Japan Doesn’t Need to Default

Noah Smith asks if Japan should default and then runs through a few pros and cons.  To me, this is a silly question.  First of all, Japan’s debt is denominated in a currency it can always create.  They have no external debt and they don’t peg their currency to a foreign currency thereby relinquishing their monetary sovereignty.  So Japan can’t really be forced to default except through inflation (they could CHOOSE to default, but that would be catastrophic and unnecessary).  That is, they can’t “run out of Yen” to meet their Yen denominated obligations.  They could, however, print so much Yen that it causes inflation to run wildly out of control which could cause numerous problems in FX markets, bond markets, etc.  Obviously, Japan isn’t suffering from an inflation problem and they’d probably welcome a bit of inflation.

But the question on so many people’s minds is – what about Japanese interest rates?  If inflation rises then interest rates will rise, right?  And then Japan will be spending an unaffordable amount on their debt servicing, right?  True, but let’s keep things in perspective.

First of all, government interest expense is fiscal policy.  Second, Japan can control the duration and interest rate they pay on their debt.  After all, they can issue Yen and they’re the monopolist of risk-free Japanese Government Bonds.  So, if you don’t want to hold Yen denominated “money” then you can opt for an interest bearing JGB which can only be issued by the Japanese government.  So let’s say the Japanese government gives you the option between risk-free 5 year JGB’s at 0.5% or risk-free deposits at 0%.  Which one will you choose?   You’ll choose the bonds until inflation rages to the point where hyperinflation destroys the Yen, right?  Until then, the Japanese Government will always find holders of their bonds because it’s a no-brainer to buy risk-free JGB’s at 0.5% when the alternative is risk-free deposits at 0%.  If you hold to maturity rather than flipping them like you’re the ETrade baby then you’ll generate a positive nominal return (though not necessarily a real return).

And that’s the kicker here.  The Japanese government is not at the mercy of bond vigilantes.  It can determine the duration of the JGBs outstanding as well as the interest rate it is willing to offer those bonds at.  So if the Japanese government is worried about interest rates then they should just shorten the duration of outstanding bonds and set a cap on the interest rate they offer those bonds at.  They’ll still find plenty of willing buyers even if the bonds generate a real negative return.  After all, the cash alternative is GUARANTEED to lose 0.5% MORE than the JGB offered.

So there, we just solved Japan’s “fiscal crisis”.  All they need to do is shorten the duration of their outstanding bond issues and understand that they can set the rate of those bonds at whatever price they want.


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Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  1. Why would people not go abroad to invest their money in stead of buying JGB at negative real return?

  2. Men like Noah Smith can be dangerous. Just what is he suggesting – advocating suicides for supposedly less suicide in the future. Hilarious post. Proves he doesn’t know anything.

    Gem of the year.

    At least rating agencies mention Japan is a net creditor of the rest of the world. Somehow Smith ignores it.

  3. One thing puzzles me. MMT/MMR always points out that a currency-issuing government can always spend up to the limit of economic capacity and resources — up to gull employment. Over that limit could cause inflation. Japan spends a lot yet they have been a essentially full employment for many years. Unemployment is 4.1%. Japan’s capacity utilization is about 86%, perhaps a shade below full capacity of 90%. But they were over 90% in 2012. So my question is why hasn’t inflation picked up, even a little?

  4. Cullen’s not going to like this much. First of all, it’s “MR” not “MMR.” Secondly, MR makes no special case for gull employment… MR doesn’t favor gulls over herons or storks for that matter! :D

  5. Noah proves that you can be an economics PhD and not know a thing about the modern economy.

  6. “All they need to do is shorten the duration of their outstanding bond issues and understand that they can set the rate of those bonds at whatever price they want”

    -This would assume the full faith of the population (marginal buyers of JGBs), I don’t believe they can set the rates at what they want. The market will tell them the rates. Shortening duration will only push rates higher and higher for them (so regardless its a lose-lose and inflation would be imminent). Your post sounds good in “theory” but in reality it won’t work like that.

  7. Yes SS! Exactly! JHS, your question is often asked, but it has to be remembered that in the end, someone is left with ¥ and that someone is faced with earning 0% on cash versus something better than that in Japanese government securities. The “pressure values” that sort out any imbalances are inflation (or at least the prospect of it) and the ¥ exchange rate (the price of the currency) – NOT the interest rates on government debt (sorry bond vigilantes)

  8. JGB yelds are not negative because inflation is < 0. Bunds are negative, treasuries up to 7 years are negative etc…

  9. If their central bank enters the market and says we stand by to buy those bonds at x%, rates will go to x%. The U.S. did exactly that during WWII. Not theory – proven reality.

  10. In other words, you’re wrong that the population is the marginal buyer of JGB. Ultimately the central bank is.

  11. “it’s a no-brainer to buy risk-free JGB’s at 0.5% when the alternative is risk-free deposits at 0%.”

    The choice could be much worse than this: it’s 0.5% JGBs or high-risk uninsured deposits with *fees* upto 2% just to generate bank NIM of 2.5%.

