When the euro crisis erupted at the end of 2009, not only retail investors but most banks too woke up to the fact that not only ill-managed sovereigns in faraway, exotic countries  may collapse under their debt burden, but highly developed countries too.

The balance-of-payment haemorrhage suddenly engulfing the eurozone threatened the very existence of the euro. Low interest rates for all of Europe and the common currency had long disguised the fact that the Mediterranean countries and Ireland too had clocked up debt which they could not possibly sustain.

Greek, Portuguese and Cypriot bonds lost value in violent spasms. Greek government bonds, the most heavily pummelled suddenly yielded close to 30 per cent – a not uncertain verdict on expected bankruptcy. The spook was banished two years later, thanks to Mario Draghi, today’s prime minister of Italy and then ECB president, when he announced unlimited liquidity support for European banks and countries. But a lesson was learned. Governments, like the rest of us, can go bust when they live a profligate life and debt levels reach unsustainable proportions.

Feeble-minded investors like me suddenly started to look aghast at other countries. All economies saw their debt piling up in the wake of the Great Financial Crisis, all but China, which was hooked on debt already, determined to grow through useless investment at any cost and could therefore weather the GFC better than others.

But the debt? Harvard scholars Carmen Reinhart and Ken Rogoff published a paper in 2010 declaring that once public debt has reached 90 per cent of a country’s GDP the economy will stall, as the cost of debt service would crowd out public and private investment.

Deteriorating public finances and worsening exchange rates would deter foreign investment and provoke capital flight. Despite their persuasive arguments, 90 per cent is the new normal today for all but a few, post-COVID. If we had zero growth as a result, rampant inflation would not be the headache it is.

Japan was always the outlier in this. With public debt at 266 per cent of GDP, it makes Greece look thrifty in comparison. Its economic growth is anaemic for decades (0.4 per cent), its population is shrinking every year

(-0.3 per cent), its productivity is and has always been the lowest among the G20, its labour participation rate (62 per cent) is poor, as the female workforce is ill-represented and immigration never envisaged.

Japan’s budget deficit is currently US$ 113bn per month, and its once fabled current and trade account surplus went negative because of ever more expensive energy imports. Yet nothing seemed to harm the yen’s role as a “safe haven” currency.

Until now that is. In the last months, Japanese yen has lost 30 per cent in value against the US$, weakening against most major currencies. Does this mean a final reckoning has come for Japan, that the world has lost trust, or just reflecting the fact that the momentous interest differential to the US$ and other lead currencies hasmade any yen investment too unattractive and futile for aggregate markets?

First, let me for the sake of clarity state that the Japanese government cannot ever go under as private entities can, or as troubled eurozone countries could have. The BoJ can print yen at will and provide their government with all necessary means.

This is a path which was not open to endangered countries in the eurozone, which were tied to the euro without having the power to devalue their currency – or to freely replenish their coffers.

In a simplistic model, the only consequence for Japan would be a continuous devaluation of the yen as the Bank of Japan finances the government, banks, corporations and perhaps even households with abandon. This could be inflationary, yes, but Japan is struggling with deeply engrained disinflation for decades and could do with a little uptick in consumption and investment.

Japan owes most money to itself – to its citizens, to its pension funds and to its central bank- Andreas Weitzer

The other reason why Japan’s debt burden is not much of a menace for foreign creditors is the fact that Japan owes most money to itself – to its citizens, to its pension funds and to its central bank. Take for example the bloated balance sheet of the Bank of Japan: it owns 75 per cent of all Japanese exchange traded funds (ETFs), almost half of all government bonds (JGB), it is the top shareholder of all of Japan’s large corporations and holds US$ 1.2tn worth of foreign currency reserves. Japan’s claims to the outside world exceed its obligations by 50 per cent.

When Japan’s Nikkei225 stock market index hit its all-time high on December 29, 1989, reaching 38,957.44, the yen was 145 to the dollar, much weaker than today. The Nikkei stands at 27,003 at the time of writing and the yen at 131/$US.

The yen exchange rate, as much as I have tried to recognise a pattern reflecting the health or sickliness of the Tokyo Stock Exchange, shows no discernible correlation to share prices. Also the yen’s reputation as a safe haven is a mystery. It tanked during the Asian Financial Crisis and it is deteriorating again now, with China’s economy struggling to expand amid new COVID lockdowns and the yuan devaluing.

In the past, we used to worry about “currency wars”, when export-oriented countries cheapened their currencies to gain an unfair competitive edge. Japan was always in the cross hairs and China too.

Today, with inflation in most industrialised countries speedily approaching double digits and corporations passing on higher energy, labour and materials prices to the consumer with impunity while heftily  topping up their profit margins, we’d love to see someone actually exporting disinflation, as opposed to inflicting inflation on others, for instance with the US dollar soaring. Investment bank Goldman Sachs is talking about “reverse currency wars”.

Before we get too optimistic, we have to bear in mind that Japan is exporting much less today than in the past. Japan is mostly manufacturing abroad these days. Yet Japan is exporting its wealth. Its industries are investing abroad and its savers, pension funds and retail investors are selling yen to buy shares and bonds abroad, as they yield vastly more than their Japanese equivalents.

It would be a rushed conclusion though to see in this the main reason for the yen’s depreciation: Japanese investors selling yen to acquire foreign assets. Most Japanese investments abroad are “hedged”, meaning that exchange rates are fixed at a cost. The means to do so are currency swaps or futures contracts, which are getting more expensive as the willingness of counter parties to hold yen is diminishing.

Right now the cost of hedging a Japanese investment in the US has become costly enough to erase any expected gain made on the basis of existing yield differentials.

As a result, Japan, the biggest buyer of US government obligations, bigger even than China, cannot be counted on when the FED is trying to shrink its holding of government bonds and mortgage loans, loath to further provide liquidity while fighting inflation in earnest. It will be interesting to see who will buy all these US bonds instead, now that Japan is becoming reluctant to pick up the bill.

I am not clairvoyant, but this indeed could be the trigger of a new financial crisis. Many dollar borrowers in the developing world are put at risk by the painfully rising US currency, causing hardship and geopolitical headaches. But these countries are too small to have a destabilising effect on financial markets. This cannot be said of Japan. Its reluctance to invest in US treasuries could change the game.

The purpose of this column is to broaden readers’ general financial knowledge and it should not be interpreted as presenting investment advice, or advice on the buying and selling of financial products.

andreas.weitzer@timesofmalta.com