The shock felt around the world

From The Next Panic: Europe’s crisis will be followed by a more devastating one, likely beginning in Japan by Peter Boone and Simon Johnson. It is all about productivity. Continued growth can only occur, all other things being equal, with increasing productivity. The importance of productivity increases if other factors such as aging of population or actual decline of population are occurring.

Debt is a useful tool for easing transitions and facilitating investments but is only viable if it leads to greater productivity. Debt taken on in order to enable current consumption is a slippery slope towards ruin. And that is what has happened in the modern developing world. Britain, if I recall correctly, pioneered government borrowing in order to fund the Napoleonic wars. Despite horrendous levels of debt incurred defeating Napoleon, the near century of peace following 1815 allowed productivity to boom and for all that debt to be managed down. That debt bought the circumstances that enabled dramatic increases in productivity.

Japan and most of Europe are now well down the financial path of ruin. Aging and soon declining populations with increasing levels of already high indebtedness married to structural deficits to fund various social programs (transfers and consumption) means that, as the article indicates, that there are dark days ahead for our fellow OECD members. China is in much the same situation with their population graying rapidly, though not yet declining.

Despite a few reprehensible outliers (California, Rhode Island, Illinois, etc.) who are in nearly as bad condition as Greece, the US is not quite at the precipice yet. The economic trauma of our allies will hurt the US economy to some degree. Backing away from structurally unsustainable obligations will hurt even more but it is not as if there is a choice. Math is a harsh mistress.

Japan’s demographic decline will be hard to reverse—and even in the best-case scenario, the positive effects of a reversal would not be felt for decades. The economy, roughly speaking, is as healthy as it is likely to become. Yet the government seems incapable of steering away from the cliff, a characteristic that should strike no one as uniquely Japanese—just look at how the Euro­pean leadership has behaved over the past half decade, or how you can polarize American politicians with the phrase debt ceiling.

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.

[snip]

The shock felt around the world will result not just from the realization that Japan is unable to meet its pension and other social obligations. Investors will also be horrified to see the disappearance of the private savings previously used to buy government debt, whether through debt defaults and bank failures or through high inflation. For ordinary Japanese, public promises about retirement benefits and price stability will be broken just as their private savings for retirement collapse.

No one can predict the timing, but without radical political change that creates a more responsible fiscal trajectory, this will happen.

The most worrisome implication of Japan’s increasingly precarious position, particularly in the wake of the 2008 crash and Europe’s ongoing crisis, is that our financial systems appear to be returning to their inherently unstable nature, which plagued the 19th and early 20th centuries. Financial institutions back then were not too big to fail—they were too big to save. Their balance sheets dwarfed most governments’ ability and willingness to provide support.

I think Boone and Johnson paint perhaps too dark a picture but there are certainly grounds for concerns about these sort of fundamental questions. You have to produce more than you consume. If you borrow to consume, the bill will come due and you had better have the cultural and governance structures in place to make the hard decisions that come with such market adjustments to economic fundamentals.

Which brings us back to reading, storytelling, and the transference of the values, knowledge and skills that have served us well in the past and which, after a decades-long assault, will see us through to a better more productive future. Reading and books are a critical element in the revitalization, resurrection and transference of that culture. Read a book today.