6/14/2010
By Brian Sozzi, Research Analyst

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Think fast, what are some of the things that pop into your head when hearing the utterance Japan?  Immediately for me my brain wanders to a land with beautiful scenery, a flag with a red circle in the middle, a storied history of communal values, and sushi.  Absent that short list, and likely yours, is a completely out of control debt to GDP ratio of 218.6%! Yes, that is correct ladies and gents, 218.6%, hands down the highest among industrialized countries on planet Earth.  I find it irrelevant from a long-term line of thinking that Japan is able to service its bloated debt, reflecting a huge savings glut, as the Japanese government is letting this debt burden hang around like cigar smoke.  As I have painfully learned in my baseball team's crushing defeats this season (yes, I manage... you expect anything else?), that when the opposition is left to linger due to a lack of run production, my team loses.  Why is this?  It's because people become complacent with the status quo, content to just muddle through innings or in the case of Japan, servicing its debt, instead of tackling the problem directly.  The Lost Decade has brought about seemingly low forever interest rates and deflation in Japan.  The output gap (output relative to GDP) is a whopping 7% according to economists. 

Yet, the newly installed finance minister Naoto Kan is pounding his chest regarding the virtues of implementing a plan that will balance the budget in a decade's time.  What you talking about Mr. Kan (RIP, Gary Coleman)?  By enacting what sure looks like a tax raising plan that cripples innovation that is needed to reduce Japan's reliance on exports, I sense an impending spate of unhappy tidings.  Japan's GDP is 75% service oriented, so no spending by the Japanese, plus a slowdown in the cyclical recovery that has boosted exports, is a formula for disaster in my humble view.

Bringing me to pen this rant is the gushing analysis of Japan's current economic situation by some.  To be sure, Japan, which boasts the third largest GDP purchasing power parity in the world, has been on a roll with respect to its economic data releases.  In annualized, real price adjusted terms, Japan's GDP touched 5% in the March ended quarter, making it four consecutive quarters of growth.  Inflation, which declined 1.9% in 2009, has actually begun to percolate as well.  At long last, those talking heads clamoring for a little inflation in Japan are receiving it.  One economist even went so far as to say recently "the best thing Japan can do is to bring inflation back to their economy."  Think about this comment for a second to see it for what it is, borderline silliness.  Assuming Japan starts to bathe in the supposedly friendly glow of inflation, it may cause savers to drop Japan's debt for fear of a poor return on investment.  Debt dumping would lower prices, sending yields higher.  Higher yields would trigger concerns in the marketplace about Japan's ability to service its debt.  Suddenly, we turn on our Bloomberg terminals in the morning and watch a print that one of the asinine credit rating agencies downgraded Japan's debt a few notches.  Think this wouldn't negatively impact our markets?  Think again is all I can say.

Two more tidbits worth noting.  One, hardly anyone is talking about a debt blow up in Japan.  I fancy that the market has become lulled into believing Japan is the king of debt servicing (outside of the U.S. of course).  Any rumblings that Japan is starting to buckle under the weight of its debt, we might as well prepare to hear the words "black swan" on television through the wee hours of the morning on into the black night sky.  Second, I have read that Goldman Sachs clients have started to bet against Japan's debt.  Is this just a case of Goldman trying to talk up its own book?  I don't know for sure.  What I do know is that  when debt hits 218.6% of a country's GDP, and the bank that houses the world's brightest financial minds says clients are bracing for turbulent waters in Japan, I take notice.

Brian Sozzi
Wall Street Strategies