Moodys and Japan – rating agency declares itself irrelevant – again

I have very (very) little time today and I am typing this in between meetings. There was a lot of non-news today – the news that pretends to be news and full of import but which in reality is largely irrelevant and just serves to flush out more nonsensical commentary from self-importance financial analysis (mostly located in private banks). Then the non-news commentary suffocates any sensible evaluation and in some cases governments are politically pressured to change policy in a destructive manner – fuelling the next wave of non-news. Today’s classic non-news was the downgrading of Japan by Moodys. Once again, a ratings agency declares itself irrelevant.

The Statement by Moodys (August 24, 2011) said that they had downgraded “the Government of Japan’s rating to Aa3 from Aa2”. Why did they do that?:

The rating downgrade is prompted by large budget deficits and the build-up in Japanese government debt since the 2009 global recession. Several factors make it difficult for Japan to slow the growth of debt-to-GDP and thus drive this rating action.

They said that the “(p)rospects for economic growth are weak, making it more difficult for the government to achieve deficit reduction targets”.

A sentence after they said that their:

… stable outlook comes from the undiminished home bias of Japanese investors and their preference for government bonds, which allows the government’s fiscal deficits to be funded at the lowest nominal rates globally. We believe that this funding cost advantage will be sustained by considerable institutional and structural strengths, which will prevail even with large budget deficits in 2011 and 2012.

So Moodys is saying: Listen to us because are important and if you ring us we will rate anything well – the higher you pay the higher the rating – please refer to the Transcript of the Credit Rating Agencies and the Financial Crisis Hearing before the Committee on Oversight and Government Reform, US House of Representatives, in October 22, 2008.

The Chair of that Committee (Henry Waxman) said at the time “The story of the credit rating agencies is a story of colossal failure … The credit rating agencies occupy a special place in our financial markets. Millions of investors rely on them for independent, objective assessments. The rating agencies broke this bond of trust, and federal regulators ignored the warning signs and did nothing to protect the public” (Source)

The Hearing exposed the fact that the Rating agencies did not properly estimate the risks of the loans they were assigning high ratings (in return for fees) and

“The story of the credit rating agencies is a story of colossal failure,” Mr. Waxman said. “The credit rating agencies occupy a special place in our financial markets. Millions of investors rely on them for independent, objective assessments. The rating agencies broke this bond of trust, and federal regulators ignored the warning signs and did nothing to protect the public.”

The evidence revealed that while “highly detailed data about each individual loan” would be required to “assess the creditworthiness of the loans in the security” a senior executive at one of the agencies said that any request by a desk operator for such information “is totally unreasonable”.

One of the problems of the government reaction to the crisis has been to allow the Ratings agencies to continue to trade.

But think about the Moodys statement in relation to Japan. The logic (and that is being kind) goes like this:

1. Economic growth is low in Japan and is pushing tax revenue down and welfare spending up – hence the budget deficit rises.

2. Given the Japanese government doesn’t exercise its legal right to spend without issuing debt to match the spending, the rising budget deficit (as a result of the cyclical downturn) also means rising public debt.

3. Moodys asserts (with no analytical or conceptual basis provided) that these rising deficits are in some way a problem per se (rather than being a reflection of the real problem – slow growth).

4. So in their Pavlovian fashion, they downgrade the credit rating presumably suggesting the Japanese government is a credit risk without acknowledging the Japanese government can never be an credit risk unless there is a collective brain explosion and the Government legislates to renege on its financial obligations.

5. They downgrade because the slow growth makes it more difficult to reduce the budget deficit without acknowledging that the budget deficit should increase to meet the challenge of slow growth.

6. But then you are left to ask two questions. First, the Moodys logic would suggest they want to increase the borrowing costs of the Japanese government by reducing the demand for bonds (because the lower rating is meant to scare investors) which if you believed their type of reasoning would further negatively impact on economic growth. So what sort of logic is that? Moodys (if you had their model outlook) is saying the Japanese economy is damaged because of the recession but we are going to make it worse and therefore worsen the problem of credit risk.

7. Second, of-course, neither their implicit notion that Japanese government debt carries a credit risk or that their ratings change anything anyway are valid. Note that a sign that government paper was not an attractive investment prospect might be rising yields as investors avoided demanding the paper. But Moodys acknowledges that there is an “undiminished home bias of Japanese investors and their preference for government bonds, which allows the government’s fiscal deficits to be funded at the lowest nominal rates globally”.

So who would you bet on? A corrupt capitalist firm that has made some monumental mistakes in the past while handing out AAA ratings to firms who were paying them to rate their products or millions of investors who every day purchase Japanese government debt at stable and the lowest yields? The same investors who have been buying Japanese government debt while deficits have been rising and public debt ratios heading up beyond 200 per cent (compared to the ridiculous Reinhardt Rogoff default threshold of 80 per cent) for the last 20 years.

