Japan, Black Swans and Debt
The news out of Japan is both gripping and agonizing. I don't have the eloquence to capture the heartache many of us here in the United States feel towards the agony being suffered by those in the path of destruction wrought by this earthquake. As things continue to unfold, we are all hoping for the best for the Japanese people.
I am sorry to disappoint our readers, but I'm traveling this week and have not gotten the time I had hoped to write for Monday. I've broken away as much as possible to check the latest out of Japan on my phone and my plan for today was to make two points. Fortunately I have found someone who made the first better than I could. Let's start with that.
My first thought when this happened, especially the nucleur meltdown, was Black Swan. Just like Hurricane Katrina, there were just too many things that could go wrong and, when you ran time out to infinity, failure at some point was essentially preordained. In this case, my initial question was whether or not they had designed for a quake of this magnitude.
The answer was, they had not. They had tested the Fukushima Dai-ichi facility for a 7.9 quake. This quake was a 9.0, more than 10 times more severe by the Richter scale. They apparently made 7.9 the highest scenario they felt possible based on past seismic data. Unfortunately, as Nassim Taleb would say, no number of observed white swans can prove that all swans are white, but a single black swan is sufficient to disprove the notion.
My source for this data, and the article you should be reading, is on the Oil Drum and is titled, How Black is the Japanese Nucleur Swan? The author concludes that this was not a black swan event as it was predictible. Yes, for some, but obviously for millions of Japanese, including those that built and operated this plan, they did not envision the possibility of an event of this magnitude. The rare event, the Black Swan, continues to be THE game-changing force for humanity.
My second thought had to do with Japan's debt and prospects for recovery. This is premature as the crisis is not over, I know, but this is how my mind digests these events.
Japan is often used as an example by American-debt-apologists of an advanced economy that has been able to withstand a high level of debt. In 2010 it had an estimated debt to GDP ratio of 196, meaning they owed roughly twice as much as their yearly economic output. The only country with a worse ratio is Zimbabwe, long held as the consensus worst-run economy in the world. For comparison, the four "failing" economies of Europe -- Greece, Ireland, Portugal and Spain -- have debt to GDP ratios of 144, 98, 83 and 63 respectively. So why has Japan been able to run up such a massive debt?
The answer is complex, and I don't pretend to understand it completely, but two principle reasons are that the debt is largely held domestically and Japan holds a high amount of foreign currency reserves.
According to the Economist, at the end of 2008, 94% of Japan's debt was held by the Japanese. For comparison, about half of U.S. debt is held domestically. The Japanese people are savers, so much so that they have seen two decades of stagnation and deflation (falling prices at least partly due to lack of consumption). The government is not likely to default on their debt as that would mean stiffing their own people. They are also not going to print money for the same reason.
This has all created a rather weird world where, despite the oversupply of Japanese debt, the rate the government finances remains very low. The current benchmark rate is 0%. Doesn't go any lower than that. There are concerns, with Japan's aging population, that domestic selling of debt to finance retirements would impact rates as Japan would then need to sell to foreign buyers. It is not clear how this crisis will impact those economics, but any uptick in rates would make life difficult with those levels of debt.
In terms of foreign currency reserves, as of February, Japan owns 9.6% of America's national debt. That is roughly $1.4 trillion. So on one hand, the government owes a lot of money. On the other, they have a big rainy day fund. This is quite stereotypically Japanese and quite un-American, but it may now be the thing that helps them through this terrible disaster.
The interesting follow up question is how this might impact the United States. It is not clear that Japan will be in a position to continue to buy and hold American debt. With QE 2 ending and the United States scheduled to run a deficit of $1.7 trillion this year, taking a major buyer of our debt off the market can't help us. Interest rates reflect the supply/demand of money, with lower demand yielding higher rates. I don't see how this helps us retain a low interest rate regime.
There is a CNBC article that touches on this, but also present a counter arguement that can be summed up by saying that, when things go all to hell, people buy dollars. Yeah, America. I'm not sure that is a long term strategy and I'm not sure that would even counterbalance the impact of a Japanese selloff of U.S. debt, but hey, there has to be two sides of every theory.
Whatever happens, it is clear that the natural order of things tends to treat systems that are both complex and efficient very cruelly. Complex and redundent or simple and efficient, but nature (including human nature) tends to destroy systems that are complex and efficient. This is where the term "fracture critical" gets it potentcy.
I'm quite a long ways from my grandfather at the moment, and I'm not sure he is in a mental state to understand what is going on, but I yearn for a conversation with him. He was one of the first U.S. Marines into Nagasaki after the atomic bomb was dropped in 1945. It affected him greatly and he was never able to share with me much beyond the obvious horror he felt. We're all human and in our hearts I believe that we all grieve for those that have been lost, those that are still in harms way and those that may be asked to pay a steep price to deal with the consequences of this event.
Thoughts of peace from us to everyone in Japan today.