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Friday, January 17, 2014

Japan Is Running A Current Account Deficit. Where Is My JGB Collapse?

One of the reasons analysts have used to explain what they thought were "too low" JGB yields is that Japan was running persistent current account surpluses. In fact, there was a theory floating around a year or so ago (before this blog was launched) which argued: the Japanese current account was moving towards a deficit and so it would be "Game Over!" for the JGB market when that happened. (Since most foreigners have no appetite to buy JGB's.)  Japan has now been running a current account deficit, but the 10-year JGB is still stuck at a level that even I think is too low at 0.67%.....

The Japan Times discusses the recent record-wide Japanese current account deficit. (The current account is a "wider" notion of a trade balance, as it includes cross-country income flows.) It has hit an impressive-sounding  ¥592.8 billion in November 2013. When you translate that into USD, that is a less ominous sounding $6 billion. For an individual, $6 billion is a lot of money, but that is a manageable amount when scaled by the size of national economies.

By way of comparison, the U.S. Treasury just released the October TIC data (link to latest release). Holdings of U.S. Long-Term Securities by Japanese entities (government plus private sector) was $1,818 billion, of which $1,113 billion was Treasury securities. (And that does not count things like Japanese-owned factories.) This means that just their U.S. securities holdings can finance the present-sized current account deficit for 25 years. And that is just U.S. holdings; the Japanese have snapped up "high yielding" bonds all over the world (which is all of them, when compared to JGB's). Foreigners need not be a net purchaser of any Japanese assets for a very long time in order for the accounts to balance.

Developed countries typically have an equity market capitalisation sized at about 100% of GDP, and debt market instruments of over 100% of GDP. Portfolio managers move their holdings back and forth across these markets at a hyperactive rate. A trade imbalance is typically around 3%-5% of GDP, and is a tiny residual relative to these portfolio flows.This is why the best course of action for a fixed income analyst in the developed markets is to ignore trade data. 

(Developing economies have less integrated financial markets, and less wealth is held in the form of liquid securities. As a result, these economies blow up regularly due to trade and financial flow imbalances. However, opening their financial markets will probably be dangerous. The developed countries built up their financial markets and wealth behind the walls of capital controls during the Bretton Woods era. How developing countries should manage international financial flows is a topic I know little about.)

I do not have a formal stock-flow consistent model to deal with this cross-country analysis, partly because attempting to model the reaction function of investors is a hazy topic. But it is clear that the portfolio shift effects will dominate the impact of trade imbalances given the size of investor portfolios; in fact, you could probably drop trade flows from your model and it will work just as well.

Returning to a related question of the level of the yen, I do not see any particular risks of out-of-control weakness due to investor over-reaction to the trade data. Japanese corporations borrow in yen, and pay most of their salaries in yen as well. If the yen drops by 1%, Japanese multinational profits rise by more than 1% (this is "operational leverage"), not even taking into account the possibility that the Japanese firms could gain market share. This means that these stocks are more valuable to foreign value investors.  The yen can fall for any number of reasons, but it will just create an increasing constituency of buyers of Japanese assets, and so the dynamics will eventually shift the other way.

(c) Brian Romanchuk 2014


  1. You point out that Japanese entities (private and government) hold $1,113 billion in Treasury securities.

    I believe that number would be included in the Federal Reserve data series FDHBPIN which is Federal Debt Held By Private Investors.

    Now my point would be that all of this money would have been government stimulus paid through deficit spending over the last 40 years or more. In other words, government borrowing made these bonds available for purchase, with the borrowing done to finance deficit spending.

    I consider foreign workers creating goods-for-American-consumption to be American workers. Yes, they live in a foreign nation, are paid with foreign currency, and vote in foreign elections, BUT, they would not have a job except for the American customer.

    AND, the American consumer would not have money to buy the foreign good except for the American Deficit.

    Now the interesting thing is that it must be agreeable with foreign governments to pay workers in the foreign currency and then watch the products of work vanish, with only a credit in the books of a customer remaining to show long term gain.

    In some way I have not yet logically linked, the Japanese Debt must be paired with American Debt. I suspect that the Japanese car maker (for example) must borrow from a Japanese bank to produce a car. Once produced, America could be a market. America would not have enough money to buy the Japanese cars in the quantity purchased unless Japan took American loans, which are conveniently provided with American Government support.

    My missing link is "what motivation makes this all happen and is so durable that the practice has continued for over 40 years?".

    I like my Japanese products, Chinese products and many more foreign made products, especially oil. BUT, it certainly seems like the economic balance is horribly out-of-balance!

    1. Thanks for the comment.

      The data should show up in the Fed as well; I do not know whether they break the foreign official holders of Treasurys by country, but it would probably be possible to figure out the BoJ holdings by comparing other sources (IMF, Japanese).

      As you note, the advantage for the U.S. with its system of relying on imports to meet consumer demand is that the U.S. effectively has access to the productive capacity of a good portion of the globe. For the foreign countries, this export-oriented strategy is a good way to develop an industrial sector that is capable to compete on a global basis. If you have an isolated economy, it is difficult to have "world class" industries - the strongest companies control their local industries, and no longer need to innovate.

      One reason for this system is that U.S. corporations have placed plants all over the globe. This was part of the effort to rebuild after WWII. And by putting the productive capacity in the foreign countries, the U.S. corporations were on the other side of the wall of protections that countries had in place. In other words, the system was asymmetric - other countries exported to the U.S., while the U.S. produced on site and needed to export less.

      As for the debt, there is a link. Imports reduce nominal incomes, and the result in a welfare state is that the government deficit expands to fill that gap. Thus the U.S. must run persistent government deficits.

      On the exporter side, if they are growing rapidly enough, the government does not need to run much of a deficit (it will, but fast GDP growth keeps the debt-GDP ratio low). Japan had low debt levels until the slowdown hit in the 1990's (yes, Reinhart & Rogoff have the causality wrong). However, Japan had been intervening to keep down the level of the yen. They buy dollars, and thus have to create yen. These would be excess reserves, but they issue bonds to drain them ("sterilise the interventions" is how people in the Gold Standard would term the operation). This means that they have much larger "gross debt" than "net debt", as the bonds they issued to "sterilise" the currency intervention have corresponding assets - U.S. government bonds.

  2. They don't call the Japanese bonds and JPY in the forex "the widow maker" for nothing. Tons of people have gone against it going on 20+ years and lost. I can understand the short story but it hasn't happened. The vast majority of Japanese bond holders are their own citizens.
    Abe stepped in and is finally getting Japan back on track by devaluing then yen and its worked out pretty well for him.

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