It doesn’t bear scrutiny really. Please read my blog – S&P decision is irrelevant – for more discussion on this point.

The problem is that the commentators are already coming out of the woodwork adding more misinformation. The Bloomberg news report carried all the normal “non-news” references such as “debt mountain” and the like.

They quoted some private banker as saying:

I hope this serves as a warning to the soon-to-be new administration … It’s imperative to begin to raise the sales tax.

1997 1997 1997 1997 1997.

The IMF has been pushing Japan into a 1997-style contraction which cements their position as one of the most destructive agencies around.

The last thing the Japanese government should be doing is withdrawing its fiscal support by increasing taxes. It has low to negative inflation, rising unemployment, rising underemployment, slow growth, a massive infrastructure deficit due to the tsunami, and flat private spending.

What does this banker think will happen if they further squeeze consumers with a sales tax rise? This is exactly what stalled their recovery in 1997. The economy contracted sharply and the budget deficit continued to rise then because the government fell into the spell of the deficit terrorists who pressured them to do some about the budget deficit by increasing taxes.

We are back to that sort of nonsensical logic.

My proposal to this bank commentator is that if the unemployment pool moves up by more than 1 person (as a result of a reduction in labour demand) as a result of a rise in the sales tax that he/she surrenders their accumulated wealth to the government for distribution to the poor and he accepts a government decision to make him the second person who joins the unemployed queue. Would he still be advocating an increasing sales tax if that was the case?

Fortunately, the Japanese government has been in this place before (as I explain in this blog – S&P decision is irrelevant) and they know full well that there is no shortage of investors queuing up to buy their bonds.

In fact, after the decision was taken yields moved imperceptibly.

Was there anything I read this lunchtime that was sensible?

Bloomberg carried an Editorial yesterday (August 23, 2010) – A Public Works Spending Deal Both Parties Can Embrace: View Jobs Under Construction

Now this might be a good news story. The story said:

It’s one of Washington’s worst kept secrets: President Barack Obama is likely to propose a new public works program in a post-Labor Day speech.

The idea is to stimulate an economy on the verge of another recession, upgrade the nation’s crumbling roads, bridges, schools and transit systems, and put unemployed Americans, especially the 6 million who have been jobless for six months or more, back to work.

It makes economic sense. The president should think big — upward of $100 billion a year for at least two years. The temporary spending burst would increase short-term deficits, some of which the congressional supercommittee would have to offset to hit its $1.5 trillion, 10-year deficit-reduction target. But the program could ultimately lower deficits through reduced safety-net spending and higher tax revenue from the newly employed.

Economists have estimated that spending $1 billion on highways and mass transit increases gross domestic product by $1.6 billion. Only extensions of unemployment insurance and food stamp benefits are better at priming the pump, except they don’t create jobs that benefit the public.

If the US President had have done this in 2007 and scaled the program up by a factor of 10 or more and sustained it for several years instead of bailing out his Wall Street mates things would have been much different now.

The deflationary effect of entrenched and high unemployment is very significant and a jobs rich intervention should be the highest priority in the US at present.

The Bloomberg article notes that such a program “doesn’t make political sense right now” so they advocate the US President holding out deregulation to the Republicans in return for their political support.

One of the examples they suggest which would provide the ” biggest deregulatory bang” would be to suspend ” would come from suspending the Davis-Bacon Act, which sets construction wages”:

The 1931 law requires contractors using federal money, whether gasoline-tax proceeds, stimulus grants or Department of Energy loan guarantees, to pay the local “prevailing wage,” as defined by the Department of Labor. The president could use his authority to suspend the law in a national emergency.

So cut wages to cheer up the idiot Republicans so they will approve a public works program. Cutting wages will damage growth because the downturn reflects a deficiency of aggregate demand. I have no solutions to the dysfunctional politics in the US at present except that the President should demonstrate some leadership and sack his mainstream economists and start educating the American people about the basic macroeconomic truths – spending equals income.

Wage cutting should not be considered an appropriate respond unless it somehow encouraged the private sector overall to save less and spend more. But a sustainable recovery requires the private sector to save more at present to reduce its debt exposure.

With net exports negative, the only way that can happen is via fiscal support – rising deficits. A conservative might not like that option but if they understood how the economy works they would have to accept the logic and then the argument would turn to where it should be – do you want more or less unemployment; higher or lower national income; higher or lower material standards of living.

If the Tea Party had to tell the truth – in terms of the real issues rather than the non-issues – they would be quickly exposed.


A bad news day overall and it is lucky I haven’t much time to chew it over.

That is enough for today!

