ArmoTrader and Jim, thank you both for keeping us on our toes. You both bring up interesting insights. It seems there are a few prominent points of contention: 1) what is the real relationship between private sector growth and government spending 2) are central banks more powerful than markets? ... and 3) is now any different than '95, '00, '05, '10... . I will try to address each of them here, though I will keep it brief as possible as these really are larger topics unto themselves.
Regarding item #1, the equation you laid out so elegantly in your response (Armo) does not capture the entirety of the problem. For starters, the underlying unit is currency (e.g. yen, dollars, etc.) which itself changes. Second, government spending often has a negative multiplier (meaning that 1$ in deficit spending leads to less than 1$ of GDP growth). It's growth, just unproductive growth. Third, there is a fundamental relationship between private sector spending and government spending. The only question is one of capital allocation. Would each dollar be better spent by the government or by the private sector? Government projects that are better spent by the government should get funded (through taxes) and those that are not productive should not. I am working on a broader piece that looks at aggregate change in GDP over a period of time vs. aggregate change in total debt. (if anyone has seen this sort of data, please let me know). Lastly, your equation focuses on the income statement of a country and does not say anything about its balance sheet/financial condition. Needless to say, these features are important as well.
Regarding item #2, are CB's more powerful than markets? True they stand at the end of the bull whip. Agreed. However, there have been many factors at work over the past 30 years to bring rates down, many outside the control of CB's in general and Bank of Japan in particular. Correlation is indeed different than causation. There are many market events historically where correlations were in place for many years consecutively and then it changed. (e.g. the relationship between natural gas prices and oil were in sync for about 20 years and then the markets changed., or how about Amaranth Advisors that put on a complex calendar spread that worked for 15 years until it didn't.)
A big reason for lowering rates globally is the ongoing trade deficits. Trade deficits (as Armo described) lead to purchase of govt bonds in deficit countries. These have been large numbers. Persistent trade deficits and surplus can't go on forever - even if they can go on for a long time. Surplus countries like Japan have used their CB to lower rates, stimulate debt and regulate banks into buying more JGB's. Lastly, debt is aggregated, while GDP is shrinking. If deflation continues more and more of the burden of the growing debt load must be born by fewer and fewer tax payers. This is different from the past 20 years as declines in the population as a whole have just begun. If BOJ is successful in targeting inflation, it resets the expectations of the markets and forces the fiscal deficit to explode.
REgarding item #3, why now? Japan's is also changing structurally because they are becoming less competitive (mfg moving to other parts of Asia), the aging and dissaving mentioned and due to Fukushima - they are now importing much more energy. So, the closed loop funding process I described - which was in place for most of the past 22 years - is coming to an end. They will increasingly need to look outside Japan for funding and/or print more. In fact, the BOJ itself has announced it now wants to break the back of deflation and is targeting 1% inflation. This alone should push yields up on JGB's, which then flows through the fiscal budget/deficit etc. Markets are in part coerced by BOJ regulation into buying JGB's, but they will still be forced to respond to fundamental changes.
In the final analysis I think you both have something to add to the discussion, so I am grateful. In particular I liked your links to other posts providing some clarification of your thinking. To sum it up, I think that war or foreign denominated debt are not the only ways to have a crisis. Thanks again.