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Another Fiscal Warning Sign for America

While many people are watching (or warning) about the United States becoming Greece, Ireland, or Spain when it comes to its national debt — all legitimate warnings — there’s another nation we should be watching: Japan.

Japan, which is now on its second decade of organized collapse by growing public debt and make-work infrastructure programs (Sound familiar?) has seen its once stellar governmental bond rating get knocked down as credit houses and creditors worry about the ability to see it paid back.

Yesterday, it took another beating seeing its bond rating downgraded from AA to AA-.

The downgrade reflects our appraisal that Japan’s government debt ratios–already among the highest for rated sovereigns–will continue to rise further than we envisaged before the global economic recession hit the country and will peak only in the mid-2020s. Specifically, we expect general government fiscal deficits to fall only modestly from an estimated 9.1% of GDP in fiscal 2010 (ending March 31, 2011) to 8.0% in fiscal 2013. In the medium term, we do not forecast the government achieving a primary balance before 2020 unless a significant fiscal consolidation program is implemented beforehand.

Japan’s debt dynamics are further depressed by persistent deflation. Falling prices have matched Japan’s growth in aggregate output since 1992, meaning the size of the economy is unchanged in nominal terms. In addition, Japan’s fast-aging population challenges both its fiscal and economic outlooks. The nation’s total social security related expenses now make up 31% of the government’s fiscal 2011 budget, and this ratio will rise absent reforms beyond those enacted in 2004. An aging and shrinking labor force contributes to our modest medium-term growth estimate of around 1%.

In our opinion, the Democratic Party of Japan-led government lacks a coherent strategy to address these negative aspects of the country’s debt dynamics, in part due to the coalition having lost its majority in the upper house of parliament last summer. We think there is a low chance that the government’s announced 2011 reviews of the nation’s social security and consumption tax systems will lead to material improvements to the intertemporal solvency of the state. We even see a risk that the Diet might not approve budget-related bills for fiscal 2011, including government financing authorization. Thus, notwithstanding the still strong domestic demand for government debt and corresponding low real interest rates, we expect Japan’s fiscal flexibility to diminish.

Why should this matter?  Well, in the past year, Moody’s said the American Bond Rating of AAA could be downgraded to AA sometime this decade.  If such a thing were to happen, it would increase the interest rate the U.S. Government is paying as it pays off its own bonds to other governments, businesses, and American citizens who purchased the bonds the U.S. Government sells.

Fiscally, in the short-term future, Japan’s more our reality than some nations in Europe.

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  • Not even close. Japan’s national debt/GDP is about 150%.

    Japan got where it is through demographics: there are no kids, and no immigration is allowed.

    In 50 years, Japan will be history. Italy will be next.