This Post Has 11 Comments

  1. A public works program is better than nothing, but it’s not all that smart. First, it requires specialised labour, and the evidence is that the construction employees thrown out of work due to the decline in house building have had no more difficulty finding alternative employment than others. So there aren’t millions of skilled construction workers available from the dole queues.

    Second, if government is going to spend more, why concentrate the expenditure on public works rather than on re-employing the teachers, librarians, police, etc etc made redundant because of the recession?

    Third, why concentrate stimulus on the public sector at all? I vote for an expansion of the entire public sector plus a payroll tax reduction to expand the private sector by about the same amount.

  2. Could it be that Republicans know that any public works program announced by Obama would increase his popularity and may improve economics?
    This is the worst fear that Republicans could ever have.
    So – how would they prevent that?
    Well – the obvious solution would be to radically increase the government debt rhetoric and scare everybody with it.
    Could it be that the recent government debt ratings are related to this?

  3. I understand why reading a Moody’s Downgrade as an indication of increased probability of Japanese default makes no sense. But I’m wondering whether the rating could still, in principle, have meaning in the sense that if Japan *did* have to print money to meet its obligations, it would inflate the currency and therefore the returns on the bonds would be less valuable. I understand that we are nowhere near an inflationary situation in Japan, but hypothetically this could be a meaningful worry, right? Again, I’m not trying to say that this downgrade is at all justified, I’m just trying to understand what useful information could, in principle, be carried by a rating, given that the actual risk of default is basically permanently zero.

  4. It is clear that a general lack of understanding of modern macroeconomics and a specific obsession (surplus fetishism) is at the heart of our self-induced economic problems. Standing behind that self-induced economic problem in the US is not just an intellectual and ideological problem but an obvious pathology; the megalomania of the oligarchs which expresses itself in paranoia, aggression, greed and hatred of the poor. Bill Mitchell summed that situation up when he wrote, “I have no solutions to the dysfunctional politics in the US..”. I have no solutions either. It is the entirety of US society which is dysfunctional.

    I spoke above of “self-induced” economic problems caused by the lunatic prescriptions of neoclassical economics. There is another set of problems which relates to “Limits to Growth”. Even if we could fix the economy along MMT lines (which program seems to face insurmountable ideological, prejudicial and vested interest obstacles), the problem of limits to growth remains.

    Either way, we are still doomed. The whole thing is an intellectual exercise. Yes, it is nice to know (from the clear objective and empirical evidence) that one is on the right side of the argument, but being right will be no hedge against the series of rolling disasters about to engulf global civilization.

  5. Ikonoclast:

    I don’t think the world is going to end, but things will probably get a lot worse before they get better. So far the great recession seems to be following the same historical path as the great depression – so I’m half-expecting some kind of world war as the economic malaise drags on and worsens. Global warming will mess us up but we won’t turn into Venus – there just isn’t enough carbon buried in the ground for that. Humanity will make it in the end.

  6. To compare Japan’s performance versus other advanced economies, a comparison of purely economic figures does not do justice to Japanese society. It is not easy arithmetically to translate into comparable figures health care systems, life expectancies, job security, etc. But they are, as they say, in the mix.

    P.S. “Very (very) little time today” means for me “We’ll have to do this another day” but for Bill close to a 2000-word text. Different time zone.

  7. “A corrupt capitalist firm [Moody’s]” :
    Bill, we are (firmly!) in the realm of free economies, a.k.a. capitalism. They are all capitalist firms and Japan’s is a capitalist economy. As in algebra, we can safely eliminate the common factor of capitalism from all parties without loss of accuracy…

  8. In reply to Grigory Graborenko. Sadly, the world could end for humans. A world war now would be disastrous because of nucelar weapons. Possibly, we may see a string of regional and civil wars involving non-nuclear nations. This seems the more likely scenario. The nuclear powers could stand back to some extent, becoming involved only by proxies or limited conventional forces.

    It is not only combustion of carbon in the ground that could cause runaway global warming. The warming of the permafrost and ocean beds releases methane. Methane from the seabed in the form of methane clathrates is present in quantities sufficient to cause an event equivalent to the Permian-Triassic extinction event.

  9. Ikonoclast:

    Don’t forget we had nuclear weapons during the cold war and didn’t use them, despite a lot of people wanting to.

    Good point about the “great dying” event. Might be hard for us to survive without a decent food chain. But life did survive (all 5% of it). It would suck for complex mammals to have to evolve all over again, but I reckon intelligent life will get another chance or two before the sun dies.

  10. Grigory

    I like your turn of phrase although I think it more than sucks for complex mammals to evolve again.

    I wonder if life forms get more intelligent the more challenging it becomes to maintain life.

    I also wonder if voters will get more intelligent the harder it is to sustain their lifestyle.

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