article addresses, namely how to raise demand in Japan! So that’s that minor point dealt with.

As to what would happen if holders of Japanese debt demand a higher rate of interest, the first point to note is that only becomes a problem (if indeed there is a problem) as debt becomes due for rollover: at which point the Japanese government (JG) faces the prospect of paying more interest.

One option is to pay the interest and send the bill to Japanese taxpayers. No “insolvency” there.  But I don’t favour governments paying a rate of interest much above zero. So that’s not my preferred option. Thus what does the Japanese government do if it doesn’t want to pay a higher rate of interest? Well it’s easy: pay off creditors on “rollover day” and tell them to get lost. That would mean in effect that as regards relevant government bonds, interest paid by JG would drop from a miserable 0.5% (which is about what it pays at the moment) to zero percent.

The only possible and minor problem is that printing money and paying off creditors (which are nearly all Japanese nationals by the way) has a slight stimulatory and/or inflationary effect. That is, QE is stimulatory.

But seems from experience in the West that the stimulatory / inflationary effect is pretty feeble. Plus to the extent that there is a stimulatory effect, that again helps solve the very problem that the Economist article addresses, namely how to raise demand in Japan.

And the REASON why the stimulatory effect is feeble is that government debt paying around 0.5% interest and cash are much the same thing. Both are (at least in theory) government liabilities, but one pays a very slightly higher rate of interest than the other.

As Martin Wolf, chief economics commentator at the Financial Times put it, “Central-bank money can also be thought of as non-interest-bearing, irredeemable government debt. But 10-year Japanese Government Bonds yield less than 0.5 per cent. So the difference between the two forms of government “debt” is tiny, particularly since the BoJ intends to reverse its monetary expansion at some point.”

As to what to do if the stimulatory effect is too much, that’s easy: all JG has to do is to grab money off the Japanese private sector. Governments (revelation of the century this) do have the power to expropriate any amount of money they like any time from their citizens.

That expropriation should deal with any excessive and hence inflationary spending by the Japanese private sector.

Why stabilise the debt?

Later, the Economist article says “Other studies are less dire, but nonetheless suggest that far bolder measures than anything under consideration will be needed to stabilise the debt.”

Hang on: why is there any need to stabilise the debt at any particular level? If Japanese households want to hold $50,000 each of Japanese government bonds, the Japanese government should let them, and pay them virtually no interest.

In fact if JG doesn’t issue that debt, households will just cut their spending so as to acquire the stock of savings they want. As a result, unemployment will rise. In short, governments really don’t have any option but to supply the private sector with the stock of savings or paper assets that the private sector wants.

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