The scary global implications of Japan’s slowdown

October 29, 2012

An elderly investor watches a stock board in Tokyo. (YOSHIKAZU TSUNO/AFP/Getty Images)

The Washington Post's Chico Harlan had an excellent story this weekend on the declining confidence in Japan's economy, the third-largest in the world after the United States and China. "The mass turnabout has helped launch an alternative — and increasingly accepted — school of thought about Japan: The country is not just in a prolonged slump but also in an inescapable decline," Harlan writes, marshaling lots of disturbing data and analysis on the country's shrinking population and ambitions, as well as its ballooning debt and corporate losses.

One indicator that could cause concern is public debt as a proportion of GDP -- a way of measuring how much the government owes versus how much the country's economy is worth. The higher this number, the greater the damage if the country's economy crashes and interest on that debt shoots up. The International Monetary Fund says that Japan's is the highest in the world, with public debt worth 229 percent of national GDP. For comparison, Greece is ranked second -- with 163 percent. The United States carries 103 percent.

Unlike those European economies, however, Japan has been able to manage its debt because interest rates have been below 1 percent. But the danger is that investors in and outside of Japan, who have poured money into Japanese debt, will one day look at the country's aging and shrinking tax base, and decide that debt might not actually be worth as much as they'd thought. Economists Peter Boone and Simon Johnson laid it out from there in a recent issue of The Atlantic. "As in Europe, the financial system in Japan could face a wave of insolvencies, triggering a broader loss of confidence," they write.

A crisis in Japan would most likely manifest as a collapse of confidence in the yen: At some point, Japanese citizens will decide that saving in any yen-­denominated asset is not worth the risk. Then interest rates will rise; the capital position of banks, insurance companies, and pension funds will worsen (because they all hold long-maturing bonds, which fall in value when rates rise); and fears of insolvency will surface.  

That's how a Japanese financial crisis could start, but its potential global effects are even scarier. The "shock felt around the world" would hit not just the many importers of Japanese goods but the nations that supply this super-populous but small nation with food and raw materials. The United States happens to be both a prominent exporter to and importer from Japan, which means the American economy would be particularly susceptible. But Japan's biggest trade partner -- and this is where it could get really bad -- is China. The Chinese are already facing an economic slowdown, but whether the country has a relatively low-pain "soft landing" or a potentially catastrophic "hard landing" could make an enormous difference in the world's ability to fully rebound from the 2008 financial crisis. 

As Harlan explains, Japan's problems are deeply rooted, going beyond hard numbers on the country's finance and demographics. "They have just given up trying to be number one,” Yoichi Funabashi, chairman of the Rebuild Japan Initiative, told Harlan. “There’s a sense in Japan that we are unprepared to be a tough, competitive player in this global world." Whatever the merits of that attitude, it's worth remembering that Japan nearly tripled its national GDP in just a decade, from 1980 to 1990. If that success reverses, it could have implications far beyond Japan.

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Max Fisher · October 29, 2012