“Japanese stocks are off to a nice start this year. The iShares MSCI Japan ETF (EWJ), a popular option among investors for getting access to Japan’s biggest traded companies, is up 4% for the year and 14% over the past month. Enjoy it while it lasts.
Japan’s recent surge is due to its new quantitative easing program — its largest in years — and the stated intentions of Prime Minister Shinzo Abe to weaken the value of the yen and boot Japan out of the deflationary slump it’s been in for the better part of two decades.
But Abe should be very careful what he wishes for. Deflation is what keeps Japan’s borrowing costs as low as they are. As of Feb. 12, Japan’s 10-year government bonds yield a pitiful 0.75%.
According to financial writer John Mauldin, an increase of just 100 basis points in borrowing costs would devour 10% of tax revenues.
Writing for Bloomberg, Gary Shilling notes that debt service now accounts for 43% of Japanese government revenue and quarter of all spending. Furthermore, more than half of all Japanese government spending is financed by new borrowing.
This means that half of every yen borrowed is used to service existing debts. It’s a debtor’s nightmare that gets worse every year with budget deficits that are consistently higher than 7% of GDP.
All of this has been made possible by Japan’s seemingly inexhaustible supply of domestic borrowers. But those days are now over….”
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