Summit Notebook

Exclusive outtakes from industry leaders

When debt monetisation makes sense

June 20, 2011


If push comes to shove and Japan runs into difficulties finding buyers for its low-yielding government bonds, a little debt monetisation — a dirty word for central banks — would not be a bad thing.

Tomoya Masanao, managing director and head of Japan portfolio management at PIMCO, told the Reuters Rebuilding Japan Summit that if private investors are not willing to buy JGBs, then the central bank should fill the breach.

“If the Japanese private sector does not have enough ability to fund the government, it’s natural that the central bank should step in,” Masanao said.

Such a move would weaken the currency, and that would be a positive for an economy that is now grappling with a strong yen on top of the many other economic challenges it is facing.

For now, Japan faces no such threat of private investors being unable to lend the government a hand. As Masanao noted, Japanese corporations and households tend to save even more money when the fiscal deficit rises — as is almost certain as government reconstruction spending kicks in after the massive March 11 earthquake, tsnuami and nuclear scare. Indeed, a chart below shows the remarkably strong relationship between government borrowing and household savings over the years.

Benchmark Japanese government bond yields are hovering near 1 percent and have only breached the 2 percent threshold twice since falling below that level in 1997. As the population ages, household savings rates have fallen. But with household financial assets at $18.5 trillion — and a little more than half of that kept in cash and low-yielding bank deposits — the supply of funds heading into JGBs remains ample, even with debt set to surpass 200 percent of Japan’s $6 trillion GDP this year.

With the euro zone debt crisis raging more than a year later, the question of whether Japan faces its own debt crisis has been hotly debated. Still, the trigger for any Japan debt crisis remains far off and will be of a much different nature than Europe’s troubles. Beyond its savings, Japan enjoys steady trade surpluses (despite the record deficit coming out of the disaster), and for that reason does not rely on foreign investors . Of course, the Bank of Japan already buys a hefty chunk of government bonds, even while arguing this does not equate to monetisation and fighting against any pressure to monetise.

Only when Japan’s current account balance flips into deficit will warning signs start to flash. If Japan has to lean more on the kindness of foreign investors, then sustaining such a heavy debt becomes a dicier prospect.

What debt monetisation won’t do is improve Japan’s potential growth rate. And that’s why Masanao thinks public debate is urgent,  not just on how the debt will be dealt with over the longer term, but whether Japan is willing to take steps to boost growth and end the steady deflation that has gripped the economy for years. As Masanao says, the special factors that have allowed Japan to support such a mountain of debt are fading.

“The mechanism that has worked to date may be gradually crumbling.”

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