The Mystery of Japan's Private Debt Levels (Solved?)

For the last couple years there has been a lot of discussion of how the macroeconomic situation in the US compares to past historical episodes. Unfortunately the discussion of debt levels has relied mostly on anecdotal data, other than the one well covered comparison of the US today with the US at the time of the Great Depression (see for example Steve Keen's charts here). I'm among those who view post-1990 Japan as a highly relevant additional example. A few months ago I finally found what I hope is reliable debt data for Japan. I'll present charts of the data first but please read the sourcing methodology further down as it's possible this method of measuring of Japanese debt may not be an apples-to-apples comparison with the US Federal Reserve's debt data (please give feedback if you have it, and I will update the post).

Japan's Private Sector Debt From 1980 to 2007

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The above chart shows the total debt in yen for Japan's household, corporate, financial, and government sectors from 1980 to 2007 (the latest available). Private sector debt actually kept rising (much more slowly) after 1990, peaking around 1997! Government debt also rose significantly during this time period. This large expansion of total debt likely contributed to the continued growth in GDP until 1997, seen here:

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The next chart shows the debt-to-GDP ratios since 1980 — i.e., factoring in the impact of economic growth (as measured by GDP) reducing the debt burden relative to incomes. By this measure, total private debt-to-GDP did peak around 1990 when stock and real estate bubbles were bursting.

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This suggests that in the context of a booming global export market and by continuing to increase its debt, Japan was able to keep growing for years after its asset bubbles burst. Interestingly the 1997-1998 time-frame is also when Japan's consumer price levels peaked (see chart here). Confirming anecdotal experience, the corporate sector was highly leveraged (much more so than the household sector), and did work on reducing debt but most notably so after 1997.

But the most striking insight this data yields is that Japan's economy from 1990 until 2005 did not deleverage on aggregate, due to the government increasing debt faster than the private sector was reducing debt, and that the private sector has only reduced debt from 386% of GDP (1990) to 328% of GDP (2007)! This government borrowing most likely explains why Japan did not experience a depression (and is somewhat consistent with the views of Richard Koo, who I have discussed before). But it reinforces the question of what the end-game is for Japan and whether it will ever be able to grow out of or pay down its massive total debt.

Note that I have seen and used in the past a couple other charts of Japan's debt-to-GDP ratios that disagreed with each other and with this data, for example this one: [UPDATE Jan 18 2010: I now believe the below chart is WRONG, see the end of this post]

I played with the Japanese Cabinet Office data I obtained for this post by excluding loan-based debt, excluding non-loan debt, excluding financial sector debt, etc and no matter what combination I tried I was unable to generate a chart that looked like this one. So one of the charts is probably wrong and it could be mine.

This article by Andy Xie, What We Can Learn as Japan's Economy Sinks, is very worthwhile reading on Japan's crisis and more (though there are a few things I'm not sure I agree with). The debt levels he cites for Japan differ a bit from what I derived, for example, he says "total indebtedness of Japan's non-financial sector is 443 percent -- probably the highest in the world, and far higher than the 240 percent in the United States."

Comparison with the US debt-to-GDP ratios around 2007

The following chart shows the rise in US debt-to-GDP levels by sector that many people have seen before:

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It is color coded to match the colors of the Japanese debt chart's sectors for easier comparison. In the US, households carry substantially higher debt than they did in Japan. Here is a comparison of the debt-to-GDP ratios by sector at the start of each crisis (Japan around 1990, the US around 2007, plus also the US around 1929 at the onset of the Great Depression):

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Household debt was much higher in the US in 2007 than past episodes, but Japan had much higher corporate debt and somewhat higher financial sector debt. Government debt was fairly comparable. The chart's debt-to-GDP numbers are in this table.

	US 2007	US 1929	Japan 1990
Household	98%	37%	62%
Corporate	75%	98%	149%
Financial	115%	22%	169%
Private Sector Total	288%	157%	386%
Government	52%	29%	62%
Foreign	14%
Total	355%	185%	447%
Total Excluding Financials	240%	163%	278%

In one respect this is a mildly optimistic outcome in relative terms — contrary to past claims (by me included), Japan's debt crisis is not dwarfed by the current US debt crisis. Depending on the US's political willingness to provide ongoing fiscal stimulus as Japan did, my opinion is this makes the Japanese style stagnation and mild deflation relatively more likely in the US, as opposed to a deep depression — though employment and GDP have already fallen more than they ever did in Japan (at least until this global crisis hit). Of course, total debt-to-GDP is not the only macroeconomic determinant that matters, so other factors could drive the US today to a different outcome.

