Japan is in deep serious trouble the moment it enters a sustainable period of negative or neutral current account balances. If Japan becomes dependent on foreigners to finance rollovers on its debt either the Yen sinks or interest rates rise. Interest rates at a mere 3% would currently consume all of Japan’s tax revenue.

Japan’s Fiscal Pressure Intensifies

Bloomberg reports Japan’s Fiscal Pressure Intensifies as Tax-Boost Plan Insufficient

Japan’s government said it will probably miss its goal of balancing the budget by 2020 even with its proposed doubling of the sales tax, underscoring the scale of the nation’s fiscal challenges.

The primary budget deficit, which excludes the cost of servicing debt, will be the equivalent of 3.1 percent of gross domestic product for the year through March 2021, the Cabinet Office said in Tokyo today. Hours after the release, Prime Minister Yoshihiko Noda reiterated his call for opposition lawmakers to engage in talks on boosting the sales levy.

“To balance the budget, the rate needs to rise further,” said Takuji Okubo, chief Japan economist at Societe Generale SA in Tokyo, referring to the sales-tax level. “We’ve passed the point where we can soft-land the fiscal situation. The question is how hard the landing is going to be.”

Japanese PM Reshuffles Cabinet to Push Tax Hike

Please consider Japanese PM reshuffles cabinet to push tax hike

Japanese Prime Minister Yoshihiko Noda carried out an anticipated cabinet reshuffle last Friday in a bid to consolidate his grip on power amid continued infighting within the ruling Democratic Party of Japan (DPJ).

Noda dumped Defence Minister Yasuo Ichikawa and Consumer Affairs Minister Kenji Yamaoka, both of whom are prominent supporters of the powerful DPJ faction headed by Ichiro Ozawa. At the same time, he promoted former DPJ president and foreign minister Katsuya Okada to deputy prime minister.

Okada has been given the task of implementing Noda’s highly unpopular plan to double Japan’s sales tax. Noda described the new lineup as “the best and strongest to push ahead with the inevitable topic of administrative, political and tax reforms,” adding, “Mr Okada will not waver or run away from a major task. He is a politician who will produce results.”

The government only announced its draft proposals for tax and social security reform on January 6. The plan involves a hike in the consumption tax rate from the present 5 percent to 8 percent in 2014 and to 10 percent in 2015. The government’s ambiguous language implies further increases in the future, with some in business circles pressing for a rate as high as 25 percent, according to the Yomiuri Shimbun.

Quite the Hike

To go from 5% sales tax to 25% would be quite the hike.

How long will this Prime Minister last? What happens if tax hikes do not go through or they raise  insufficient revenue?

First Trade Deficit Since 1980

While pondering the above questions, please consider Japan logs first trade deficit since 1980

Japan logged its first annual trade deficit in 2011 for over 30 years as the aftermath of the March earthquake raised fuel import costs even as slowing global growth and the yen’s strength hit exports, threatening to erode the country’s ability to fund its huge public debt with domestic savings.

Few market players expect Japan to immediately run a deficit in the current account, which includes trade and returns on the country’s huge past investments abroad, as a steady inflow of profits and capital gains from overseas outweigh the trade deficit.

But the trade data underscores a broader trend in which Japan’s competitive edge in the global market is eroding and it is increasingly reliant on fuel imports due to the loss of nuclear power, with reactors staying closed after routine checks due to public safety fears following the March disaster.

“What it means is that the time when Japan runs out of savings — ‘Sayonara net creditor country’ — that point is coming closer,” said Jesper Koll, head of equities research at JPMorgan in Japan.

“It means Japan becomes dependent on global savings to fund its deficit and either the currency weakens or interest rates rise.”

Japan logged a trade deficit of 2.49 trillion yen ($32 billion) for 2011, Ministry of Finance data showed on Wednesday, the first annual deficit since 1980.

Total exports shrank 2.7 percent last year while imports surged 12.0 percent, reflecting reduced earnings from goods and services and higher spending on crude and fuel oil.

In a sign of the continuing pain from slowing global growth, exports fell 8.0 percent in December from a year earlier, roughly matching a median market forecast for a 7.9 percent drop, due partly to weak shipments of electronics parts.

Imports rose 8.1 percent in December from a year earlier, in line with a 8.0 percent annual gain expected, bringing the trade balance to a deficit of 205.1 billion yen, against 139.7 billion yen expected. It marked the third straight month of deficits.

Bank of Japan Governor Masaaki Shirakawa said on Tuesday he did not expect Japan to continue logging a trade deficit as a trend and did not foresee the country’s current account balance tipping into the red in the near future.

But Japan’s days of logging huge trade surpluses may be over as it relies more on fuel imports, which may weaken the yen in the longer term.

Running a current account deficit would spell trouble for Japan as it means it cannot pay the cost of financing its huge public debt without overseas funds, although few analysts expect this to happen in the foreseeable future.

Japan Faces Moment of Truth

This is a moment of truth for Japan, perhaps the first of many. The question at hand is critical: Is the trade deficit a new trend or simply the long-lasting spillover from the tsunami?

Today’s answer may be different than tomorrow’s.

A prolonged European recession coupled with stubbornly high oil prices and a slowdown in China is the disaster scenario for Japan.

That scenario is not at all unlikely. A deep European recession is a given and I believe a serious slowdown in China is a given as well. By pressing for tax hikes, it seems Japan’s prime minister feels the same way, regardless of what the Bank of Japan says for public consumption.

Mike “Mish” Shedlock
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