Practical analysis for investment professionals
20 April 2012

The Japanese Debt Crisis (Part 2): When Does Japan Cross the Event Horizon?

As noted in the first part of this series on Japan’s looming debt crisis, the economic consequences of Japan’s aging population are just beginning to manifest themselves, and dissaving — the act of spending down your life savings — isn’t the only problem that arises. Social and health care spending also accelerate, often placing greater and greater burdens on the government. For example, social security spending in Japan has leapt from 19.7% of the federal budget to more than 31% in the past decade (between 2000 and 2011), according to Japan’s Ministry of Finance.  Already, social spending and national debt service costs are causing the federal budget deficit to grow to unwieldy heights and are clearly threatening the cash flow model that has enabled Japan’s rates to stay so low.

All of this raises the question: With a funding deficit virtually exploding in Japan right now, can the event horizon for a debt crisis be that far off?

Should the Japanese government move to curb social security benefits, it will only accelerate the need for households to fund more of their own retirement living and health care expenses, exacerbating the dissavings that has already begun among households. Of course, there are some positive changes which offset the negatives to a degree. A shrinking population also reduces the levels of infrastructure investment and capital formation required, so national savings are enhanced. Nevertheless, the inherent pressures of rising social security costs and rising debt and debt-service costs will require the Japanese workforce to work harder simply to maintain the status quo — in which the fiscal deficit is already 11% of GDP, as noted in Figure 1. If Japan’s current economic model is left unchanged, the fiscal deficit would skyrocket toward 20% of GDP over the next several years. And remember, there are no free lunches. Any cuts in Japan’s federal budget will have consequences elsewhere.

Figure 1: Japanese Government Revenues vs. Expenditures

Japanese Government Revenues vs. Expenditures

Sources: Ministry of Finance, CFA Institute.

The crown jewel in Japan’s virtuous cash flow cycle of the past 22 years is its large foreign currency holdings. Due to the many years of trade surpluses, Japan’s corporations maintain vast sums of corporate savings denominated in foreign currencies. These foreign currency holdings generate substantial amounts of investment income each year. However, the control of these vast sums is concentrated in a few hands. Likewise, the bond market (and hence, interest rates) is controlled by many of these same hands. And because bonds are priced in a market, if and when the managers of this capital decide to sell, they can cause a stampede for the exit.

Moreover, what happens to the yen exchange rate if and when this capital is repatriated? Stewards of these foreign currency portfolios sell foreign currencies and buy yen — driving up the value of the yen — and worsening the competitiveness of Japanese exports. Unlike China, which uses its large foreign currency holdings to buy commodities and foreign manufacturers to control strategic assets, Japan is shrinking, so it needs little for growth. While Japan could benefit from the purchase of natural resources and other raw materials which it currently imports, its opportunity set is more limited. The greatest growth industry in Japan right now is perhaps health care, but health care is delivered locally. What strategic value could be gleaned by owning hospitals in say Vietnam or Europe? Consequently, there are limits to the strategic benefits that portfolio allocation could offer Japan.

Already, these corporate investors and banks, in particular, are becoming increasingly concerned about maintaining the status quo. Their ability and willingness are being directly challenged by the escalation of national debt service, the expansion of fiscal deficits, and the ramifications of the Fukushima disaster, as well as the current pressure on the yen exchange rate. Already, Japan’s debt service is 23% of GDP, with interest rates at 1%. What happens if and when rates rise? In short, debt service would explode and crowd out huge portions of the federal budget, as illustrated in Figure 2.

Figure 2: Japanese Debt Service and Rates: What Happens Next?

Japanese Debt Service and Rates

Sources: Ministry of Finance, Bank of Japan, and CFA Institute.

So, what causes rates to rise? Rates rise when the market senses a paradigm shift. Perhaps first is what corporate asset managers decide to do. Second, the general dissaving that is spawned by aging will reduce aggregate demand at a time when aggregate supply is increasing. Third, a stronger yen means fewer exports and, furthermore, the shift in energy policy after the Fukushima disaster means a downward structural shift in the current account balance. Not only does aging impact federal budgets, but it also puts downward pressure on GDP as described in Part 1. Only now, the funding surplus has become a funding deficit and the required monetization of debt is increasingly likely to lead to some inflation (although it is partly offset by the deflationary impacts of a shrinking population).

