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Home Publications Blogs Beat the Press What Does S&P's Downgrade of Japan's Debt Mean?

What Does S&P's Downgrade of Japan's Debt Mean?

Wednesday, 24 August 2011 04:58

The NYT reported on S&P's downgrade of Japanese government debt to the 4th highest level. It explained the downgrade by noting Japan's continued weak growth, political problems and concerns about deflation. These are factors that might concern the Japanese public when they vote for their leaders, but it is difficult to see what they have to do with bondholders holding Japanese government debt.

Bondholders are presumably worried about whether they will get paid back. None of the issues raised in this discussion have any direct bearing on whether Japan's government can repay its debt. In fact, since the debt is denominated in yen, it would be difficult to understand how Japan would be unable to repay its debt, unless it forgets how to print yen.

In fact, the concern about deflation undermines one of the arguments that is occasionally made in the context of the U.S. downgrade, that S&P is concerned about inflation eroding the value of the debt. While this story never made sense in any case, if Japan sees deflation then bondholders will actually be repaid in yen that are worth more than the yen they lent. (The credit rating agencies are not in the business of making inflation forecasts. Furthermore, if an increased risk of inflation was the basis for its downgrade then S&P should have downgraded all dollar denominated debt regardless of the issuer.)

It is important for the media to analyze the basis for these downgrades since there are serious questions about the competence of S&P and the other credit rating companies. They rated hundreds of billions of dollars of subprime mortgage backed securities as Aaa. They also gave top investment grade ratings to Lehman, Bear Stearns and AIG until their bankruptcies (or bailout in the case of AIG).

Given their abysmal track record, it is entirely plausible that there is no basis for their downgrades of sovereign debt. There certainly cannot be a prima facie assumption that they have any idea what they are doing. 

Comments (6)Add Comment
written by GP, August 24, 2011 8:57
Moody's downgraded Japa, not S&P
written by skeptonomist, August 24, 2011 9:05
I agree that S&P's downgrade is probably meaningless, but again the fact that a country has its own currency certainly does not prevent it from defaulting on its international debt. Dean himself often refers to Argentina's default of 2002. Japan and the US are not Argentina or Greece, but the difference is not primarily a matter of currency or monetary policy, it is the underlying soundness of the economy.
Moody's, not S&P
written by LI, August 24, 2011 9:12
And the fact that it's Moody's (which would more properly be "Buffett's") and not S&P matters. and I doubt we'll see him or McDaniel forced out like Sharma. It also matters in terms of not having a hard currency reserve-status competitor with a better 2/3 rating than us - so it may be a bit of a preemptive move on our part to stabilize the situation still embedded in billions of financial contracts.

But let's be clear here - is it your position that countries with their own currencies should always be rated AAA? It'd be nice if we could do away with the obscure letters and get the "Expected Real Present Value" instead.
written by Alex Sinclair, August 24, 2011 10:19
Japan is a basket case. The issuance of new debt exceeds current revenues and the savings rate has dropped below 2% from 16%. The large buyers of JGB's are mostly net sellers and the retirement fund is liquidating $78 billion for the year with higher liquidations next year. Japan Post, the largest financial institution in the world, owns a high % of JGB's and is trying to diversify away from JGB's. Older Japanese, who were the savers, are entering retirement and liquidating bank deposits because earnings/interest is littl or nothing. Even if the central bank buys JGB's; it does not improve the long term outlook. Confidence about the government's ability to pay back the debt and what it is worth when you get it back is the real question. Once confidence is lost, it is hard to recover. Japan is in for a series of credit downgrades because the rating agencies must look at the big picture. It is only a matter of time til they lack enough buyers. International buyers are not interested in low yielding JGB's with a big currency risk.
written by Alex Sinclair, August 24, 2011 4:56
Japan has used Keynesian stimulus, almost exclusively for infrastructure, over 21 years and it did not revive their economy but left them with a huge pile of debt. Interest cost at a blended 1.4% is now 22.4% of revenues. Social Security is 55% of the budget and getting larger. Japan should downsize government to give their young people a chance at financial survival. Japan's government is in the business of destroying wealth. Stocks are off 80% in 22 years and real estate is off 60% in 21 years and the government is in the process of borrowing the savings of an industrious people and they will not be able to pay them back. Face the facts politicians should have financial limits from the very start. They are not capable of managing finances. Japan needs to cut the size and cost of their government substantially and/or reduce their unfunded social security and retirement benefits to a manageable level. Half of current spending is borrowed and the economy has not been growing and with the government absorbing the savings; it will not be growing. By the time the people realize that the government cannot meet its promises; it will put a lot of people in dire straits.
Pittsburgh Pirates
written by Pittsburgh Pirates, August 26, 2011 9:22

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.