Excessive debt is becoming a double-edged sword for Shinzo Abe’s Japan. For all the prime minister’s talk of fiscal consolidation and tax hikes to pay down debt, Tokyo keeps smashing records. The latest: national IOUs hit ¥1,080,441 billion in September, increasing by the equivalent of Nicaragua’s annual output in just three months.
But the debt that should worry Abe’s team the most over the next few months is Tokyo’s $1.1 trillion of U.S. Treasuries.
Even the International Monetary Fund recently threw shade at tax cuts for the wealthy — like U.S. President Donald Trump’s. It argued they’re not worth the fiscal fallout — rising bond yields and weakened creditworthiness — if middle-class households don’t enjoy most of the benefits. Republicans are pushing ahead anyway, leaving the Bank of Japan and Finance Ministry with the fallout — and a dicey geopolitical dilemma.
Best-case scenario is a $1.5 trillion price tag for cuts that will salve GOP donors but do little to hasten growth and wages. Cutting corporate taxes from 35 percent to 20 percent means little if not accompanied by guarantees executives will share the spoils with workers, as opposed to buying back stocks and upping dividends.
The only thing guaranteed here is who Trump expects to finance this gamble: Abe’s Japan and Chinese President Xi Jinping’s China, which is on the hook for $1.2 trillion of Uncle Sam’s securities. Question is, what will Washington’s bankers do? Ditto for other Asians in financial harm’s way. Hong Kong is sitting on $195 billion of Treasuries, while Taiwan has $184 billion, India has $145 billion and Singapore has $125 billion.
In the short run, Asia is likely to top up on dollars. Part of the calculus is to cap local exchange rates. It’s also about capital preservation. Any hint dollar-denominated debt is being shunned — a couple of bad bond auctions, perhaps — would shake global markets and leave governments with massive paper losses.
The longer-term strategies are anyone’s guess. Given the vast political capital Abe is investing in The Donald, odds are high that he would opt to bankroll “Trumponomics.” It might pay off in terms of better security assurances for Tokyo. Abe might also conclude that if massive tax cuts gin up U.S. growth — again, a big “if” — the end justifies the means for global growth.
Xi, by contrast, must be getting antsy about Beijing’s direct exposure to Trump’s erraticism. After declaring bankruptcy myriad times in his real estate magnate days, Trump hinted more than once that a U.S. default is an option. In May 2016, CNBC asked Trump how he’d manage a widening budget deficit. “I would borrow,” he said, “knowing that if the economy crashed, you could make a deal.”
Beijing was plenty spooked by Washington’s massive stimulus moves following the 2008 Lehman Brothers crisis, evidenced by then-Premier Wen Jiabao dropping all diplomatic pretense. “We have made a huge amount of loans to the United States,” Wen said in 2009. “Of course, we are concerned about the safety of our assets.” He urged Washington “to honor its words, stay a credible nation and ensure the safety of Chinese assets.” Words that proved prescient by August 2011, when Standard & Poor’s downgraded the U.S. for the first time.
Around that time, Beijing mulled retaliating against then-U.S. President Barack Obama’s flirtations with Taiwan. The state-run People’s Daily declared: “Now is the time for China to use its financial weapon to teach the U.S. a lesson.” Trump’s ties with Xi may be on the mend, but the trade war he’s long threatened remains a risk. It’s always possible, too, that Trump will once again move to weaken the dollar.
In recent years, America’s reliance on its Asian bankers has begun to be viewed through the lens of national security threats. At what point, though, do Beijing, Tokyo, Hong Kong and others begin feeling like dupes in a giant pyramid scheme, one relying on more and more foreign money flowing into treasuries to protect early arrivers?
Cornell University’s Eswar Prasad tackled this question in his 2014 book, “The Dollar Trap.” Last month, he sounded a fresh alarm. The “danger is that Trump will get his wish for a weaker dollar — permanently,” Prasad said. “Even the mere possibility of reduced faith in the dollar, alongside higher inflation, could push up interest rates, leading to larger budget deficits and lower growth.”
Massive tax cuts the U.S. can’t afford could hasten that reckoning, putting Tokyo and Beijing in a tight spot. Do Washington’s bankers enable bad behavior by gorging on new U.S. debt? Does Abe double down on the dollar to keep the peace — both diplomatically and financially — possibly at the expense of state money in the future?
Abe should be cautious about increasing Tokyo’s exposure to Trump’s borrowing binge. It’s not like Japan doesn’t have enough debt woes of its own.
William Pesek is a Tokyo-based journalist and the author of “Japanization: What the World Can Learn from Japan’s Lost Decades.” Follow him on Twitter: @williampesek