As the world economy groans under soaring levels of debt, the place to look is Japan, whose current government debt-to-GDP ratio is an eye watering 253 per cent. It is Japan, which led the developed world into its current mess, that is likely to lead the world out of it by cancelling debt. The consequences of such a move, if it happens, would be far reaching.
It has mostly faded from memory, but in the 1980s Japan had a debt bubble that makes what has been happening now in the West seem prudent. The Imperial Palace, which was admittedly never going to be on the market, was said to be worth close to all the real estate in California. The Ginza office district was worth about twice the real estate in California.
Japan, in other words, led the world into its current era of ridiculous debt accumulation. But almost on the tick of 1990 the Japanese asset bubbles collapsed, and for the subsequent 28 years the country has had zero, or even negative, interest rates — a desperate attempt to inject liquidity into the economy. It has failed because, with corporations and individuals in negative asset territory, no-one wanted to borrow any more. The Japanese economy ground to a halt.
During most of the 1990s and up until about 2006, the policies of western governments, particularly the United States, could be described as a failed attempt to avoid the fate of Japan. Interest rates were progressively lowered, which led to greater recklessness, and then to the ultimate recklessness, the derivatives debacle, which nearly brought down the entire financial system in 2007.
The world economy now suffers from Japan-style levels of indebtedness, and central banks have been making Japan-style efforts to keep the ball rolling. The current level of global debt is, according to the IMF, $US164 trillion, which equates with 224 per cent of global GDP. About $US21 trillion has been created by the G7 central banks since the global financial crisis, and the central banks, especially the US Federal Reserve, have been providing low interest money to the banks to keep the private banking system operating.
Instead of prosecuting the bankers whose criminal recklessness created the GFC, they were instead showered with cheap money that made it extremely easy to turn a profit because, having got it for almost nothing, they could lend it out at higher rates. This pump priming (called quantitative easing) was more successful than the Japanese efforts to stimulate the economy, but it has led to crippling indebtedness.
When debt becomes unsustainably large, typically there are only two ways out: rampant inflation, which erodes the real value of the debt, or debt forgiveness. Inflation does not seem to be likely to occur, although there has certainly been massive asset inflation, especially in property markets and stock markets (where cheap debt is being used for large scale share buybacks). But globalisation, which drives down wage rates, has translated into lower prices in many of the goods that are measured in consumer price indexes.
That means that some form of debt forgiveness is probably the only way to get out of the current holding pattern in which government interest rates around the developed world are being kept close to zero — a strategy that has meant that the finance sector has become stronger and stronger relative to the real economy. The parasite is slowly killing the host.
So here is a prediction. Japan will be the first country to undertake debt cancellation. It is well placed to do so, because most of Japan’s debt is owed to Japanese entities; financially the country is hermetically sealed off to a large extent. And it may as well, because the debt will never be paid back anyway.
Japan has two other reasons to at least consider such a move. One is that it has had close to 30 years of stagnation, so it is now obvious that using the usual levers of monetary and fiscal policy will not work.
The other is that the Japanese have a better sense than many in the West that money is a created artefact, a social fiction we invent (this even applies to gold, whose value is only stable because we decide that is the case — otherwise it is just a yellow metal).
This writer can remember a discussion in the 1980s with a Japanese financial analyst in which the interviewer expressed alarm that Japanese stock valuations were ten times higher than in the West. The analyst assured the interviewer that he just did not understand the unique, Japanese approach to finance.
At some point, that unique approach to finance could well result in the Japanese simply cancelling some of their debt. Just as Japan led the world into the era of asset bubbles and ridiculous levels of debt, it may well lead the world out of the trap it is falling into.
It would send a signal to the rest of the world that the only way to avoid a further crisis in money, of the kind we saw in the global financial crisis, is to do what societies have done for 5000 years when debt becomes unsustainable — write it off and start again.
This article first appeared in Eureka Street