Thesis 2012 Financial Repression

Thesis 2012 Financial Repression-71
Some of the best-known research on financial crises asserts that countries get into trouble when debt-to-GDP ratios surpass 80%.

Some of the best-known research on financial crises asserts that countries get into trouble when debt-to-GDP ratios surpass 80%.

As the original “Asian Tiger,” Japan employed this strategy to great effect over the years, growing GDP sharply on the back of strong exports.

As long as GDP and exports are growing, this model works.

The BOJ was ferociously trying to stimulate the economy with aggressive easing.

In addition to low rates, the BOJ maintained high levels of money supply and credit growth, which drove the creation of the bubble as illustrated in Figure 2.

Because this portfolio is large, Japan — as a country — regularly earns more income on its foreign currency holdings than they pay out to foreign investors.

In combination, the trade surplus and the income surplus brings new money into corporate Japan.

While this monetization of debt creates inflationary pressures, it has thus far been offset by the deflationary pressures of a declining workforce and declining population.

There are short-term fluctuations from year to year, but it is clear when looking at averages decade by decade that funding pressures in Japan have been growing over time.

Therefore, Japan’s ability to finance its federal government will be determined by the health of its GDP growth (which grows tax revenues, all else equal), its ability to grow federal tax revenues, its ability to control its budget, its ability and willingness to use its substantial foreign exchange reserves, and perhaps most importantly, its ability to continue selling bonds to the public.

The secret of Japan’s ability to finance itself over the past 22 years is that it has used its current account surplus to create a closed loop — more money flows into Japan than flows out, and that net inflow is largely invested in JGBs (Japanese government bonds).

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