Week 1: The Japanese Goliath Debt

Is it sustainable or near collapse?

Hello everyone,

This week’s topic is focused on Japan's debt crisis and how sustainable or unsustainable it is.

Why is it important?

Japan is the third largest economy in the world, falling back only to China and the US. Its problems and the high probability of entering a strong recession can (and will) strongly affect everyone.

What is the problem?

Japan has the highest debt-GDP ratio in the world. It dates back to the 90s when the Japanese debt began to swell and reached 100% of GDP. Nowadays, the Japanese debt rates over 240% of GDP.

Making it simple, this rate shows that the amount of money Japan spends is 2.4 times higher than the amount of money it generates. Is this sustainable? Well…no. Debt does not come alone. Interest rates are associated with debt and so, the Japanese economy has not been able to generate enough money to support national expenses and pay out the debt.

Having a debt-GDP ratio over 100% is not per si an economic problem. The exponential growth of this ratio is what makes it an economic problem. In the case of Japan, a crisis.

How did we get here?

Back in the 1980s, France, Japan, Germany, UK and US signed a joint agreement (Plaza Accord) to depreciate the US dollar so US exports would become more attractive. This led to the appreciation of the yen (Japanese currency) which turned Japanese exports less attractive and so the export level decreased which led to GDP stagnation.

Japan took some measures such as lowering rates which led to the asset price bubble Japan faced in the late 1980s.

Following that, Japan faced deflation. With deflation, people stopped to invest and started to save more money which does not benefit economic growth.

Given this, the Japanese government adopted a strategy to stimulate economic growth, incentivize people to buy stuff, get mortgages, and convert deflation to a 2% inflation rate. This strategy is about issuing and buying bonds (JGBs) constantly.

How (economically) sustainable is this?

The problem here is that these buying levels are getting out of control, especially after Corona years. So if we get a lot of people selling their Japanese bonds, the central bank needs to buy all these bonds to control yield rates. That is what has happened over the past years and by the end of 2020, the bank has removed its self-imposed ceiling on buying JGBs and owns now more than 50% of these bonds (and so, their own debt).

Some argue that this is a sustainable situation as Japan owns its own debt (or more than half of it). However, the issue is that with this huge buying amount, there is no way back and so, if at any point the Japanese central bank stops buying these bonds, the yield in these bonds will increase insanely and blow up the entire economy.

If this turns out to be the case, starting a business in Japan, and getting a mortgage or any other debt will only be possible at extremely high-interest rates, which is not attractive (at all). And so, investments will decrease drastically, and economic growth that has been stable over the past decades will decrease.

So..what’s next?

Over this last year, the yield on these bonds has increased exponentially due to the increasing amount of people selling the JGBs which pressures the Japanese central bank to buy more and more of these bonds.

What will happen next? I cannot say but the alert signs are very clear. The Japanese bank might be able to keep buying (an unrealistic scenario in my opinion) or the yields will just explode and Japan will enter a very profound recession, which will impact the global economy.

This may turn out better than what it looks now, but I feel that this topic needs more awareness and discussion.

If you reached this point of the article, “props to you”, thanks for reading this and let me know your thoughts on it :)