• Substantially higher household debt, especially with non-recourse mortgages standard in the US, could be a much more negative factor relative to Japan. There are far more distressed household balance sheets than corporate ones given the relative number of entities in each sector, so this could increase the system's susceptibility to full-blown debt deflation, especially given that households have less incentive to "extend and pretend" by faking solvency through relaxed accounting rules than corporations do.
• The global context today is that most nations in the world have been involved in this crisis, many of them with high debt levels of their own. This probably explains in part why the current crisis has been deeper than Japan's post-1990, but the question remains whether this crisis is winding down or whether deflation will intensify and cause even deeper economic pain in the years ahead. With deleveraging barely having begun, there is strong reason to believe that we have years of adjustment still ahead.
• Other differences in financial markets today such as the huge global derivatives market and associated counterparty risks could be relevant.
  

Many people summarize the options for removing excessive debt as inflate or default. While the long term result is uncertain, Japan has been carving a third option for nearly the last two decades — reduce nominal interest rates to very low levels to reduce the debt servicing burden while leaving the debt in place in an attempt to grow out of it, even if doing so is accompanied by economic stagnation. Note that this approach does not seem to cure insolvency, except perhaps through the long and slow process of using earnings for balance sheet repair. No doubt demographics are different in Japan compared to other countries and this has some impact, but the US and Europe are also increasingly facing aging populations.

Methodology for Obtaining Japan's Debt Data

I derived the data from selected balance sheet liabilities within the aggregate national accounts stock data provided by the "Economic and Social Research Institute (ESRI), Cabinet Office, Government of Japan." See "Part 2 Stock" under the heading "Accounts classified by Institutional Sectors". The super-set of liabilities listed across households, non-financial corporations, financial corporations, and general government are (the bolded ones are what I used):

• Currency and deposits
• Loans
• Securities other than shares
• Shares and other equities
• --> Of which shares
• Financial derivatives
• Insurance and pension reserves
• Other liabilities

Loans are clearly one kind of debt. It seems likely that securities other than shares are a good proxy for all other debt (e.g., bonds). Is this incorrect? This OECD definition of "securities other than shares" is:

"Securities other than shares consist of bills, bonds, certificates of deposit, commercial paper, debentures, and similar instruments normally traded in the financial markets."

The Federal Reserve Flow of Funds guide defines debt as follows:

"Credit market borrowing or lending is defined here as the transfer of funds through certain financial instruments: open market paper, Treasury and agency securities, municipal securities, corporate and foreign bonds, bank loans not elsewhere classified, other loans and advances (such as loans made under various federal programs), mortgages, and consumer credit. Excluded from the definition are a number of other items that are also sources and uses of funds for the sectors — official reserves, special drawing rights certificates, Treasury currency, deposits and interbank items, security repurchase agreements, corporate equities, mutual fund and money market mutual fund shares, trade credit, security credit, life insurance and pension fund reserves, business taxes payable, investment in bank personal trusts, proprietors’ equity in noncorporate business, and miscellaneous items; a sector’s credit market borrowing is thus not the same as the increase in its total liabilities."

It seems quite possible, especially for the financial sector, that the "securities other than shares" contain types of debt that are excluded from the US debt measures (for example, perhaps certificates of deposit). PLEASE TELL ME IF YOU KNOW WHETHER THESE MEASURES ARE COMPARABLE.

I did compare this data to a few individual data points I was able to find on Japan's sector-specific debt levels around 1990, and this data appears to be in line with those data points. The main unconfirmed data is Japan's financial sector for which I have found no other data points to compare.

Another Pre-Crisis Comparison: Sweden

The Swedish government's response to their early 1990s crisis has often been held up as a model for what the US should do, so it would be valuable to have an idea of the relative size of their crisis as well. As I summarized in an earlier post, the data points I've found for Sweden around 1990 so far are:

• 170% total debt-to-GDP
• 127% private sector debt-to-GDP (source)
  
• 43% government debt-to-GDP (source)

It's not clear whether the private sector measure includes the financial sector, but if it does, Sweden's debt levels were much smaller than Japan's in 1990 or the US in 2007. However, they were more comparable to the US at the start of the Great Depression. Yet like Japan, Sweden was able to grow exports to a booming global economy in the 1990s. So while the absolute debt-to-GDP measure is central, I don't believe it is the only important macroeconomic determinant.

UPDATE 10/14/2009: I added a foreign debt row to the table of debt-to-GDP numbers (a commenter pointed out the numbers do not sum otherwise, so I probably shouldn't have skipped it in the first place).

UPDATE 10/14/2009: After originally posting, I did seek input on the derivation of this Japan debt data from a highly financially-savvy blogger, and he replied that "yes" it was comparable to the US data (though I can't guarantee he looked at it in detail).

UPDATE 1/18/2010: McKinsey has released a study on deleveraging that seems to validate my findings here. The only difference is that their numbers for Japan's financial sector are consistently around 50% of GDP less than what I found (perhaps reflecting exclusion of some specific bank liability such as certificates of deposit?). But the overall shape of the trends do match, most notably that public debt expansion has exceeded private debt reduction. Here is one of their charts: