Is Darkness Descending over the Land of the Rising Sun?

Japan's Debt Crisis Explained

Written By Josh Schlicht

Not long ago, Japan had the most aspiring economy in the world. Rising from the ashes of war, Japan experienced unprecedented export-driven economic growth for decades and was designated as the ‘Miracle Economy’. In the early 1980s, American pundits routinely warned that Japan would become the dominant world economic power and would inevitably threaten the hegemony of the US. This fear was never realized as Japan’s economy reached its spectacular peak in 1989¹. The nation’s economy has been in severe stagnation ever since. Thirty years later, Japan still retains its spot as one of the world’s great developed democracies, but is plagued by low GDP growth and an enormous mounting debt. Japan’s economy only has one top metric nowadays: ‘greatest per capita debt in the entire world’. At face value this debt is perplexing. Why has Japan, one of the world’s greatest exporters and creditors, deliberately borrowed its way into such a insurmountable, and potentially suicidal, debt?

Background

Japan’s economic methodology gives crucial insight into the future of debt management in developed nations. Many nations are facing similar issues as Japan: stagnant growth, aging populations, and augmented budget deficits. Japan, however, having matured earlier than most nations, is at the forefront of confronting these issues. Japan currently boasts the world’s largest debt to GDP ratio, with debt amounting to a staggering 263% of GDP². Despite this tremendous debt, Japan has managed to avoid a crisis, maintain a stable currency, preserve low interest rates, and retain a majority of debt domestically. By evaluating Japan’s institutional structure and economic policies, economists and nation states may gain key insights into the validity of Modern Monetary Theory.

Japan’s Modern Take on Monetary Theory

An analysis of the Japanese Government’s economic policies reveals that the policies are inherently tied to Modern Monetary Theory (MMT). MMT dictates that if a government prints its own fiat currency, it can finance any amount of spending or debt repayment without tax revenues³. The function of taxation shifts, from being used to gather revenue required to spend, to being utilized to control unemployment and inflation.

Over the last few decades, the Japanese Government has directed monetary and fiscal policy to accommodate a neoliberal vision of economic stability. This economic stability has been manifested through an expansionary monetary policy with low interest rates and aggressive quantitative easing. Additionally, Japan has resisted harsh fiscal policy, opting instead for sustained government spending and lax corporate taxes⁴. To bridge the gap between revenues and spending, Japan sells large amounts of government bonds and accumulates debt.

Japan has been able to retain the majority (90%) of debt domestically through bonds. This is done deliberately so that the debt is issued and paid in the nation's own currency, the Yen. MMT theorizes that if a nation’s debt is denominated in its own currency, and that currency maintains its demand, then it is impossible to default as money can be printed to pay the interest⁵. So why does Japan have such a massive debt if it can print endless money? The answer once again lies in MMT. The demand for one’s currency maintains its value domestically and internationally. Therefore, the only reason for Japan taking on such a drastic debt is to boost the essential demand for their currency through bonds. This debt is taken on by financial institutions and investors who are attracted by the safe profit from guaranteed interest.

International Leverage

Japan meticulously uses their position as a global creditor to leverage their position as a reliable economy and offset the stigma of its massive debt. Japan currently is the largest creditor in the world and holds the most U.S. debt of any nation with 1.1 trillion in American Treasuries⁶. While Japan is a close ally of the United States, holding this significant debt does provide Japan with leverage over the U.S. Hypothetically, if Japan “refused to extend new credits or sold off existing assets, Japanese investors could force painful adjustments on the U.S. financial sector”. This powerful position over American finances has allowed Japan to continue its radically loose monetary policy without being labeled a currency manipulator. By utilizing its symbiotic creditor relationship with the United States, Japan has also artificially raised the demand on their own low-yield Government bonds. The “bulk of Japan’s bond investment abroad has been hedged, often through the cross-currency swaps market”. Japanese investors then pay a premium on this swap, and Japanese Government debt is bought by foreigners. The Japanese position as a powerful creditor has allowed the country to justify the further creation of its debt.

Age, Xenophobia, and Democracy

Japanese politicians and voters have willingly permitted the proliferation of their incredible debt. Japan’s ruling Liberal and Democratic Party, headed by Fumio Kishida, has recently pushed forward with further quantitative easing and loose monetary policy. Constant monetary stimulus has led to Japanese debt constantly marching upwards. The spending has been popular with the majority of citizens who have benefitted from large infrastructure projects, corporate tax cuts, and elder welfare spending increases⁷. Economist Jim Rogers states “many policy measures serve only to kick the can down the road, rather than go far enough to yield results”. Japan’s aging population is reliant on government health and welfare programs, making budget cuts and austerity measures unpopular and infeasible. Japan, like many democratic nations, has had difficulty pushing austerity measures on a voting public.

The nation’s stagnation and subsequent debt are almost directly connected to their old, dying workforce. However, Japan refuses to consider the economic boosting capability of migration. Past governments have rhetorically supported increased migration, but programs have yielded pathetic results⁸. This failure to integrate foreigners is not new for Japan, a nation rampant with ethnocentrism. Only 2% of Japan is made of foreign born citizens. Of which, half of them attest to mistreatment and discrimination. When polled, Japanese voters revealed that only “23% believe the Japanese government should allow more immigrants to move to their country”. Japan’s economic policies can therefore be linked to nation’s dogmatic ethnocentrism. The Japanese populace has refused to open for migration opting for artificial economic stimulation and debt augmentation instead.

The Fight Against Deflation

Money creation is typically offset by the prospect of inflation. However, in recent years Japan has had the opposite problem, deflation. Deflation has lowered wages and stalled the Japanese economy for years. To manage this, a yearly inflation goal of 2% has been set, Japan’s Treasury has fired up its printers, and “doubled its money supply in 2013 alone”. This introduction of the printed money into the economy was done via the “Bank of Japan buying ¥7tn yen (£46bn) of government bonds each month using electronically created money”⁹. A major goal of this quantitative easing policy is to force the interest rates to remain low and lower long-term yields. To further elucidate their position, the Bank of Japan stated that doubling the supply was "executed for the purpose of conducting monetary policy and not for the purpose of financing fiscal deficits"¹⁰. This statement alone encapsulates the thought process of the Bank of Japan and the Government. Essentially, the Government’s economic ideology has focused on economic manipulation instead of debt repayment or fiscal cuts.

The Bill is Due

The Japanese Government may be incorrect in their assumption that if borrowing can continue indefinitely interest rates can be kept at a low level. In 2023, demand for long term Japanese bonds is slowly drying up as once-loyal investors seek higher returns elsewhere and weigh the ever-increasing risk of Government default. The trends are quite concerning; Japan spent 22% of its annual budget on debt redemption and interest payment last year, more than the 15% spent on public works, education and defense combined¹¹. These colossal payments are degrading Japan’s ability to function as a nation. No one is certain of what will happen when Japan’s payments on interest inevitably surpass their national GDP, but it will likely be catastrophic.

Conclusion

Japan engaged in cutting-edge economic experimentation by embracing the principles of Modern Monetary Theory. This novel course, despite its uncertainty, has been favorable to Japan’s aging and xenophobic voting base and has kept their economy running for decades. However, this bold strategy has relied on Japan’s respected creditor status and loyal domestic investor class. If these hallmarks fall away, or if interest payments become untenable, Japan’s Government and Economy could implode. But for now, Japan soldiers on.

1. Pham, Peter. “When Will Japan's Debt Crisis Implode?” Forbes, Forbes Magazine, 12 Dec. 2017.

2. Debt to GDP Ratio by Country 2020. https://worldpopulationreview.com/countries/countries-by-national-debt/.

3. Mitchell, Bill. “Modern Monetary Theory and Inflation – Part 1.” Modern Monetary Theory. Economic Outlook, January 6, 2011.

4. Dooley, Ben. “Modern Monetary Theory's Reluctant Poster Child: Japan.” The New York Times. The New York Times, June 5, 2019.

5. Wray, L. Randall (2015). Modern Money Theory : A Primer on Macroeconomics for Sovereign Monetary Systems. Houndmills, Basingstoke, Hampshire New York, NY: Palgrave Macmillan. pp. 137–141, 199–206.

6. Patti, Domm. “Japan Surpasses China as Largest Foreign Holder of US Treasurys.” CNBC. CNBC, August 15, 2019.

7. Sim, Walter. “Entrenched Political Interests Bode Long-Term Malaise for Japan: Investor Jim Rogers.” The Straits Times, October 31, 2019.

8. “Japan: Now Open to Foreign Workers, but Still Just as Racist?” South China Morning Post, May 17, 2019. /// Stokes, Bruce, and Kat Devlin. “Japanese Views on Immigrants, Immigration, Emigration.” Pew Research Center's Global Attitudes Project. Pew Research Center, December 30, 2019.

