Spending on Social Security and Debt Service Soars
We recently wrote about Shinzo Abe's desire to beef up Japan's military and alter the pacifist constitution to do so. Apart from the fact that this will divert scarce resources into wasteful lines of production that do little more than increase the probability of war, an important question is: how will he pay for it? Consider the recent trends in government spending in Japan. We have discussed this topic before, but have recently found a chart that illustrates the central fiscal problem nicely.
The growth in Japan's government spending per category since 1960 (source: Japan's MoF). The two largest and fastest growing items are spending on social security and debt service. Defense spending is fairly small slice of the overall spending pie, and now Abe wants push its rate of growth up as well - click to enlarge.
The two biggest fiscal problems Japan faces are social security spending which is increasing by leaps and bounds as society ages and the debt service, which appears to be in an unstoppable upward spiral in spite of Japan still enjoying the lowest interest rates in the world. Both items are set to grow appreciably further. Of course, debt service is what government must now pay for the spending excesses and deficits of the past.
Government Debt - Safe for All Eternity?
Many market participants and observers seem to be pretending that nothing untoward can ever happen to the huge amount of debt that has been accumulated. On the other hand, many recognize fatalistically that this is actually impossible. The point of no return has long been passed. As Ludwig von Mises wrote in Human Action:
Now, the irredeemable perpetual public debt presupposes the stability of purchasing power. Although the state and its compulsion may be eternal, the interest paid on the public debt could be eternal only if based on a standard of unchanging value. In this form the investor who for security's sake shuns the market, entrepreneurship, and investment in free enterprise and prefers government bonds is faced again with the problem of the changeability of all human affairs. ...
If the government uses the sums borrowed for investment in those lines in which they best serve the wants of the consumers, and if it succeeds in these entrepreneurial activities in free and equal competition with all private entrepreneurs, it is in the same position as any other businessman; it can pay interest because it has made surpluses. But if the government invests funds unsuccessfully and no surplus results, or if it spends the money for current expenditure, the capital borrowed shrinks or disappears entirely, and no source is opened from which interest and principal could be paid. Then taxing the people is the only method available for complying with the articles of the credit contract. In asking taxes for such payments the government makes the citizens answerable for money squandered in the past. The taxes paid are not compensated by any present service rendered by the government's apparatus. The government pays interest on capital which has been consumed and no longer exists. The treasury is burdened with the unfortunate results of past policies. ...
The long-term public and semi-public credit is a foreign and disturbing element in the structure of a market society. Its establishment was a futile attempt to go beyond the limits of human action´and to create an orbit of security and eternity removed from the transitoriness and instability of earthly affairs. What an arrogant presumption to borrow and to lend money for ever and ever, to make contracts for eternity, to stipulate for all times to come! ...
The financial history of the last century shows a steady increase in the amount of public indebtedness. Nobody believes that the states will eternally drag the burden of these interest payments. It is obvious that sooner or later all these debts will be liquidated in some way or other, but certainly not by payment of´interest and principal according to the terms of the contract. A host of sophisticated writers are already busy elaborating the moral palliation for the day of final settlement. [Emphasis added]
It is a good bet that the inflationary policy initiated by the Abe government has precisely this aim: namely to make the government's debt payable in money of lower purchasing power. The 'revival of the economy' the inflationary policy is allegedly supposed to bring about can never be anything but a short term illusion.
Considering the extreme risks that come with this policy in Japan's case, it could be argued that it increases regime uncertainty, which in turn makes the appraisal of future conditions that much more difficult for entrepreneurs - who are therefore likely to refrain from investing. The correct appraisal of future conditions and prices which are then compared with the costs of inputs is an indispensable feature of economic calculation. Since Japan can no longer successfully suppress interest rates further below their natural level, the potential malinvestment of capital is not likely to be the main problem. The main problem is that investment may be shunned altogether.
In addition, the 'shot in the arm' given to Japan's export oriented industries by the decline in the exchange value of the yen is but a temporary, fleeting phenomenon. Already parts of Japan's economy are suffering from the increase in import prices. Eventually all prices and wages will have adjusted to the new exchange rate and then not even exporters will have an advantage anymore. Judging from the government's interventionist bent, this will then result in additional steps to lower the currency's value, and so on, ad infinitum.
As to the current holders of JGBs, we wish them good luck, they are going to need it.
The yen's dismal performance over recent months.
Charts by Japanese Ministry of Finance, BarCharts.