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Japan and Moody’s
In November 1998, the day after the Japanese Government announced a large-scale fiscal stimulus to its ailing economy, Moody’s Investors Service began the first of a series of downgradings of the Japanese Government’s yen-denominated bonds, by taking the Aaa (triple A) rating away. The next major Moody’s downgrade occurred on September 8, 2000.

Then, in December 2001, Moody’s further downgraded the Japan Governments yen-denominated bond rating to Aa3 from Aa2. On May 31, 2002, Moody’s Investors Service cut Japan’s long-term credit rating by a further two grades to A2, or below that given to Botswana, Chile and Hungary.

In a statement at the time, Moody’s said that its decision “reflects the conclusion that the Japanese government’s current and anticipated economic policies will be insufficient to prevent continued deterioration in Japan’s domestic debt position … Japan’s general government indebtedness, however measured, will approach levels unprecedented in the postwar era in the developed world, and as such Japan will be entering ‘uncharted territory’.”

The then Japanese Finance Minister responded (with some foresight): “They’re doing it for business. Just because they do such things we won’t change our policies … The market doesn’t seem to be paying attention.” Indeed, the Government continued to have no problems finding buyers for their debt, which is all yen-denominated and sold mainly to domestic investors.

In the New York Times the logic of the rating was questioned:

How … could a country that receives foreign aid from Japan have a better rating than Japan itself? Japan, with an economy almost 1,000 times the size of Botswana’s, has the world’s largest foreign reserves, $446 billion; the world’s largest domestic savings, $11.4 trillion; and about $1 trillion in overseas investments. And 95 percent of the debt is held by Japanese people …

Rating sovereign debt according to default risk is nonsensical. While Japan’s economy was struggling at the time, the default risk on yen-denominated sovereign debt was nil given that the yen is a floating exchange rate.

Once we understand how a sovereign government operates with respect to the monetary system this point become obvious.

First, when a particular government bond matures (that is, becomes due for repayment) the Government of Japan would simply credit the bank account of the holder with the principle and interest and cancel the accounting record of that debt instrument. Simple as that. The banking reserves would rise by that amount and the wealth of the private investor would change in mix from bond to bank deposit.

Second, the massive fiscal deficits that the Japanese Government has run since the 1990s just work in the same way – adding reserves on a daily basis to the banking system (as people spend the yen and deposit them back into bank accounts etc). The bond issues are designed to give the private sector an interest-bearing financial asset to replace the non-interest earning bank reserves. The way the Bank of Japan (BOJ) has kept the interest rate in Japan at virtually zero for years now is that they do not issue debt volume of debt to match the reserve-add of the deficit spending. That is, they leave just enough excess reserves in the cash system overnight each day to force the interbank market to compete the rate down to zero. This is a very clever way of ensuring that the longer rates (the so-called investment rates) are as low as they can be.

Third, what if the Japanese Government decided it didn’t want to issue any more debt but still ran the deficits? The net spending would still occur – day by day – and provide stimulus to the economy. But the liquidity effects would just remain in the excess banking reserves and force the private sector to hold the new net financial assets pouring in each day via the deficits in the form of reserves rather than interest-bearing bonds. The other angle on this that is often overlooked is that the bond holdings of the private sector also constitute an income source – that is, the government interest payments on its outstanding debt constitute another avenue for stimulus. So when the Government retires debt it reduces private incomes.

The Japanese Government is very sophisticated and knew that Government debt was seen as a safe haven during its decade or more of volatile economic times and also realised that the steady and predictable income flow derived by the private sector holding the public debt was a source of security and a positive influence on growth.

So any notion that a government that is running large fiscal deficits and also issuing debt for monetary policy reasons or in the Japanese case (given they have zero short-term interest rates anyway) for risk reduction purposes, might be a risk is ridiculous.

Note that this analysis does not consider foreign-currency denominated public debt which is subject to exchange rate exposure and clearly tells us that a sovereign government should never issue debt in any currency other than its own.

For Australia, foreign holders of our public debt will clearly face exchange rate (or currency) risk. But that is not related to the decision of the Government to net spend unless you bring the old furphy out that these amorphous hedge funds out there will mark a currency down if a Government borrows to much. That is possible but unlikely. Suggesting that this will push up interest rates (to provide some cover for the currency risk) assumes that the Government is stupid enough to keep borrowing from markets that want to impose this type of penalty. …

När Japan kan hantera detta så här infinner sig frågan varför den svenska sk 90-tals krisen utspelade sig som den gjorde. Och då speciellt efter att den fasta kronkursen släppts och kronan tilläts flyta. Än i denna dag är hela det politiska etablissemanget livrädda för "inviseble bond vigliantes" och deras lakejer på rating institut och grötmyndigt svammel från OECD och IMF.


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