  12. It is horrible and disgusting to say the least. He is advocating default (subtly) saying that people suicide now and supposedly there is less suicide later. (But he is saying won’t really lead to as much suicides as one would expect as unemployment would be the norm, so less of a stigma etc. but shows his stupidity – he is presenting it as if there are only two options, suicides now or more suicides later).

    Hopefully Krugman trashes it to bin.

  13. So default = suicides now and less suicides later and

    no default = less suicides now and much more suicides later.

    according to him :-)

  14. Amazing how even educated people do get even the most basic macro concepts. They are so obsessed with money. Money is micro. Does not matter if is 10 yen or 10 trillion.

    In the end macro always comes down to gross productivity. Actual and potential.

  15. Once you get the hyperinflation feedback loops it is really too late. People are already getting out of JGBs. You can see this because the central bank is monetizing very fast, like over 6% increase in the money supply in the last month. So your idea that until there is hyperinflation people will accept 0.5% is just not true. The volatility on the value of the yen is so great that the risk of being stuck in that currency for 5 years is far worse than the tiny interest you can get. Their risk models will be telling them to get out of the yen.

    Hyperinflation happens over and over again. By your theory Venezuala should not be able to get hyperinflation either, yet they are doing it. Japan will contradict your theory as well.


  16. “They could, however, print so much Yen that it causes inflation to run wildly out of control which could cause numerous problems in FX markets, bond markets, etc. ”

    Then Why The F (frick) don’t they DO IT??????????????????

  17. They don’t even need to issue bonds. And if he currency drops enough their exports will counterbalance at some point.

  18. I am not an economist, which is probably why I do not understand the analysis stating the Bank of Japan has complete control over interest rates of Japanese sovereign bonds. First, Mr. Roche states the Japanese government offers buyers the option of no-interest bank deposits or low-interest bonds. Why are these the only choice? Why can’t bond buyers acquire corporate bonds or bonds from other nations if they determine the risks of owning Japanese bonds outweigh the income from the bonds?

    Second, if prices for Japanese bonds began to slide on the resale market as buyers began to doubt the creditworthiness of Japan, how could the Bank of Japan force buyers to buy new bonds at a lower interest rate than bonds selling in the secondary market?

    At some point the ability of Japan to service its debt cold come into question in the bond market. No country can simply borrow more and more money in perpetuity without resorting to serious inflation and/or restructuring of its debts.

  19. Smith doesn’t seem to have a response. He snickers in the comment section of that article with some of his readers at the fact you are in business, which is supposed to lead us to the conclusion that you are just some guy selling shinola, not to be taken seriously. There is one fellow arguing an mmt perspective therein whom he ignores. IMO it’s time to ignore Noah Smith, as he thinks writing an econ blog is about producing output that rivals “I love the smell of my own farts” for content and quality.

  20. Cullen,

    Could you clarify what the following means?

    “They could, however, print so much Yen that it causes inflation to run wildly out of control which could cause numerous problems in FX markets, bond markets, etc.”

    I understand the BoJ has nearly unlimited capacity to create bank reserves, allowing them to keep interest rates from spiking, so there is very minimal sovereign default risk. But everything I’ve read from you suggests the BoJ has very little power to directly increase the money supply, since banks are the ones who print money. Perhaps you just chose this wording for the sake of brevity, but I don’t understand how your explanation makes sense operationally.

    I do agree the BoJ can weaken the Yen (along with Fed QE to the USD), which can create EM disinflation. So QE can boost global money supply growth by allowing EM central banks to loosen monetary policy (since EM countries are not constrained by the zero lower-bound). Therefore, QE may boost global output. But that process ultimately seems deflationary, not inflationary.

    However, Japan’s central government could redistribute bank deposits from Rich Peter to Poor Paul (either by taxing or borrowing), which would increase the consumption to output ratio. I’m pretty sure you agree that a loss of output is inflationary. Do you also agree that a gain in consumption relative to output is inflationary? It does not appear to be the “printing of Yen” that would really cause inflation (Japan’s money supply-to-GDP ratio is huge).

    Do you really think it is a coincidence that the great inflation of the 1970s followed 4 decades of the most bank deposit redistribution in US history? Maybe super-high tax rates are inflationary, because they promote consumption. Do you really think it is a coincidence that the great disinflation of the past 30 years followed supply-side reforms (helping boost output) and tax cuts that discouraged consumption? Maybe inflation is less about the money supply (again, Japan’s money supply is huge), and more about the distribution of wealth. The consumption/output ratio appears to be very important to me.

  21. Cullen, you say people will keep buying JGBs. However, if they did not buy them or roll them over, do you agree that if the central bank was nearly the only buyer for trillions of dollars worth of bonds that it would be inflationary?

  22. There’s a lot of hidden unemployment in Japan. Companies are very reluctant to fire workers because it would break the socalled “Social contract” (“Lifetime employment”). That’s why the official unemployment is so low.

    That’s why it would take A LOT OF growth to get rid of all that hidden unemployment. But it won’t happen because japanese production costs have to come down significantly as well. High production costs is the reason why japanese companies have outsourced production to South East Asia, China.