In a report released in the lead-up to its big meeting in Tokyo this week, the International Monetary Fund cut its global growth forecasts and sharply warned that the world economic slowdown is worsening. Although the report singled out U.S. and European policymakers, it's sadly appropriate that the meeting will be held in Tokyo, because Japan's economy is the one we really ought to worry about -- and it's even more worrisome for the lessons it holds for our own.
To be sure, never a year passes without dire warnings of financial collapse in Japan. The latest comes from economists Peter Boone and Simon Johnson, who see tragedy ahead. They write:
A crisis in Japan would most likely manifest as a collapse of confidence in the yen: At some point, Japanese citizens will decide that saving in any yen-denominated asset is not worth the risk. Then interest rates will rise; the capital position of banks, insurance companies, and pension funds will worsen (because they all hold long-maturing bonds, which fall in value when rates rise); and fears of insolvency will surface.
It is easy to dismiss such concerns, as they have been regularly voiced over at least the past 12 years and thus far proven wrong. After all, Japanese interest rates have not skyrocketed, so clearly the crisis has not arrived.
To be blunt, the debt situation in Japan is not sustainable. The fiscal deficits supporting the Japanese economy appear never ending; the Japanese economy never gained enough strength to eliminate the dependency on fiscal stimulus, leading to an excessive buildup of government debt that now exceeds 200 percent of GDP. (While there is no clear line at which debt loads become a problem, in October the IMF identified 100 percent of GDP as the threshold that will create political and economic pressure to reduce the debt.)
Japan needs to close its fiscal gap, but has yet to find the political will to do so via tax increases or spending cuts. As Greek or Spanish politicians can testify, fiscal austerity is easy to say, hard to do; raising taxes or cutting spending would only deepen the malaise, just like it has elsewhere. If fiscal policy is off the table, it's up to central bankers to boost growth. But with Japan's economy now operating at the zero bound -- a situation in which interest rates are extremely low and cannot be expected to go lower -- the Bank of Japan has fewer tools to counteract the recession.