Tag Archive for: FederalGovernmentDebt

Japan’s Government Looted the Future—and Its Children Are Paying the Price

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Estimated Reading Time: 3 minutes

Japan’s fiscal mismanagement and massive national debt violate the principles of democratic fiscal responsibility.

 

Editor’s Note: The years from 1991 to 2001 are known as “The Lost Decade” in Japan. After years of rapid growth in the 1980s, the Japanese economy fell into a prolonged slump marked by persistent, high unemployment, low growth rates, and erratic monetary policy. (See “The Lost Decade” for additional information on this.)

In recent years, Japan’s economy has somewhat rebounded but as economist Hiroshi Yoshida explains below, new issues are now arising that call into question Tokyo’s increasing debt. One of the problems he identifies is present here in the US as well, namely, “Not enough people stand up for future generations when it comes to fiscal policy.”)

 

The only transactions that can happen in a market are ones where both parties mutually benefit and can say arigatо̄ (thank you, in Japanese) as a result. By using accounting to examine such transactions we know that both parties’ utility increases; both are better off as a result of completing the transaction. On top of that, people are not worse off than they were before should they decline to engage in a given transaction.

Governments are run by taxes. The main concern of public finance, however, has from the beginning been to raise the largest sums with the least resistance. In a nation that advocates democracy, the people also called the citizens or the taxpayers, are sovereign. Taxes can only be levied with the consent of the governed. Running a deficit and burdening children and the unborn is in direct conflict with the principles underlying democratic fiscal policy. Never shift your deficit onto your children; that is a cornerstone to democratic governance.

Here in Japan, we must also reject the notion that we can rack up the national debt and use it as a source of financing. Yet future generations don’t have a say in what the government does here and now. Not enough people stand up for future generations when it comes to fiscal policy. In 1965, Japanese government bonds (JGBs) were issued to cover a revenue shortfall of 5.3% of government spending. Last year in 2021, that increased to cover 40 percent of government spending. The outstanding balance of government bonds issued on an ongoing basis is now twice Japan’s GDP.

When the market is allowed to function it determines interest rates, the rate at which people can borrow capital. If the economy does not grow, it is not possible for a borrower such as the Japanese government to pay back a loan with interest.

The 1492 Summa de arithmetica, written by Italian mathematician Luca Pacioli (1445-1517), contains a mathematical law known as the Rule of 72. This rule states that if you divide a given interest rate by 72, you can find the number of years needed for the principal investment to double. That would mean it takes 10 years for an investment to double at a 7.2 % interest rate. Let’s try this with an electronic calculator to see if it really works. Enter the number “1” and hit “x” button twice, and input 1.072 (a 7.2% interest rate). Hit the “=” button 10 times. The initial value ends up doubling, doesn’t it? When Japan started to stray from a balanced budget (1972-1987) the interest rate on JGBs was around 8%.

The interest rate on government bonds has since been lowered to reduce the rapidly growing outstanding debt and the cost of government bonds. It will take 14,400 years to double the principal at the current interest rate of 0.005 percent. To give you an idea of how long 14,400 years is, 14,400 years ago is when mankind finally began rice cultivation in the Yangtze River basin in China. That is prehistory; a time before mankind started keeping written records. It is impossible to double the principal of a sum of money without taking a long time at such an interest rate. Not only has issuing government debt left future generations to foot the bill, but the interest rate of only 0.005 percent on JGBs is a statement of the nation’s inability to grow the economy. Hopefully, Japanese taxpayers will take notice of this.

By lowering interest rates, the government’s interest payments have become smaller and the future value of money has decreased. The Bank of Japan holds more than half of the JGBs issued by the Japanese government. And now, as both the rate and value of the yen against the US dollar begin to fall, prices have started to rise. The price of iPhones in Japan is going up 20 percent this month.

Where there is good politics, people gather. That is to say, people vote with their feet, as my friends in America know from inter-state migration. Japan’s fiscal mismanagement and massive national debt violate the principles of democratic fiscal responsibility. As a result, Japan is losing its lure and appeal to future generations and the birth rate continues to plummet.

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This article was published by FEE, Foundation for Economic Education and is reproduced with permission.

 

Government Debt and Inflation: Reality Intrudes

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Estimated Reading Time: 3 minutes

The last couple of years has witnessed extraordinary spending by the federal government. It has been quite the party. Figure 1 shows government spending since 2000.

The increase to 30 percent of Gross Domestic Product (GDP) in 2020 stands out. Government revenue, also shown in Figure 1, does not jump. Federal government revenue in 2020 and 2021 is not particularly higher or lower than in earlier years. The increase in spending was financed by dramatic increases in debt. Public debt issued by the federal government increased from 107.4 percent of GDP at the end of the fiscal year 2019 to 127.6 percent two years later. As Figure 2 shows, the increase and the level are quite extraordinary.

Interest rates have been relatively low recently, which makes this level of debt not as onerous as it could be. In fiscal year 2021, the average interest rate on public debt was 1.8 percent per year. The low level of interest rates in the economy has made it possible for the federal government to borrow at historically low rates and to have relatively modest interest payments.

There is every reason to expect these low rates to disappear in the next year or two. In 1981, after the Great Inflation, the federal government paid an average interest rate over 13 percent in 1981 and 1982.

Inflation in the United States today is running over 7 percent per year; the low level of current rates will not persist. Whether the level of rates gets to 13 percent depends in part on the Federal Reserve. The Federal Reserve increased short-term interest rates at its meeting on March 15. Given the level of inflation of over 7 percent per year, there is little doubt that the Fed’s target interest rate and the interest rates paid by the Treasury will be rising quite a bit over the next year or even two if inflation is to be subdued.

The implications of higher interest rates for the federal government’s budget are not appealing. Even at the low average interest rate of 1.8 percent per year, interest payments were 12.7 percent of federal government revenue in fiscal year 2021.

What will happen when average interest rates on public debt increase? Holders of public debt today at 1.8 percent are losing on average more than 5 percent of the purchasing power of their funds in a year. An average interest rate of 5 percent on public debt suggests interest payments equal to 35 percent of current federal government revenue. This interest rate is hardly an attractive proposition though. At an interest rate of 5 percentage points, anyone holding public debt at current inflation rates still would be losing 2 percent a year in purchasing power. An average interest rate of 7 percent, high relative to recent interest rates but not high relative to recent inflation rates, would require 50 percent of the government’s revenue.

The Federal Reserve is currently committed to a slow increase in interest rates. A slow pace carries its own risks for controlling inflation. It does imply, though, that these extraordinary levels of interest payments compared to federal government revenue will not be reached in the near term. Just later rather than sooner.

There is a dilemma here though. Raising interest rates slowly given the current high inflation will let inflation get worse. Raising interest rates quickly has the potential to make the federal government’s budget deficit dramatically worse.

Sooner or later, absent substantially lowering government spending or raising taxes, interest payments will overwhelm the government’s budget. The situation might even be termed a sovereign debt crisis because all the spending, revenue, deficit, and inflation choices are unpalatable.

One plausible resolution of the dilemma is to increase inflation even more than people expect. This would inflate away the extraordinary debt issued in the last couple of years. In a way, it resolves the dilemma, just not in a very desirable way from the viewpoint of holders of depreciating US dollars.

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This article was published by AIER, American Institute for Economic Research, and is reproduced with permission.