The world's economic leadership was gathered at the annual conclave in Davos, Switzerland, but today's major financial news was Standard & Poor's downgrading of Japanese debt from AAA to AA.
What makes this significant is that up to now the countries sustaining a downgrade to their credit rating have been middle size countries. This was the first time that an economic giant with trillions in foreign currency reserves has been handed a slap on the wrist. There is no need to press the panic button yet, as the ratings mean that Japan has a "very strong capacity" to meet its financial commitments as opposed to AAA rated countries, such as the United States, whose ability is rated "extremely strong".
While Japan's balance of payments with other countries is still healthy, Japan's internal debt is rocketing to over 200% of GDP . This is an astounding figure considering that Greece and Ireland, the 2 countries in Europe that so far have had to receive an economic bailout, had "only" 137% and 113% GDP internal debts, respectively.
Japan has been fortunate in managing debt repayments because its debt is internal. Japanese workers who cannot count on a lavish social security net upon retirement, have been snapping up bonds even though they do not pay any interest. However as Japan gets increasingly greyer, the percentage of workers will decline and Japan will have to pay off its debts at higher and more crushing interest rates.
In Japan, the reaction to the lowered rating was mixed, including within the government itself. One Japanese official blamed the messenger, questioning the reliability of the ratings agencies who had given questionable securities a clean bill of health prior to the economic crash. Newly appointed Economy Minister Kaoru Yosano said that the move was "regrettable" and might be a reflection of Standard and Poor's unfamiliarity with the Japanese government's reform plans.
However, in explaining its decision, Standard & Poor's claimed that it had studied the reform plans. They were very nice indeed but S&P doubted that the current government had the gumption to follow through on them, or in finance-speak: "In our opinion, the Democratic Party of Japan-led government lacks a coherent strategy to address these negative aspects of the country's debt dynamics,".
Japanese Prime Minister Naoto Kan dodged questions by claiming that since he had been ensconced in Parliament he was unaware of the decision and would have to study it. The Liberal Democratic opposition made political hay out of the news, claiming that the action vindicated the party's warnings to the government.
Paradoxically, the decision may help Kan and Yosano sell their fiscal stability package to their skeptical colleagues in the cabinet and to the Japanese Parliament.
The unspoken question is, if this can happen to Japan,when will the rating agencies get around to the United States. This will be a particularly relevant question if President Obama means what he said in the State of the Union address and increases American debt to pay for a massive education and technology program.