Abe's Debt Bomb

Happy New Year. Out with the old, in with the new, or year going, year coming, as they say in Japan. This week: Prime Minister Abe prepares to detonate the debt bomb, spurious data on Japan’s “surging” fossil fuel use, and contemplating nuclear war without nuclear weapons.

The Fukushima Daiichi NPP catastrophe would pose enormous challenges to any country, even to one with the best material circumstances to respond to it. To understand why Japan is so dismally unable to decommission the site and give a better life to its victims, one has to take account of dire lack of human and financial resources that Japan has even for its normal functioning, let alone for recovery from a massive natural disaster and what may be the largest industrial accident in history.

The problem is that few people in Japan, from its leaders to its kindergarten students, are even aware of how bad things are. For the last twenty years, Japan has been living by borrowing the savings accumulated by the post-war generation that rebuilt the country. Since this borrowed money has allowed the nation to maintain a comfortable standard of living, few are aware of just how bad things are going to get. Pretty soon, the cheap supply of money will be gone.

One person with the professional credentials to alert the world to this coming crisis is J. Kyle Bass, founder of Hayman Capital in Houston, Texas. He is famous for having foreseen the subprime crisis and for having protected his clients from it. Since then he has been warning of the dangers of sovereign debt.

In a video of his keynote address at the AmeriCatalyst conference on October 1, 2012, Kyle Bass had much to say about the frightening day of reckoning that is in Japan’s near future. Notes on the parts of his keynote address pertaining to Japan are below:

1.           The quantitative analysis of the global debt crisis is already done. It is now only a matter of when and how the consequences will be realized.

2.           In the past ten years, total global credit market debt (sovereign obligations, corporate and household debt…,) has gone from $80 trillion to $200 trillion – this is 11% compound annual growth rate. This rate is way ahead of global population growth (1.2%) and GDP growth (3.8%).

3.           We know from history how this ends. This ends with war, which is economic entropy played to its logical conclusion.

4.           Global debt is 340% of global GDP.

5.           Post WWII, 48% of countries decided to restructure their debt.

6.           We have already seen social unrest over food and entitlements. What we have seen in Greece, for example, is not just a little social unrest.

7.           We all react to pessimistic forecasts with the optimism bias. We admit bad things will happen, but we think they will happen elsewhere to other people.

8.           Another sign that history is repeating itself in is in the recent expression of nationalism between China and Japan over the Senkakus, islands which, despite what you have heard, have no resources worth fighting for.

9.           Many people fail to see looming crises because they believe axiomatic truths (truths deemed to be true only because everyone repeats them) such as “real estate always goes up.” An axiomatic truth about Japan is that its debt doesn’t matter because “Japan is self-funding” – that it doesn’t borrow money outside Japan, so things will be alright. This is simply not true.

10.        We are slow to see crises coming because doomsday beliefs don’t help us, so we don’t want to believe them even though they may be accurate.

11.        The end won’t be announced. The people managing the crisis and making decisions in back rooms believe, “When it becomes serious you have to lie.” Their job is to promote confidence. [This is strikingly similar to what happens in a nuclear emergency. Preventing panic is believed to be a justifiable sin.]

12.        Japan has a debt to GDP ratio of 211%. This is far higher than some other developed nations that are considered to have serious problems with a ratio of around 100%.

13.        There is 1 x 10E+15 yen of debt in Japan [that’s a 1 followed by 15 zeros, or one thousand trillion. Or it’s 1.17 x 10E+13 US dollars at 85 yen/dollar, which is $11.7 trillion. US debt: $16 trillion, with a GDP and population both about 2.5 times those of Japan]. Japan's debt can never be repaid.

14.        There will be a bond crisis in Japan in the next 2 to 3 years.

15.        Japan now spends 10.5 trillion yen/year on interest, while it brings in only 42 trillion yen in revenue.

16.        If interest rates go from where they are now (less than 1% and very close to zero) to 2% or higher, Japan will be in default. Every yen of revenue will have to go to interest payments. This is very simple math that many smart people refuse to acknowledge.

