Developed Country Deficits Versus Developing Country Surpluses
A big factors in the “bubbles” of credit seen prior to the current financial/economic crisis was the emergence of a global saving glut during the past eight to ten years.
A number of key industrial countries other than the United States have seen their current accounts move substantially toward deficit since 1996, including France, Italy, Spain, Australia, and the United Kingdom. The principal exceptions to this trend among the major industrial countries are Germany and Japan, both of which saw substantial increases in their current account balances 1996. A key difference between the two groups of developed countries is that the countries whose current accounts have moved toward deficit have generally experienced substantial housing appreciation and increases in household wealth, while Germany and Japan–whose economies have been growing slowly despite very low interest rates–have not. As higher home prices in turn have encouraged households to increase their consumption, there is an evident link between rising household wealth and a tendency for the current account to shift toward deficit. However, the greater extent to which capital inflows acted to augment residential construction and especially current consumption spending, the greater the future economic burden of repaying the foreign debt became.
Thus the large current account deficit of the United States in particular requiredsubstantial flows of foreign financing even before the current financial/economic crisis. This financing was increasingly dependent on foreign investment, particularly the recycling of excess savings in the developing markets through foreign government purchases of US treasuries.
On the other hand, the balance of payments of developing countries moved into surplus as the result of successive crises (Asian currency crisis, Russia, Brazil, Argentina debt crises), emerging-market nations either chose or were forced into new strategies for managing international capital flows. Asian developing nations in particular built up “war chests” of foreign reserves used as a buffer against potential capital outflows. These countries increased reserves through current account surpluses and the expedient of issuing debt to their citizens, thereby mobilizing domestic saving, and then used the proceeds to buy U.S. Treasury securities and other assets. Another factor that contributed to the swing toward current-account surplus among other non-industrialized nations (particularly the Middle East) was the sharp rise in oil prices. Between 1996 and 2003, for example, the bulk of the increase in the U.S. current account deficit was balanced by changes in the current account positions of developing countries, which moved from a collective deficit to a surplus between 1996 and 2003.
The result was rapid capital flows into the United States and other developed nations, fueling bull markets in stock prices and in the value of the dollar. Thus the rapid increase in the U.S. current account deficit between 1996 and 2000 was fueled to a significant extent both by increased global saving and the greater interest on the part of foreigners in investing in the United States.
What Has Changed?
In the aftermath of the financial/economic crisis, fiscal deficits of the developed nations are set to explode. It is now estimated that total government bond issuance by the US, Europe and Japan will reach the JPY equivalent of JPY400 trillion in 2009, which represents an increase of JPY100 trillion over 2008. According to the US Congressional Budget Office, the US will be issuing approximately JPY136 trillion of Treasuries in 2009 to fund a projected fiscal deficit of USD1.2 trillion, which represents a 1.6-fold increase. According to Barclays Capital forecasts, sovereign debt issuance in the Euro area will reach JPY108 trillion. Japan on the other hand is expected to issue JPY132 trillion of debt including debt to refinance maturing JGBs.
High Risk of Sovereign Debt Indigestion
It is in this context of planned massive sovereign debt issuance that the recent failure of the first Euro sovereign debt issuance by Germany is an ominous warning.
If the excess savings glut in the developing nations was still growing at the pre-crisis pace, this JPY400 trillion of new sovereign debt might have been much easier absorbed. However, China, with the worlds largest pile of foreign exchange reserves, will need to fund their own massive domestic stimulus plan of $586 billion. On the other hand, oil exporting nations will have trouble funding fiscal budgets based on crude oil prices well above $60/bbl. Below $50/bbl, these nations will have to use increasing amounts of crude oil export revenues to offset budget deficits, and in the worst case, will have to dip into their sovereign wealth funds to plug budget holes. Moreover, forecasts for a decline in global trade in 2009 mean significant reductions in developing country balance of payments surpluses.
What this strongly implies is that all of the developed country planned debtissues may not be able to be smoothly absorbed by excess developing country savings without higher interest rates. As current government bond yields have priced in ultralow inflationary expectations of +/-1% for the next 10 years, there is also significant capital loss risk should all these efforts to kick-start the global economy unleash the dogs of inflation.
Debauching of the USD and Euro
The corrolary to massive developed country sovereign debt issues is the debauching of the USD and Euro. The JPY will not be debauched as much because a) Japan remains a net supplier of excess savings to the developed world, and b) less than 10% of Japan’s sovereign debt is owned by foreigners, even though Japan will need to attract more foreign capital to fund its latest round of debt issues. Foreign investors do need however to closely monitor, a) the rapid decline in Japanese individual savings rates (to 2.2% of late) and b) the increasing reluctance of individual Japanese savers to buy JGBs.
From what we can determine, the surge in JPY was much more the product of repatriation of excess Japanese savings in the form of reduced holdings in US treasuries and reduced forex trading as well as holdings in foreign funds by Japanese individuals than it was due to an unwinding of leveraged yen carry trades. Thus further repatriation of Japanese savings could, a) push JPY to a new high beyond the prior JPY79.5/USD in 1995, and b) exacerbate the supply-demand balance for US treasuries.
Japan investor tokyo takes 