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Looming Japanese Debt Crisis: How will it Affect the U.S.?
Last January we highlighted that Japan was stepping up their foreign exchange borrowings through the Federal Reserve. They currently stand at $18.1 billion and have remained about that size since their initial borrowing in December. Though this amount is hardly alarming, it may possibly be an indicator of events to come.
Japan is in a precarious situation given the size of their debt, the demographics of their population, the history of their international finances, and the current trend towards current account deficits that could upset a very fine balance.
We detailed all of these elements about Japan last January in a blogpost and warned that if sustained current account deficits were to persist in Japan, the United States could find itself in a precarious situation of its own.
Sure enough, yesterday, Japan reported the largest current account deficit since comparable records began in 1985. It’s one of only five monthly current account deficits ever recorded, and by far the largest.
Below is an updated chart from our previous post:
The Financial Times wrote the following about the alarming shortfall:
“Following a full-year trade deficit in 2011, a first for Japan for more than two decades, fears are intensifying that the country is rapidly moving towards a lasting current-account deficit, which could lead to a reliance on foreigners buying government bonds. That, in turn, could drive up interest rates, threatening a fiscal crisis.”
Japan’s current account deficit is likely to reverse to a surplus next month, and many economists are not expecting full-year current account deficits for years to come. Given the size of Japan’s exports, one can hardly argue. Continued current account surpluses in the near-term are about as much of a sure thing as the Greek debt swap agreement that occurred just three hours ago.
But the writing is on the wall for it to happen sooner rather than later, and who knows, 2012 may very well see a full-year deficit. After all, no one expected Japan to turn in a trade deficit for 2011, and they did just that.
Point is, the future is unpredictable, and the US is not at all in a position to deal with the effects of Japan running deficits. Japan’s immediate solution would be to start dumping treasuries.
Politicians can banter all they want about the right time to begin reducing America’s debt and curb spending. If, however, some exogenous shock occurs like say one of our largest creditors selling a trillion dollars in treasury securities, talk is cheap. The market, that we’ve all seemed to have forgotten, will make our decisions for us.
Our previous post can be found here.