17.        A trade surplus turns into corporate profits and wages which become savings that can be used to fund government bonds.

18.        Self-funding of deficit spending is possible only if the trade surplus is large enough. Japan is now showing trade deficits, but even a surplus can be insufficient if it is not big enough to fix the problem. The only choice is to print more money or be a capital importer. Both of these alternatives lead to higher interest rates on the national debt.

19.        Competition for foreign investment will be severe when Japan has to borrow internationally. Who will buy Japanese bonds at 0.5% if they can get higher returns by buying the bonds of other countries? In the past, investors settled for the low returns on Japanese bonds because of the strength of the yen and the economic stability of the country. These strengths will not exist in the future.

20.        The homeostasis of the past 20 years cannot continue. Japan is at the end of its rope.

21.        The desperation is evident in the advertising campaign that uses Sumo wrestlers and the girl band AKB48 to sell government bonds.

22.        Similar problems exist elsewhere. The Asian trade surplus is at its lowest in recent history. The world is about to enter an era of sovereign restructurings.

Just before the recent Japanese election, Kyle Bass added to his October speech by writing on his blog about the ill-advised economic policy that the new prime minister, Shinzo Abe, wishes to follow: 

“Japan is already running a minus $100 billion trade balance…, and the country's GDP has been hit by Chinese boycott stemming from the Diaoyu/Senkuku islands dispute… We think Abe is a shoo-in. And he said he's going to do everything possible to get to 3 percent inflation. He doesn't even know what he wishes for because if he gets there, he detonates his debt bomb.
  When there's a press release put on the BOJ's website from the MOF, the BOJ and the government — that's analogous to Bernanke, Geithner and Hillary Clinton issuing a joint press release saying 'we're going to end deflation'. This is how it begins to happen. Their backs are against the wall. They have a full crisis. They absolutely have to change the manner in which they deal with their currency.”

Interestingly, for the past two weeks the Japanese media have been awash in the new axiomatic truth that because TEPCO stocks, and the stock market in general, responded favorably to Abe’s inflationary plans, this must mean that economic recovery is at hand. I heard this view repeated several times by people around me, even by my students who are, at all other times, blissfully ignorant of current events.

Spurious claims about fossil fuel imports

Kyle Bass’ analysis should be taken seriously, but the discussion needs to expand to the broader issues of environmental preservation and avoidance of conflict and social upheaval. Obviously, the implications are enormous. If every yen of government revenue has to go to service debt, that means there will be no money for education, health care, pensions, defense, and none for cleaning up the legacy of Japan’s fifty-year experiment with nuclear power. The debt bomb leaves nothing for decommissioning the wreckage of Fukushima Daiichi, nothing for decommissioning aging reactors, nothing for a final storage solution for the nuclear waste now in temporary storage. And definitely nothing for the 160,000 nuclear evacuees.

Furthermore, the fiscal crisis tempts policy makers to see further use of nuclear power plants as the solution to the trade deficit.  Nuclear fuel is indeed extremely cheap compared with the cost of importing fossil fuels. There are the future costs of decommissioning and spent fuel storage, but no one is going to worry about those in a crisis. As usual, push that one off onto future generations. The other large cost is construction of the plants, but that has already been done. In fact, all the money sunk into the nuclear industry could be considered as regrettable addition to the national debt, a lost opportunity to invest in renewables and energy efficiency. Even if everyone could agree that it was a horrible error to go down the nuclear road, the logic dictates that they might as well use the facilities that have been built.  On the other hand, it might be wiser to see the Fukushima catastrophe as a final warning about operating nuclear plants in a land riddled with seismic fault lines. The Japanese government risks destroying the whole country with another nuclear accident, but with their backs up against the wall, this is the sort of desperate kamikaze behavior politicians now favor.

In addition to the Fukushima catastrophe, the nuclear industry wasted trillions of yen in national treasure before 2011. One of the largest nuclear plants in the world, TEPCO’s Kashiwazaki, has been offline since the 2007 Niigata earthquake because of newly discovered fault lines that weren’t supposed to be there. Fault lines keep appearing under other existing reactors. The reprocessing facility in Rokkasho and the fast breeder Monju reactor have wasted trillions of yen also, without having ever produced any of their promised benefits.

