The Coming Worldwide Financial Implosion

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Published on Friday, 10 August 2012 14:37

Written by Bill Bonner, Founder and President, Agora Inc.

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The big news yesterday went almost unnoticed. Bloomberg was there, however, and had this report:

About 200 housewives marched down a shopping street in central Tokyo, beating pans with ladles and shouting slogans criticizing a government plan to double Japan's 5% consumption tax.

"Ordinary people like us have a limited amount of money we can spend each month," said Natsuyo Makabe, a protester who took part in three demonstrations in June against the tax as well as nuclear energy and a free-trade pact. "Ninety-nine percent of the public will have to cut back on what they buy."

The apron protesters, as they are known, argue that a tax increase would crimp household budgets just when the economy can't withstand a drop in consumption.

They say it's a bad time for Prime Minister Yoshihiko Noda to rein in public debt that will be over 230% of national output this year, the biggest anywhere. The tax plan has already cleared the lower house of Japan's parliament, and Noda this week brokered a deal to bring the bill to the upper house today.

Japan's debt is ballooning as its population is aging and shrinking, meaning there are only 2.4 working-age Japanese to support one senior citizen now, compared with 9.1 in 1965. If he gets this tax issue wrong, Noda could throttle consumption, reduce tax revenue, and still leave Japan deep in debt. If the tax increase is defeated, the debt problem remains unsolved.

Yet Japan's bonds have never been more popular. The ticking fiscal time bomb is being drowned out by noise from the euro crisis, which has turned Japan into a haven for bond investors. Foreign ownership of Japanese government bonds rose to a record 8.3% last year.

Yields on the 10-year benchmark slid half a basis point to 0.795% today in Tokyo, after last month falling to 0.72%, the lowest since 2003. Only Switzerland pays less to borrow. Yet Japan's debt comes to about $93,000 per person, compared with about $33,000 in both the U.S. and Greece, according to Bloomberg data.

You're probably thinking what most of the world's financial press thought. This story seems small. Unimportant. Insignificant.

But it is THE story of our time -- and a harbinger of the coming worldwide financial implosion.

Do you recall the news reports in 2001 as Argentina slipped into the biggest default the world had ever seen -- $100 billion worth?

Groups of housewives began beating on pots. They called them the cacerolazos. They were protesting the corralito, in which the government forcibly trapped (corralled) their savings by freezing bank accounts and blocking physical access to banks. This backfired almost immediately... triggered a nationwide panic... and led to a breakdown in the financial system -- including the above-mentioned defaults.

The background to the story was that Argentina had borrowed too much money from foreign creditors. So much that it couldn't pay back its debts. And because the peso was pegged to the U.S. dollar, it meant Argentina had no independent monetary policy. This led to a variety of measures -- including shutting down the banking system to top capital flight.

In the end, however, nothing worked... except the default.

Bad debt is bad debt. It is bad because it can't be repaid. The debtor can hem and haw... he can delay and obfuscate. But he can't pay. And sooner or later, the day of reckoning comes... and all hell breaks loose.

That is why this story is important.

To keep up with the debt, Japan is taking more money from citizens -- by way of a bigger sales tax. The tax is modest. It should be no big deal. But there is only a limited amount of real purchasing power in an economy. And it is that purchasing power that must, ultimately, be the source of debt repayment.

A sales tax merely transfers money from households to the government. Japan's households already are not big spenders. The extra tax will make them spend less, leading to further economic weakness... and possibly the need for more borrowing!

In their book This Time Is Different, professors Ken Rogoff and Carmen Reinhart note that after government debt passes 90% of GDP, it weighs so heavily on the economy that it acts as a brake on growth. In small countries -- or those that can't borrow in their own currencies -- the breakdown comes quickly. In large ones, it can take many years.

Japan has the world's third-largest economy after the U.S. and China. It also has a printing press.

In today's world, as we observed a few days ago, a printing press in the hands of debtor nation is like a bomb strapped to the back of a bank robber. It works only if people think you're crazy enough to pull the cord.

If you seem ready to blow yourself up, people will give you money. Bank clerks hand over stacks of $100 bills. Investors give you hundreds of billions, sure that you will print up enough to make sure they get paid back.

This bank-robbing phenomenon makes it easy to sustain debts far beyond those that any sensible person would consider healthy. At 230% of GDP, a normal interest rate of 5% would mean that more than 11% of output must be used to support past spending.

Japan's government collects 28% of GDP in taxes and borrows another 10%. But this works only if it pays almost nothing on interest on its debt. Were interest rates to return to "normal" levels, Japan would have to cut half of its spending in order to stabilize its debt.

Is that likely?

No. It is probably not even possible, since cutting government spending on that scale would bring such a sharp drop in GDP and tax collections that the entire economy would fall apart.

More likely, Japan will print money to cover its debts. This will spook investors, who will drop the Japanese yen and Japanese bonds. Still a disaster, but of a different sort.

In short, Japan's debt is bad. It is just a matter of time until the world realizes it. Maybe a year. Maybe five years. We will see.

But when Japan's debt goes bad, investors will begin to take a hard look at other big economies that also have printing presses, especially the U.S.

At this writing, the U.S. could still probably escape disaster. It is a political issue now. A government with enough guts and foresight could cut spending by 10%, foreswear borrowing and avoid the Japan trap.

Will that happen?

We wouldn't bet on it.

Editor's Note: A potential loss as large as Black Friday and Black Monday...

I'm predicting that, on Oct. 1, 2012, a major economic catastrophe will occur in the United States. When the markets open the next day, you could see stocks plunge 10% or more. A one-day loss of that size has happened only three other times in history...

On Oct. 28 and 29, 1929 -- the start of the Great Depression. And on Oct. 19, 1987, better known as "Black Monday" to stock market veterans.

Will this October be the beginning of the next depression? To find out... and to learn about safe alternatives for your money outside the stock market, read this letter now...