Japan's Demographic Timebomb

Here is a great picture from a recent Economist article (“Into the Unknown”) showing the rapid shift in Japan’s population from 1950 to 2055. From 1955 to 2005, the steadily increasing population of working age people (reflected in the pyramid shape of the left most schematic) and rising productivity of its workforce propelled Japan to become the world’s second largest economy. However, over the next forty years, the working age population is forecasted to shrink so quickly that by 2050 it will be smaller than it was in 1950 (dropping from a high point of 87mm in 1995 to less than 50 million by 2050; see second chart). Similarly, over this timeframe, Japan’s population, currently 127 million people, is expected to fall by 38 million or nearly 30%! By 2050, four out of ten Japanese will be over 65.

As the population ages, the nation’s pension system is becoming increasingly strained. When public pensions were introduced in the 1960s, there were 11 workers for every pensioner. Now there are a mere 2.6, compared with an OECD average of four.

Finally, Japan’s rapidly aging population has resulted in a substantial reduction in the nation’s savings rate. Once above 20% of disposable income, the ratio has dropped to about 2%, and the Economist posits that it could go negative over the next few years. Given that 95% of the government’s debts are financed by domestic savings (primarily banks, pension schemes, and insurance companies), Japan could be forced to seek external financing to sustain its huge public sector debt. Rates would undoubtedly rise under this scenario given that Japan currently borrows at a paltry 10-year rate of 1% from its risk-averse populace.

Given all these facts, its not terribly difficult to sympathize with the bearish thesis surrounding Japanese government bonds.