A Japanese Crisis Nears

Japan has receded from the headlines of late but that's about to change. In the next two months, it's expected the Prime Minister Shinzo Abe will make a decision on whether to increase Japan's consumption tax from 5% to 8% in April next year. If approved, consumer spending will take significant hit and given that it accounts for around 60% of GDP, hopes for an economic recovery could be dashed. If the tax hike is delayed on the other hand, rating agencies are likely to downgrade Japanese debt, resulting in increased interest costs - the last thing that the massively indebted country needs. International investors would also lose faith in Japan's turnaround strategy. Either way, it appears a lose-lose situation. Much less talked about is the impact on Japan from possible QE tapering in the U.S.. If America decides to cut back on money printing next month, and interest rates there rise as a consequence, that would put upward pressure on rates around the world. That's not what Japan needs given that only a small rise in rates would result in its government debt burden becoming overwhelming - interest rates increasing to just 2% would mean interest expense on government debt equating to 80% of government revenue. Either of these events may bring forward a Japanese sovereign debt crisis. Long-time readers will know that I view such a crisis as inevitable with the government debt load so large that there are no good choices left. Keep in mind that a Japanese debt crisis would have enormous global consequences. Unlike Greece or Cyprus, Japan matters. It's the world's third largest economy and a key trading partner to all of the large powers. How Japan plays out for the remainder of 2013 will be of critical importance to everyone. A quadrillion yen debt Over the past week, Japan celebrated an unusual feat: total government debt passed the one quadrillion yen mark. That's 1,000,000,000,000,000 yen (15 zeros if you're counting). Of course, it's not so daunting in U.S. dollar terms, at a measly US$10.5 trillion. Still, the debt versus the country's GDP is 230%, the highest in the developed world. And if you add in corporate and private debt, total Japanese debt equates to 500% of GDP.  It's a reminder of the enormous task that Japan's relatively new government faces: how does it reduce this staggering debt without impoverishing the country? We're about to get a further glimpse into whether the government is heading in the right direction when preliminary GDP figures are released on Monday. Optimists, including the vast majority of economists and stock brokers, suggest that Monday's figures will confirm that the economy is improving and the government's policies are having an impact. And on the surface, things do appear to be progressing: 1) Inflation has turned positive. The consumer price index (CPI) turned positive in June, +0.4% year-on-year (YoY). Core CPI, excluding more volatile items such as food and energy, was still negative however at -0.2%, though it was an improvement from the -0.4% of the prior month.

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