Economic Collapse: Japan Downgrade Could Spark the Next Stock Market Crash

Japan DowngradeMoody’s and Fitch did this last spring. Standard & Poor’s (S&P) has joined them by downgrading Japan’s economy rating from AA- to A+, sending a strong signal that the rating agency is not bullish on “Abenomics” pulling the country out of economic collapse mode. All this despite the “promising start” after Prime Minister Shinzo Abe was first elected.

At first glance, the downgrade is not very substantial. However, this is S&P’s first rating cut since January 2011—before Abe’s election and in the midst of an economic slump. Now, the agency’s decision could have serious consequences for the Japanese economy—just as it happened for some European countries a few years ago.

According to S&P, “the government’s strategy to reinvigorate growth and overcome deflation seems unable to reverse the deterioration of Japan’s [credit risk] over the next two to three years.” In other words, S&P has forecast sluggish growth for Japan’s economy over the next few months. Apart from flaws in “Abenomics” and a sluggish internal consumption, external factors are putting pressure on Japan. If the Japanese economy doesn’t recover, the world risks an economic crisis in 2016.

“Abenomics” is a term derived from Prime Minister Shinzo Abe who won an election based on the promise of more public spending and an expansionary monetary policy in order to devalue the yen compared to the U.S. dollar (one dollar =  approx. 100 Yen) to stimulate exports and stimulate domestic industrial growth. In theory, leading to more domestic spending.  However, weak emerging markets, which have suffered yet another weak quarter and the slowdown in China, have weakened prospects of an export-driven recovery.

It seems Japan is suffering from the same malaise affecting China, a notion corroborated by the rise of debt. In other words, in 2016 both Japan and China could face recession if not outright economic collapse. The contagion would spread quickly to the rest of the world, making a U.S. stock market crash inevitable.

Inordinate Debt and Lingering Effects of 2008 Financial Crisis

Japan’s economy is still feeling the effects of the 2008 financial crisis and the great earthquake of March 2011, which caused a deadly tsunami and a nuclear meltdown. Nevertheless, Japan has also been the target of the international banking system’s mishmash of cures, which often exacerbate rather than cure the disease.

The International Monetary Fund’s (IMF) pressure to cut debt led Japan to raise sales taxes from five to eight percent in April 2014, reducing domestic consumption and precipitating Japan into recession. Prime Minister Abe has decided to postpone a scheduled second increase to the spring of 2017.

Meanwhile, Japan’s public debt, fueled by the bursting of a financial bubble originating in the early 1990s, is estimated at over 1,000 trillion yen. That needs a special word typically used to measure distances between galaxies: 1 quadrillion (over 7,500 billion U.S. dollars), or twice as much as its gross domestic product (GDP).

Echoes of Greece aside, the one redeeming quality of Japan’s debt is that, unlike the Mediterranean country, Japanese investors own it with the Bank of Japan having the lion’s share. Accordingly, in 2013 that very institution embarked on a major asset buyback program through government bonds with rates that “should increase when the central bank normalizes monetary policy.”

Of course, Japan is still the world’s third-largest economy and the world’s largest creditor. S&P has acknowledged this, noting that it still boasts a “diversified economy and stable political and financial systems.”

Still, Japan is now planning to introduce a three trillion yen (about US$24.0 billion) stimulus package while many analysts believe that the Bank of Japan will have to further ease its already “loose” monetary policy, further devaluating the yen. Moreover, in view of the effect of China’s devaluation of the yuan, further downward pressure on commodity prices would strengthen the deflationary trends that have emerged.

There is also the risk of a further yuan devaluation as possible retaliation should the U.S. raise interest rates on September 17th. Japan feels its inflation rate is too low in comparison to its two percent target while it remains highly dependent on China, which alone accounts for 2.7% of Japanese GDP according to Andrew Garthwaite of Credit Suisse. Nomura Securities, one of Japan’s largest financial institutions, warned that any further depreciation of the yuan would be bad news for Japanese exporters”.

From a different perspective, the world-renowned economist Thomas Piketty expressed his own skepticism of “Abenomics.” He blames the aforementioned sales tax increase for having failed to achieve any measurable growth, adding that the country is facing an unprecedented rise (in the post WWII period) of economic inequality.

Piketty said that Japan’s Gini coefficient (which measures the gap between rich and poor) is more pronounced in Japan than it is in Germany, France, Italy, and Canada, and 16% of the Japanese population lives below the poverty threshold as defined by the OECD (have fewer resources than half the average income).