It is a dangerous illusion to be tempted to go back to nuclear as a fix for the fiscal deficit. It is folly to carry on with a dangerous technology that has devoured, and will continue to devour, so much of the nation’s wealth.

Nonetheless, there is an emerging axiomatic truth that Japan needs to reduce fossil fuel imports in order to mitigate economic decline. It has been repeated often in the domestic and international media throughout 2012, but the numbers don’t seem to back up the claim.

OECD data reports that its member countries use the majority of fossil fuels for transport, heating and industrial applications, and non-energy uses such as plastics. I couldn’t find any data on Japan itself, but it is not likely to be much different from the average of OECD countries (which Japan belongs to). Before 2011, about 20-30% of Japan’s electricity was produced by nuclear energy, and after the shutdown of nuclear plants this had to be covered by increased use of fossil fuels. But electricity is not the biggest part of energy consumption. The International Energy Association reports, for example, “In 2009, heat represented 47% of final energy consumption [worldwide], compared with 17% for electricity, 27% transport; and 9% for non-energy use.”

Much of the reporting on the energy crunch caused by the loss of nuclear has framed it as a sudden 40% (or larger, the figures vary widly) increase in fossil fuel imports, but the increase of course has to be much smaller when it is seen as an addition to fossil fuel imports for all purposes, not only for electricity generation.

Japan gets all its fossil fuels through imports, and according to the World Bank, for the last decade in Japan, energy derived from fossil fuel accounted for about 81% of all energy produced. The rest came from hydro, nuclear and renewables. If this is the case, how could the loss of nuclear power cause such a crippling disaster for the balance of trade? At most, the increase in fuel imports would have been 10-15% if we imagine adding to the 81% figure above (assuming renewables and hydro would account for the remainder). If it had really been such a crisis, there would have been a conservation program aimed at reducing the biggest factor in fuel imports - consumption of fossil fuels for transportation and heating. There would have been fuel rationing in a real emergency. Instead, all the talk was of the need to conserve only electricity, and even that attempt wasn’t as severe as it could have been. The cigarette vending machines stayed on, and people were told to keep shopping to support the economy.

The Federation of Electric Utilities of Japan provided this data about the spike in fuel imports, comparing January 2011 and January 2012:

Mark Caine, a research officer at Research Officer at the London School of Economics, used the above table to write an obfuscating report about Japan’s energy crunch. It is typical of how the power companies and the media confused the public about how Japan consumes fossil fuels:

“The Federation of Electric Power Companies, an industry group representing Japan's largest electric utilities, has just released new data on Japanese fossil fuel imports for January 2012. The data reveal that last month, despite an overall drop in economy-wide energy use, Japan imported and consumed far larger quantities of fossil fuels than it did in January 2011 [italics added], before its earthquake, tsunami, and nuclear disaster upended its economy and energy system.”

He states, “Japan imported and consumed far larger quantities…,” but what is obscured here quite deliberately is the fact that this data refers not to fuel imports by Japan as a whole but to fuel imports by Japan’s electric utilities. Their purchases increased, but purchases for transportation and other uses did not. Later in the report he writes, “To meet surging demand for these fossil fuels, Japanese utilities increased imports of fuel oil by 165%, crude oil by 174%, LNG by 39%, and coal by 12%. It appears that much of this fuel was used for thermal power generation.” If not for thermal power generation, what might have these electric power companies used the fuel for? In any case, even if this sentence now uses the factually correct grammatical subject “Japanese utilities,” the numbers still seem suspicious. If nuclear used to account for 30% of electricity generation, how could its loss cause these increases of fossil fuel imports of over 150%? The government’s own charts show fossil fuel generated electricity going from about 60% to 80%, only a 33% increase (Japan Agency for Natural Resources and Energy. 2012 White Paper on Energy, p. 132). The public is clearly being deceived.

