Japan's Exorbitant Privilege

The concept of "exorbitant privilege" has received great attention from policy makers as well as academics worldwide. The idea originally referred to the willingness of foreigners to hold large quantities of US government debt at extremely low interest rates, due to the dollar's world reserve currency status. In recent years, the term exorbitant privilege has been expanded to explain why the US appears to be enjoying excess return from its external assets over liabilities across all asset classes, including foreign direct investment, equities and other forms of portfolio investment. In this paper, we give a brief review of the recent literature on exorbitant privilege, and then proceed to discuss exorbitant privilege in the context of another country, Japan, which has been the world's largest creditor nation for more than two decades.

Contrary to conventional wisdom, we find that Japan's overall performance in international investing has not been nearly as catastrophic as it is sometimes portrayed. Indeed, in recent years, Japan has been enjoying positive exorbitant privilege, from the narrow definition to the broad definition. The evidence might be interpreted as suggesting that Japan has achieved safe-haven status, particularly against extreme events as suggested, for example, by Farhi and Gabaix (2013). However, it is notable that Japan's debt liabilities are of considerably shorter duration than its debt assets, implying the country's overall foreign portfolio is subject to maturity transformation risks. Moreover, the short-term portfolio external debt is overwhelmingly government debt and the long-term portfolio external assets are mainly private. In addition, the government itself holds huge amount of long-term external assets through its reserves. Whether Japan continues to enjoy its exorbitant privilege in future decades depends, of course, on successfully navigating such risks.