The risk was the unlikely subject of a best-selling novel earlier in the year. The book, Nihon Kokusai, or Japanese Government Bonds, tells the story of fixed-income traders who decide to boycott a government bond auction. The action leads to soaring Japanese rates, a freefall in the yen and the stock market, and nail-biting in Washington. White House officials fret Japanese investors will sell their massive holdings of US Treasuries to cover losses.
The book became an unlikely topic of countless television talk shows and stimulated discussion among Japanese voters about risks posed by the bond market. While its author, former bond trader Main Kohda, concedes her book is sensational, she also asserts that its premise -- a meltdown in Japan's bond market -- is quite plausible.
The problem, she asserts, is the incestuous relationship between the government and Japan's banks. The intimacy manifests itself in low bond yields. The government wants low borrowing costs, while banks don't want to upset politicians by bidding up rates.
Perhaps Prime Minister Junichiro Koizumi has read Kohda's book. His first pledge was to cap new debt sales below 30 trillion yen in the fiscal year that begins April 1, 2002. While his Liberal Democratic Party seems content with issuing more debt, Koizumi understands that doing so could raise Japan's borrowing costs. That would not only destabilize the economy and send stocks lower, but hamper the Bank of Japan's efforts to stimulate demand.
Hence the wave of panic shooting through Japan's bond market now that Koizumi may be relaxing plans to limit bond sales. The economy is back in recession and the Nikkei 225 stock average this week hit a 16-year low. The turn of events puts the spotlight on banks; falling stocks reduce the value of their equity investments and, in turn, hinder their ability to write off bad loans.
Cognizant of this point, Koizumi's finance minister said Tokyo should consider "comprehensive or powerful measures" if things deteriorate further. To analysts, that means more spending financed by bonds. Since Japan already has the biggest government bond market in the world, more debt issuance may not sit well with global investors.
Up until now, that would've been fine, considering that, unlike US debt, domestic investors hold the vast majority of Japanese bonds. But what if investors suddenly panic over Japan's finances? Say, because of another rating downgrade? Or if consumers lose faith in Tokyo's ability to keep bond yields from surging and costing them some of their coveted savings? No one knows how all this will play out. All we do know is that Japan may have perfected the art of creating financial bubbles.
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