9. “Japanese Central Bank Doubles Money Supply in Fresh Bid to Spur Inflation.” The Guardian. Guardian News and Media, April 4, 2013. ///

10. Fullwiler, Scott; Grey, Rohan; Tankus, Nathan. "An MMT response on what causes inflation". FT Alphaville. The Financial Times Ltd. March 1, 2019.

11. Kihara, Leika, and Tetsushi Kajimoto. “Analysis: Japan's debt time bomb to complicate BOJ exit path.” Reuters, 10 February 2023, https://www.reuters.com/markets/asia/japans-debt-time-bomb-complicate-boj-exit-path-2023-02-10/.

Additional Sources:

• Oh, Sunny. “Here's a Lesson from Japan about the Threat of a U.S. Debt Crisis.” MarketWatch. MarketWatch, May 14, 2018.

• Blecker, Robert A. “The Ticking Debt Bomb: Why the U.S. International Financial Position Is Not Sustainable.” Economic Policy Institute.

• “A Puzzle in Japan's Balance of Payments: What Explains Strong Foreign Demand for JGBs?” Council on Foreign Relations. Council on Foreign Relations.

• “Abenomics and the Japanese Economy.” Council on Foreign Relations. Council on Foreign Relations. https://www.cfr.org/backgrounder/abenomics-and-japanese-economy.

• “A Puzzle in Japan's Balance of Payments: What Explains Strong Foreign Demand for JGBs?” Council on Foreign Relations. Council on Foreign Relations. https://www.cfr.org/blog/puzzle-japans-balance-payments-what-explains-strong-foreign-demand-jgbs.

• Blecker, Robert A. “The Ticking Debt Bomb: Why the U.S. International Financial Position Is Not Sustainable.” Economic Policy Institute. https://www.epi.org/publication/briefingpapers_debtbomb/.

• Dooley, Ben. “Modern Monetary Theory's Reluctant Poster Child: Japan.” The New York Times. The New York Times, June 5, 2019. https://www.nytimes.com/2019/06/05/business/modern-monetary-theorys-reluctant-poster-child-japan.html.

• Fujikawa, Megumi. “Trillion Schmillion: Japan Isn't Even Trying to Hit Its Bond-Buying Target.” The Wall Street Journal. Dow Jones & Company, January 21, 2019. https://www.wsj.com/articles/numbers-game-for-the-bank-of-japan-80-trillion-means-about-20-trillion-11548072005?mod=article_inline.

• Fullwiler, Scott; Grey, Rohan; Tankus, Nathan (1 March 2019). "An MMT response on what causes inflation". FT Alphaville. The Financial Times Ltd. Retrieved 27 April 2019.

• “Japan: Now Open to Foreign Workers, but Still Just as Racist?” South China Morning Post, May 17, 2019. https://www.scmp.com/week-asia/politics/article/3009800/japan-now-open-foreign-workers-still-just-racist.

• “Japanese Central Bank Doubles Money Supply in Fresh Bid to Spur Inflation.” The Guardian. Guardian News and Media, April 4, 2013. https://www.theguardian.com/business/2013/apr/04/japan-bank-money-supply-inflation-deflation.

• Oh, Sunny. “Here's a Lesson from Japan about the Threat of a U.S. Debt Crisis.” MarketWatch. MarketWatch, May 14, 2018.

• Pattidomm. “Japan Surpasses China as Largest Foreign Holder of US Treasurys.” CNBC. CNBC, August 15, 2019.

• Pham, Peter. “When Will Japan's Debt Crisis Implode?” Forbes, Forbes Magazine, 12 Dec. 2017.

• Sim, Walter. “Entrenched Political Interests Bode Long-Term Malaise for Japan: Investor Jim Rogers.” The Straits Times, October 31, 2019. https://www.straitstimes.com/asia/east-asia/entrenched-political-interests-bode-long-term-malaise-for-japan-investor-jim-rogers.

• Stokes, Bruce, and Kat Devlin. “Japanese Views on Immigrants, Immigration, Emigration.” Pew Research Center's Global Attitudes Project. Pew Research Center, December 30, 2019. https://www.pewresearch.org/global/2018/11/12/perceptions-of-immigrants-immigration-and-emigration/.

• Wray, L. Randall (2015). Modern Money Theory : A Primer on Macroeconomics for Sovereign Monetary Systems. Houndmills, Basingstoke, Hampshire New York, NY: Palgrave Macmillan. pp. 137–141, 199–206.