No.7｜Government bonds are highly addictive(Part 1)

This article is a translation of this article.

Now everything is being converted into money. We can't live without money. Yet, Japan's financial situation is interpreted so optimistically that the situation is worse than ever before, despite the fact that it is the most important issue in every Japanese's life. What's going on?

1) The current financial situation in Japan

Japan's finances are just plain awful. The following graph shows the changes in expenditures (一般会計歳出) and revenues (一般会計税収). Invariably, expenditures have far exceeded revenues. (The fact that revenues and expenditures remain open all the time has been derided as "the mouth of the crocodile".) The shortfall has been made up by large amounts of debt.

Tax Revenue, Expenditure, and National Debt Issuance
Cited from 
https://www.mof.go.jp/zaisei/current-situation/situation-dependent.html
(The red bar graph (国債発行額）shows the amount of government bonds issued in that year. Due to the pandemic, the crocodile jaws seems to have dislocated.)

To evaluate the fiscal health, the debt to GDP ratio is often discussed. Japan's debt-to-GDP ratio grew steadily, reaching a recent level of 238% (2019), much higher than that of any other country. It's hard to know how to judge whether it's healthy or not, but this is a rare and unusual situation in history.

The increase in the deficit is mainly due to the rapid increase in social security expenditures. The aging of the population due to increased life expectancy has caused medical and nursing care costs to skyrocket, while failing to raise tax revenues.

Unfortunately, the outlook for future social security payments is worse than it is now. Although the government expects GDP to continue to rise in the future, social insurance costs are expected to increase even more and the balance of payments will deteriorate further (see figure below). 

Projected Future Social Security Bill (in trillions of yen)
(介護 = Nursing care, 医療 = Medical care)
Cited from https://www.mof.go.jp/zaisei/aging-society/society-estimate.html

Strictly speaking, we should focus not only on the national debt balance but also on the asset balance. However. "Most of the tangible assets formed by construction bonds do not generate cash flows," was said, "and if they cannot be sold in the market, or if they are, they may decline in value in the event of a financial crisis". In effect, they can hardly be relied upon as emergency assets. (Cited from here. Translated into English.)

2) How is the financial situation interpreted?

At first glance, finances are on fire, but how is it interpreted by the public? Here are three popular theories.

① Rapid inflation theory (pessimism)
The ratio of national debt to GDP is in dangerous territory. If interest rates rise slightly in any way even in the future, the debt will snowball due to mounting interest costs. This further reduces confidence in government bonds, and the situation worsens as interest rates rise. Higher interest rates will push up prices, and severe inflation will hit Japan in the future.

② The theory of unlimited refinancing (optimism)
Unlike the Greek crisis of 2009, the Bank of Japan can directly underwrite government bonds in a crisis, allowing it to refinance them forever without default. Constantly refinancing does not result in a burden on anyone and does not impose a burden on the next generation.

③ The theory of resolution due to economic growth (somewhat optimistic)
Paying off the debt with austerity (i.e., cutting government spending and raising taxes) will lead to economic stagnation, which will result in a lack of revenue growth and exacerbate the situation. Instead, aggressive economic stimulus policies can increase tax revenues and reduce the debt-to-GDP ratio while limiting the burden on the public.

The current administration, in position ③, seeks to stimulate the economy through aggressive fiscal and other-dimensional monetary easing. If we can raise the inflation rate to a moderate level (2%), the value of cash can be reduced. It can give consumers an incentive to move from savings to consumption. In this scenario, the money lying dormant under the deflationary environment would be spent, corporate performance would increase, workers' incomes would rise, and tax revenues would increase, improving the balance of payments.

As a matter of fact, the logic in ③ above is not wrong, but it is not accurate. An important point of view is missing, and it is unrealistic. What on earth was wrong with this theory?

3) GDP is not an indicator of wealth.

To begin with, it is easy to get caught up in the idea that GDP growth is good. The word "growth" has a very positive meaning, but GDP growth is not necessarily a good thing. Let's tell one hypothetical story.

"A group of people live on an enclosed island. There, in a land of abundant nature, they had no shortage of food, and after working a little each day, they were free to live as they pleased. They were able to live comfortably, sharing and occasionally bartering for what was missing."

This island would be a form of paradise. However, since there is no monetary transaction, the GDP is calculated to be zero, and there is no need to increase the GDP; rather, if we start wasting resources excessively, it will eat up the resources of the island and cause its future decline, keeping the GDP growth to zero will lead to the wealth of the island. .

Even in the real world, resources are finite. If we continue to consume more resources than we can regenerate, we will eventually run out of them. It is natural that infinite growth leads to social decay.

There are many inappropriate aspects of GDP. Aggressively destroying the environment, polluting the air, and selling masks and air purifiers will still increase GDP. Similarly, whether a catastrophe forces reconstruction or a pandemic increases health care costs, GDP increases.

Conversely, if the share of goods and second-hand goods are sold, consumers can get good quality goods at a lower price, but sales of new goods will fall, and total GDP will decrease. The same is true if, for example, technology improves the longevity of tires or fuel efficiency.

GDP growth does not necessarily mean wealth. Especially in a mature country like Japan, GDP is not a target figure. Nevertheless, we tend to look at GDP as an absolute.

4) Will GDP increase in the future?

Nevertheless, GDP is useful as a reference for an indicator, e.g., the size of the economy. Will GDP continue to grow in the future as the government predicts?

The following graph shows the projected population in Japan. The population peaked in 2004 and is now on a roller coaster ride down to the bottom.

Changes in Japan's Population
Cited from https://www.mlit.go.jp/common/000135837.pdf

The next chart shows the change in the age structure. The working-age population (The green zone, 生産年齢人口) is declining and the elderly population (Dark green zone, 高齢人口) will continue to grow. The fertility rate in 2019 remains low, at 1.36, down 0.06 from the previous year.

Demographic Changes
Cited from https://www.mlit.go.jp/common/000135837.pdf

Of course, a decrease in the working-age population is directly related to a decrease in GDP: between 2018 and 2050, the working-age population will decrease by two-thirds, and the "working-age population to total population" will decrease to 52% by 2050. We are a super-aging society where  one person has to live to support another one. The burden of care and childcare will be even heavier than it is now. Nevertheless, pension and financial planning is based on "overly optimistic" projections that productivity will continue to increase, growing by nearly 1.4 times between 2018 and 2050 (about twice GDP per capita, taking into account the decline in the working-age population).

Also, these long-term plans do not include contingencies. For example, current pandemics, near-future Nankai Trough and metropolitan earthquakes, intense rainfall and typhoons caused by climate change, and possible future financial crises are not included in the calculations. We tend to anticipate the future in a linear fashion, but rarely do we move forward peacefully.

Climate change and the corona are transforming the structure of society. The environmental destruction is progressing, and the social system based on mass production and mass consumption is showing its limits. The current system cannot be allowed to continue as it is. One should not believe without a doubt that the fiscal improvement of natural revenue growth relies on economic growth.

(Continued in Part II)