Commentary by William Pesek
Dec. 12 (Bloomberg) -- It’s not a legacy any Japanese or American leader wants: that of debtor in chief.
Japanese Prime Minister Taro Aso is currently well ahead of U.S. President George W. Bush. Japan’s federal budget deficit is 5.2 percent of gross domestic product, while the U.S.’s is 3.6 percent. When viewed in terms of population -- 127 million Japanese to 309 million Americans -- Japan’s trajectory looks even worse.
What about all that off-balance-sheet U.S. debt? The Iraq and Afghanistan wars are one thing. All the borrowing the U.S. will do to avoid a repeat of the Great Depression and bail out key industries is quite another. It’s conceivable that the U.S. will knock Japan from its biggest-debtor perch.
Welcome to the Aso-versus-Bush Big Debt Sweepstakes, a contest neither leader would want to win. Throughout the world, debt managers are gearing up for a historic increase in borrowing. The stakes are high and sweeping in their implications.
Aso has been premier only since September. Yet he has been a Liberal Democratic Party bigwig for two decades and it will be on his watch that plans are scrapped to balance the budget by 2011. While the real U.S. debt explosion may be on President-elect Barack Obama’s watch, the process began under Bush.
The Organization for Economic Cooperation and Development estimates Japan’s debt stands at more than 1.7 times GDP, the highest ratio among its 30 member countries.
Ugly Trends
U.S. trends also are decidedly ugly. As James Grant, editor of Grant’s Interest Rate Observer in New York, noted on Nov. 28, total U.S. credit-market debt stood at $51 trillion at the end of the second quarter. That makes the ratio of debt to GDP 357 percent. In 1929, debt was 185 percent of GDP.
Other astute debt watchers, such as Paul Kasriel of Northern Trust Corp. in Chicago, are aghast at where the U.S. finds itself. Case in point: A trial balloon floated in the Wall Street Journal this week regarding the Federal Reserve issuing its own debt.
“This is akin to a counterfeiter issuing her own debt,” Kasriel wrote in a Dec. 10 report. “There could never be a default. All the counterfeiter would have to do is print up some new currency to pay the interest on or redeem her debt.”
Markets also are buzzing about the possible arrival of “Obama bonds,” inspired by a program tried during Jimmy Carter’s presidency in the late 1970s. The idea is to sell debt in foreign currencies to halt a precipitous drop in the dollar.
‘Gobs of Money’
“The government is going to be spending gobs of money,” says Peter Fisher, New York-based co-head of fixed income at BlackRock Inc.
As a former U.S. Treasury official in charge of debt issuance, Fisher knows intimately how the process of funding all that spending works. He recently suggested that the U.S. should consider issuing 100-year bonds, given the likely magnitude of its future debt load.
Japanese officials also know lots about selling debt. The U.S., as it’s often pointed out, is looking like Japan in the 1990s. Just like the Bank of Japan’s key interest rate, the Fed’s benchmark looks to be headed to zero. A massive borrowing binge is taking place to stabilize growth.
All this brings to mind James Carville’s 1992 observation. The White House adviser said he wanted to be reincarnated as the bond market so he could come back and scare everyone. These days, it’s the stock market keeping everyone up at night. That will change as credit-rating companies begin warning to downgrade the U.S. and Japan.
‘Not Unreasonable’
It’s quite disorienting for old-school bond aficionados to see yields on two-year U.S. notes fall from this year’s high of 3.11 percent in June to 0.86 percent. That’s “not unreasonable,” JPMorgan Chase & Co. analysts Terry Belton and Srini Ramaswamy in New York said in a Nov. 28 report. Yields in Japan were between 0.1 percent and 0.8 percent for three months after the BOJ began its zero-rate policy in 1999.
In recent years, when economists such as Stephen Roach at Morgan Stanley said the U.S. was becoming Japan-like, detractors pointed to the health of American banks relative to Japan’s. We now know U.S. lenders were anything but sound, thanks to lax risk management.
As U.S. officials study Japanese market history, debt is perhaps the most cautionary of tales. Japan’s reliance on debt- financed public spending to jolt the economy in the 1990s seemed logical. Officials never had an exit strategy, and Japan is still reliant on borrowing.
“While government intervention is necessary, it should be temporary and reversible,” Mohamed El-Erian, co-chief executive officer of Newport Beach, California-based Pacific Investment Management Co., said on Dec. 9. “There has to be clarity on Day 1 as to what are the exit mechanisms.”
With Japan and the U.S. in deepening recessions, expect the two biggest economies to issue debt as rarely seen before. It’s up for grabs which will be the chief debtor five years from now.
(William Pesek is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: William Pesek in Tokyo at wpesek@bloomberg.net
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