One of the world's major debt monitors has turned its sights on Japan, a clear signal that the bond market's intolerance for bloated government debt is spreading beyond the weak nations of Europe to the major global economies.
Citing its failure to devise a strategy for corralling its worsening public debt, Standard and Poor's has cut its sovereign rating for Japan by a single notch, to the equivalent of double-A-minus from double-A. The move came more than a year after it put the industrial world's most heavily indebted country on notice that it faced such a downgrade if it failed to make progress on getting its fiscal house in order.
Until Thursday, the focus of mounting government debt troubles was largely confined to the peripheral countries of the euro zone, such as Greece and Portugal. But S&P's downgrade opened a new front, and came at the same time that the International Monetary Fund issued a stark warning of its own aimed at Japan and the United States.
The long-term implication is that countries that fail to rein in their debt and deficits will be punished in the markets and forced to pay considerably more to finance their budgets, which will add to their debt woes.
"In advanced economies where fiscal sustainability has not been a market concern, credible plans going well beyond 2011 need to be put in place urgently to lock in benevolent market sentiment," the IMF declared in a report.
Thursday's downgrade immediately caused the Japanese yen to weaken slightly. But it won't have any effect on the government's financing capability because Tokyo obtains 95 per cent of what it needs from its own citizens at extremely low rates.
This is not sustainable, critics argue, because of Japan's deeply unfavourable demographics, leaving too few savers to cover the government's ever-expanding financial needs.
"Japan will fail," Carl Weinberg, chief economist with High Frequency Economics, said flatly. "It's just a question of when. This Madoff scheme can't go on forever. The situation is extremely dire."
The Japanese downgrade "is not a big deal in itself," Julian Jessop, chief international economist with Capital Economics, said in a report. But the reasons "support our fears that 2011 will be the year when Japan's dire fiscal position finally impacts markets both at home and abroad."
And if Japan deserves to be taken to task by the debt monitors, then the U.S. should also be stripped of its triple-A credit score, because of its even faster-growing debt, some analysts argue. Both S&P and rival ratings agency Moody's have warned that the top-drawer U.S. rating could come under pressure.
"Even though the U.S. dollar is the [world] reserve currency, Washington faces limits on how many bonds and dollars it can print without wreaking havoc. It is now over the limit," said Peter Morici, a professor at the University of Maryland's business school and a vociferous critic of U.S. finance and trade policies.
Japan's ratio of debt to gross domestic product exceeds 200 per cent. The U.S. is forecast to reach 100 per cent in March, based on current levels of debt accumulation and economic growth. By comparison, Ireland's ratio is an estimated 94 per cent and Canada's stands at about 83 per cent.
The IMF projects that the average for advanced economies will hit 110 per cent by 2015, double the IMF's target.
Japan and China, which overtook Japan last year to become the world's second-biggest economy, now share the same rating from S&P. But the two countries have been heading in opposite directions since the financial crisis. While China's infusion of vast amounts of stimulus has sent its economy into overdrive and unleashed inflation, Japan's own stimulus efforts have failed to halt long-term deflation or do much to reanimate a weak economy.
But not all the news from Japan is grim. The trade picture is brightening and deflation's grip on the economy appears to be easing slightly, although core consumer prices fell 0.4 per cent last month from a year earlier, marking 22 consecutive months of declines. Exports shot up 13 per cent year-over-year in December and are expected to remain healthy through the early part of 2011, diminishing the likelihood of another recession.
Japan also remains a major net creditor with large surpluses, which helps shore up the value of the yen. But these reserves are not available for debt reduction. And here, the situation is going from bad to worse.
The ability of the government to meet its rising debt obligations without tapping international markets at considerably higher interest rates "only lasts as long as there are at least as many people joining the pool as there are people leaving," Mr. Weinberg said. That's simply not the case today. And fewer young people are saving the way the postwar generation did.
Japan's finance ministry projects public debt will surge again in the fiscal year beginning April 1, to a record ¥997.7-trillion ($11.98-trillion), according to Bloomberg News.
The IMF calculates that for Japan to stabilize its debt ratio at even its current high level, it would have to boost taxes or slash spending by an amount equal to 14 per cent of the economy. That would mean, as one example, hiking the consumption tax to a crippling 25 per cent from 5 per cent.
Meanwhile, debt service costs have grown so high relative to GDP, "even if they don't borrow another dime their debt ratio will rise forever," Mr. Weinberg said. "Whatever problems Portugal and Spain and Ireland and Greece may have, Japan has them twofold."