Japan has the largest debt problem in the G20 by measure of debt-to-GDP ratio near 200%. Moreover, Japan’s aging demographics and lack of growth give Japan little ability to pay that debt back.

Citing those debt concerns, Japan’s Credit Rating Cut to AA- by S&P;

Japan’s credit rating was cut for the first time in nine years by Standard & Poor’s as persistent deflation and political gridlock undermine efforts to reduce a 943 trillion yen ($11 trillion) debt burden.

The world’s most indebted nation is now ranked at AA-, the fourth-highest level, putting the country on a par with China, which likely passed Japan last year to become the second-largest economy. The government lacks a “coherent strategy” to address the nation’s debt, the rating company said in a statement. The outlook for the rating is stable, S&P; said.

The yen and bond futures fell on concern the downgrade will push up the cost of borrowing for Japan, where public debt is about twice the size of gross domestic product. Vice Finance Minister Fumihiko Igarashi this week said the government must fix its finances to avoid a debt crisis that could trigger a “global depression.”

“I hope this serves as a warning for the government, they have absolutely no sense of crisis,” said Azusa Kato, an economist at BNP Paribas in Tokyo. “Once bond yields spike and the fire is lit, the amount needed to finance Japan’s borrowing needs is going to jump and it’s going to be too late.”

It is possible for companies to have higher ratings than the local or foreign currency ratings of their home country, S&P; said in a May 2009 report. The best candidates have a robust export base, little reliance on the public sector and sell products with “relatively inelastic” demand. The S&P; report said businesses with sales mainly in local currency, subject to regulation and heavily dependent on imports probably won’t pass stress tests without “heavy overcollateralization or reserves.”

Finance Minister Yoshihiko Noda said Jan. 24 the debt burden has risen to a point where Japan can’t rely on bond sales to cover revenue shortfalls. Economy Minister Yosano warned the same day that such a reliance on such sales could lead to a jump in borrowing costs.

“If we continue relying on bond sales to make up for spending that exceeds revenue, we could see long-term interest rates increase or a deterioration in our debt ratio, causing Japan to lose credibility globally,” Yosano told parliament.

Japan’s borrowing costs are among the lowest in the industrialized world, helping it fund its debt load. The yield on the benchmark 10-year bond slipped 1 basis point to 1.23 percent as of 10:47 p.m. in Tokyo. It touched 1.26 percent in Jan. 19, the highest since Dec. 16.

Japanese Debt Time Bomb

It’s only a matter of time before Japan’s debt problem matters in a serious way. However, it’s important to note that it’s only been a matter of time for the last decade as well.

The key to understanding the urgency now is the warning from Finance Minister Yoshihiko Noda that Japan’s debt burden has risen to a point where Japan can’t rely on bond sales to cover revenue shortfalls.

Japan has reached the point where its savers need to draw down their savings in retirement, and thus need to sell Japanese government bonds, not buy them. However, the Japanese government has squandered those savings (and 100% more of GDP as well) building bridges to nowhere fighting deflation.

Nations often default on foreign debt, but this is debt the government owes the Japanese people.

Will Japan embark on a huge austerity program in the midst of deflation? Will Japan simply print the money? If so, what happens to interest rates?

Should those interest rates rise to a mere 3% or so, interest on Japan’s national debt will consume most of its revenue.

This mess shows the foolishness of using Keynesian and Monetarist stimulus to defeat deflation. Neither worked. Now Japan is left with an enormous debt problem and no way to solve it.

The Yen is flying high right now, the crucial question is for how long?

Mike “Mish” Shedlock
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