The hand-wringing over fossil fuel imports appears to be a well-crafted public relations trope that has succeeded in winning back some public sympathy for the restart of nuclear plants. However, the fact that Kyle Bass didn’t mention the energy crunch at all lends support to my theory that it is a cynical distraction. People who have been paying attention to Japan for a long time know that its severe demographic, economic and fiscal problems had started long before March 2011. For that matter, the nuclear industry had been bruised and battered for a long time as well. The one good thing about Fukushima Daiichi is that it woke people up to the overlooked hazards of other plants: Kashiwazaki, Shika, Hamaoka, Tsuruga, Mihama, Higashidori, Rokkasho, Monju – so many with newly discovered problems that even if the new Nuclear Regulatory Authority decides that some plants are safe to restart, the future costs of decommissioning all the unsafe ones will be staggering expenses lasting for decades.

Nuclear War without Nuclear Weapons

As if this sobering fact were not enough, I have to conclude with Kyle Bass’ rhetorical question (at 5:00 in the video referenced above): “You know how this ends, right?... This ends through war… it’s economic entropy played to its logical conclusion.”  A war among developed countries - for example, the U.S., Japan and China fighting over control of the South China Sea – is almost impossible to imagine. It would be like no war the world has ever known.

All wars since WWII have involved conflict between or within developing nations (which were often proxy wars between superpowers) or between superpowers and developing nations. One type of conflict that hasn’t happened in seventy years is direct conflict among superpowers and developed nations. When London, Tokyo and Dresden were being bombarded during WWII, there were no nuclear power plants. If there had been, Japan and Europe would have been rendered uninhabitable. We know what happened when Chernobyl exploded, and that it could have been more devastating if a second explosion had not been averted. The frightening question to contemplate concerns what would happen today if a similar conflict erupted between China and Japan, or any other pair or alliance of countries with nuclear power plants.

A modern war would proceed much like the 1990-91 Gulf War on Iraq. Before troops marched in, attackers would aim to soften up the enemy, to destroy infrastructure and the ability of the enemy to wage war. Electricity supplies would be knocked out, so nuclear power plants would be forced to rely on backup power, but it would be unlikely that they could keep it going long enough. Supplies of emergency diesel fuel would be unreliable, and the main grid might not be repairable while the country was under attack. If things got really ugly, there could be deliberate or accidental bombing of nuclear power plants or spent fuel storage sites. Some facilities are supposedly built to withstand air plane crashes, but consider the vulnerability of spent fuel storage, especially the ruins of Fukushima’ spent fuel pools.
The existence of four hundred nuclear plants around the world might be a deterrence in the same way that nuclear arsenals are. If hostile nations rationally assess the risks, they will be deterred from escalating tensions with any nation that has a civilian nuclear capacity, let alone one with nuclear weapons. During WWII, American forces began planning for the occupation of Japan while they were still bombing it, which is the reason they spared the Imperial Palace and a few other locations. In the same way, aggressors might refrain from creating a nuclear wasteland in a country they might want to exploit or occupy at some future date. Or they might refrain from creating a nuclear catastrophe that would impact wide regions beyond the countries involved in the conflict. On the bright side, another kind of deterrence lies in the fact that so many developed countries have little for aggressors to covet. It is doubtful that anyone would want to occupy and govern a country that has the nuclear fallout and wreckage of Fukushima Daiichi to clean up – a job that is to be done by a population that now needs more adult diapers than baby diapers. The recently elected Japanese hawks talk so much about the need for better defense, but they fail to see that this goal may have already been achieved. If you want to be safe from attack, wear an old coat and drive an aging, rusted car.

Further reading:

Martin Walker. "Japan's Looming Crisis." UPI.com. November 19, 2012.
Khosrow B. Semnani, Gary M. Sandquist. "The Next Chernobyl?" The New York Times. January 2, 2013.
A contrary view: 
Joe Weisenthal. "Kyle Bass's Most Famous Trade Is A Disaster, And It Is Never Going To Work Out." Business Insider. May 20, 2012.