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People wait in line in front of a closed petrol station to get a number to be able to get fuel later in the day in the town of Tonoi on March 17, 2011, six days after a major earthquake and tsunami hit the northeastern coast of Japan. (NICHOLAS KAMM)
People wait in line in front of a closed petrol station to get a number to be able to get fuel later in the day in the town of Tonoi on March 17, 2011, six days after a major earthquake and tsunami hit the northeastern coast of Japan. (NICHOLAS KAMM)

Why Japan will avert a fiscal crash Add to ...

"One has to assume Japanese residents are a much less footloose debt-owning class than, say, London hedge funds."

Quite apart from the fact that low-yielding JGBs have proved a good investment in recent deflationary years, Mr. Noland expects banks, insurers and pension funds will readily accede if the government asks them to buy extra quake reconstruction bonds.

In a country with a high degree of social cohesion, the loyalty of individual investors in Japan's hour of need can also be taken for granted.

"If the government says 'we're going to tighten our belts; cut expenditure in other areas and shift spending to rebuild Sendai; and we're going to issue more bonds at the margin to make that happen', I simply do not believe the Japanese public is going to dump Japanese bonds," Mr. Noland said.

Jeremy Lawson, an economist with the Institute of International Finance, a lobby group for global banks in Washington, agreed. The trajectory of Japan's debt is unsustainable, but, in the short term, "domestic residents may display even greater willingness to lend to the government as an act of national solidarity," Mr. Lawson said in a report.


That's today, though. What about the future?

If Japan's households are avid buyers of bonds, it is because they are sitting on a mountain of savings - some ¥1,400-trillion ($17,320-billion), compared with approximately ¥870-trillion in outstanding long-term government bonds.

Japanese workers built up that huge nest egg as they toiled successfully to rebuild their country from the ashes of World War Two. But the young work force that catapulted Japan ahead of West Germany in the 1960s to become the world's second-largest economy is now aging fast. Pensioners are now spending those savings.

Little noticed by the rest of the world, Japan's household savings rate has in fact already plunged to about 3 per cent of disposable income from a peak of 18 per cent in the early 1980s.

Despite the government's big budget deficit, Japan still enjoys surplus national savings, reflected in a current account surplus, thanks to high corporate savings and a large income stream from its overseas investments. Japan is the world's largest creditor nation, with net external assets of ¥225.5-trillion, according to official figures.

The question preoccupying economists is how long it will take for the savings rate to erode and drive the current account into deficit. At that point, Japan will have to import capital to balance its books. That's when unexpected shocks like the Sendai quake could trigger a financial as well as a humanitarian crisis by undermining the confidence of foreign investors.

"Without policy adjustment, the space for household assets to absorb public debt will continue to shrink over the medium term," said Kiichi Tokuoka, an economist with the International Monetary Fund.

In a January 2010 working paper, he said Japan's gross public debt could exceed households' gross financial assets by 2015 or 2020, depending on the accounting treatment.

"Although these results do not imply any specific turning point for public debt financing, they suggest that if current trends continue, domestic financing could become more difficult toward the mid-2010s, placing a premium on other sources of funding, including from overseas," he wrote.


George Magnus, senior economic adviser to UBS in London, guessed that three years was too short a time for Japan to reach the turning point. But 10 years was too long because the aging of the work force was inexorable.

"At some point in the medium term, I do think there's a sporting possibility that Japan will start to run trade deficits and have to start selling debt abroad," said Magnus, the author of a study on the economics of aging. "And that probably is when the crunch will come, because people will want to see Japan taking material measures to manage its public debt over the longer term."

Crucially, no respected economist is arguing that Japan should think twice about spending right away whatever is needed to put the economy back on its feet.

One of the lessons from the recession brought on by the collapse of investment bank Lehman Brothers in 2008 is that the increase in the public debt ratio in Japan and other countries was not due to fiscal spending to stimulate the economy. Rather, it was more due to the abrupt slowdown in economic growth.

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