Since being elected at the end of last year, Shinzo Abe promised an ambitious economic plan to push the Japanese economy out of the zombie state it has been in for the last two decades.

Through a stimulus package and by pressuring the Japanese central bank, Abe is willing to push inflation up to a 2pc target in just two years. With the help of the recently nominated BOJ governor Haruhiko Kuroda, the shock therapy was already announced.

The BOJ will engage in massive asset purchases to keep short-term interest rates as low as possible while injecting money into the economy and eventually inflating prices.

The monetary base will double in less than two years and attain a record level of 270 trillion ($2.8 trillion) by the end of 2014!

This radical policy is already pushing prices higher and the yen lower, driving significant improvements for Japanese exporters. But, four months after the BOJ announcement…

Abenomics Isn’t Ever Going to Work

In fact, Japan is under deep trouble and may eventually trigger the next financial crisis.

Prices at the end of 2012 were equal to 1992 prices, two decades of no inflation

A Massive Debt Pile

As announced by the government last week, Japan’s total debt reached 1,008,600,000,000,000 yen. I wrote down the number for our readers to notice how big and ungovernable such a number truly is.

We’re used to hearing the word trillion in the news, but this time, we will hear a new one, quadrillion, when referring to Japan’s debt (with America not far behind). One quadrillion yen corresponds to $10.23 trillion, which is bigger than the four largest European economies combined.

But what is really worrying is the fact that number corresponds to a debt-to-GDP ratio of 230%!

The fact that massive austerity measures were applied to fight smaller debt-to-GDP ratios of around 120% and 150% in European countries makes me scratch my head when looking at Japan’s number. For how long can they keep on stimulating their economy and adding to the massive debt pile without worrying about it?

The truth is that most of the debt is held domestically, unlike what happens in Europe, and that is the game changer. Furthermore it explains why they can live with it. Still, it is a worrying situation that may spiral into a ferocious debt crisis leading the country to a default on its debt payment obligations.

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If interest rates rise to 2% for example, 80% of government revenues would be needed just to pay interest, let alone debt repayments. But this raises the question:

“If Abe plans to raise inflation to 2%, how does he plan to hold interest rates at the current 0.75% level on 10-year government bonds?”

A Bleak Future Unfolding

If the BOJ continues to buy assets at the current pace and the Japanese government doesn’t drastically cut down on its expenses, ratings agencies will revise down their sovereign debt rating and interest rates will start rising making it impossible for the government to repay and service the outstanding debt.

But if Abe decides to impose a consumption tax as planned by the previous government, history shows the risk of economic derailing is huge, which most likely would lead to a ratings downgrade anyway.

Japan seems to be steeped in a lose-lose situation, which will most likely end with debt holders suffering a hair cut in the future.

In the meantime the BOJ will attempt to remedy the situation, continuing to buy government bonds to keep interest rates low. That’s the only way to avoid a default. But, in doing that, there may soon come a time when they need to buy 100% of all new debt issues plus any outstanding debt until the BOJ is the only government creditor.

The cost would be the collapse of the yen and then with the massive increase of import prices (especially energy prices), along with a substantial wave of hyperinflation. At attempting to target a 2% inflation level, Japan may depart from a deflation state to arrive at a hyperinflation crisis.

Investors should avoid the yen at all costs until the future is clearer in terms of how Abe will address the debt problem and while the BOJ keeps on injecting money into the economy.

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