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Tuesday, August 09, 2011 11:25 AM

Worst Demand on Record for Japanese 40-Year Bonds; Can Japan Service its Debt? How?

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Inquiring minds may be wondering "With a Debt-to-GDP ratio exceeding 200%, how is Japan going to service its national debt?"

I have been wondering that for for years. Adding fuel to the debate, please consider Worst 40-Year Bond Sale Shows Cash King as Investors Flinch

The worst demand on record for 40- year Japanese bonds sold yesterday signals growing concern about Japan’s ability to service the world’s biggest debt pile and the risk of holding long-term securities while markets are volatile.

The 400 billion yen ($5.2 billion) sale drew bids valued at 2.03 times the amount on offer, the weakest since the Ministry of Finance began selling the securities in 2007.

The yield on the 2.2 percent bond maturing in March 2051 jumped 15 basis points to 2.335 percent as of 5:07 p.m. in Tokyo at Japan Bond Trading Co., the nation’s largest interdealer debt broker.

Japan’s Ministry of Finance said that every 1 percentage- point increase in 10-year yields above 2 percent would add 1 trillion yen in debt-servicing costs to a projection of 22.9 trillion yen for the fiscal year starting April 2012. The nation’s total debt may reach 219 percent of gross domestic product next year, according to the Organization for Economic Cooperation and Development.
Double-Edged Sword

Please note that was not a failed auction. Indeed it was oversubscribed. However, nearly all of that demand is internal.

Internal demand is a double-edged sword. Right now it is still sufficient. However, when (not if), Japan ever needs foreign buyers for its bond market, rates will not be 2.3% on 40-year bonds.

On account of miserable and worsening demographics, bond redemptions have started. However, those redemptions are a still a trickle. That trickle will at some point turn into a torrent.

Balance of Trade a Key Issue

People have been talking about this for years, although I have not seen discussion of the trade angle before.

Here is the key: If Japan does not maintain a trade surplus covering both interest on its national debt and bond redemptions, all hell will break loose. This gives rise to the question as to how long Japan's vaunted export machine can remain intact. I do not have the answer to that question, but China and the rest of Asia are nibbling away bits and pieces now. The tsunami sure did not help.

Trade issues and demographics explain Japan's paranoia regarding a strengthening Yen. It is also another one of those global imbalances that "does not matter, until it does, and it will" kind of things.

It is mathematically impossible for every country to maintain a trade surplus, yet every country wants to do just that.

Mike "Mish" Shedlock
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