Reconstruction Maths for Naoto Kan

Take a look at the chart below. It is the calculation I make of how much 'spare cash' the Japanese economy is spinning off every month.  That is, when each household has paid its monthly bills, how much - if any - of its wage packed is  left over to be banked. Plus the positive cashflow after investment - if any - of  corporate Japan.   This is the private sector savings surplus (or deficit), and it's the crucial cashflow indicator of any economy.  Why? Because it monitors the net cashflow of the private sector into, or out of,  the financial system. Over the last 12 months to Feb 11, Japan's net cashflow came to just under Y48 trillion. Hang on to that number.  

When the financial system gets this cash, it can, by definition, do only one of two things with it: it can use it to buy foreign assets, or it can use it to buy government bonds.

So if an economy is running a savings surplus (and almost all are right now, including the US, UK, China, and the Eurozone) then the fundamental job of a financial system is to find something to do with the cash. (Choose your bubble.) Conversely, if an economy is running a private sector savings deficit, the fundamental job of a financial system is to create a cashflow (by selling such government or foreign assets as it has) to keep the private sector show on the road.

(There's a tendency, when an economies veer from savings surplus to savings deficit, to discover  which part of the financial system has been mispricing its products. Korea is a serial offender: in every dive from surplus to deficit over the last 13 years, another bit of the financial system has dropped off - merchant banks, bond investment trusts, credit card companies and associated insurance schemes, and now savings banks.)  

Japan is in surplus to the tune of around Y48 trillion. And that is also the frame which PM Kan has to keep in mind as he ponders how to pay the reconstruction bills from the multiple catastrophes of March 11.  And it is truly finely balanced. Before the catastrophe, Kan was working with a constraint of issuing no more than Y40 trillion of new government bonds a year - comfortably, but not too comfortably within the immediate cashflow available to buy them.  But the latest estimates of the immediate reconstruction bills comes in at a further Y25 trillion, of which the government anticipates shouldering Y10t trillion.  That would take new  issuance right up to, and slightly beyond, the economy's available Y48 trillion net positive cashflow.

But that's assuming that the available cashflow stays stable. But it won't - it'll slump. After Kobe in 1995, corporate cashflows crunched hard, and we should certainly expect something similar and worse this time.  As a clue, since March 11,  Japanese companies have tried to borrow Y8.4 trillion from Japan's top seven banks - and this is in a banking market where there were Y6.9 trillion of net repayments made in the 12m to Feb 2011! Clearly, corporate Japan knows its free cashflow is drying up fast. And these cashflows can't be replaced or even significantly offset by the household sector. Last year by my calculations (from MOF's quarterly private sector balance sheets) corporate Japan generated Y57 trillion in free cashflow, whilst  private consumption in Japan is running at only around Y280 trillion a year. It would take a heck of a slump in private consumption. . . .

Conclusion? We'll see Japan's financial system selling foreign assets this year (and next) to cover the reconstruction bill.  Australia, don't say you weren't warned.