Now the bond market in Japan is well aware of how the game is played.  Of course, the Bank of Japan plays a key role in all of this – in part by buying JGB’s when demand is weak, and in part by cajoling these same financial institutions to purchase JGB’s.  With the tools of regulation at their backs, the BOJ does indeed wield much power.  What the bond market is perhaps missing are the ongoing incremental changes that have accumulated over 22 years. Such a consistent message to the market establishes a strong belief among market participants.  It’s when this belief begins to change that rates will change.  So, are beliefs changing?  On the margin, banks are showing more reluctance to increasing their exposure to JGB’s.  And on balance, the funding deficit is becoming a large problem, changing the very economic model that has enabled Japan for so long. These changes will place increasing pressure on the BOJ to keep the status quo alive and somehow prevent the market from realizing the game has changed.  Bank of Japan Governor Masaaki Shirakawa truly has the challenge of a lifetime to keep it all together.

Some have argued that Japan can ameliorate its budget shortfall by raising tax rates. In economics, there are no grand solutions, only trade-offs. So, it is a fallacy to think that increasing tax rates necessarily increases tax revenues to the government. Many governments and countries have tried raising tax rates and failed to increase tax revenues either due to tax avoidance or damage to economic growth (or both). Japan is currently considering a number of measures to increase taxes (including a proposal to double the national sales tax, from 5% to 10%), but it is not at all clear that these measures will grow the overall tax revenues to the federal government because of various trade-offs across the global economy.  And Japan’s funding model is vulnerable to changes in behavior that emanate from changes in tax policy.  For instance, what if the rise in tax rates causes capital flight from Japan and the delicate funding deficit accelerates?

Other analysts have compared Japan’s relatively low tax revenue/GDP ratio with that of other countries, claiming that there is ample room to raise taxes. However, this belies the welfare society construct that Japan has developed in the past 75 years. In contrast to the welfare state, the welfare society provides social benefits through private employers. Japan’s welfare society attempts to maintain near-total employment via liberal government loans to private companies, often circumventing the need for unemployment benefits. Also, retirement pensions come largely from personal savings and company compensation rather than as benefits from the state. So, the state has intentionally shifted the cost of its social programs to companies. Should it raise taxes on the private sector, additional pressure would be placed on corporate budgets, thereby weakening the economy.

Compounding matters, Japan’s manufacturing prowess is weakening while the country as a whole is becoming less competitive. They have lost leadership positions in a number of key industries and the rise of the yen is making their exports less competitive as well. Moreover, pressured budgets make it more difficult to engage in the long-range R&D spending that had helped the country become a global leader in manufacturing. As an example, once a stalwart in consumer technology, Sony recently announced the layoff of 10,000 workers.

Since the epic global financial meltdown in 2008, the U.S. Federal Reserve has maintained an aggressive policy of depreciating the U.S. dollar. As noted in Figure 3, the yen has appreciated some 30% against its post-bubble average, as well as against the dollar, since the collapse in 2008.

Figure 3: Yen vs. US$

Japan Yen vs US Dollars

Sources: St. Louis Federal Reserve Bank, CFA Institute.

This recent appreciation of the yen is exacerbating all of Japan’s problems — its export products are now 30% more expensive on global markets. Its profile is similar against other major currencies. For the first time since the Japanese bubble collapsed, Japan will now need substantial alternate forms of funding to keep the government afloat. Consider Table 1, which illustrates how the funding sources of the federal government are changing and the pressures these changes will place on the Japanese bond market over the next 10 years.

Table 1: Japan Funding Surplus/Deficit Decade by Decade

Japan: Funding Surplus/Deficit Decade by Decade

The funding deficit over the 2000–10 time frame has been modestly negative and made up for with accommodative policy by the Bank of Japan. This accommodative policy has been offset by deflationary forces in Japan, so the net effect has been mild deflation. Looking forward, if this funding deficit of, say, –5% of GDP were made up for with accommodative monetary policy, then the inflationary force of this accommodative monetary policy would very likely exceed the mild deflation (say, –1% or so) that has been occurring in Japan for some time. The net result would be some mild inflation of, perhaps, 2–4% (depending on how much monetization and how much debt issuance occurs), but it would likely be enough to recalibrate the bond market’s expectations. And if JGB yields rise from 1% to just 2%, Japan’s debt service will explode. Thus, a vicious cycle of higher yields, greater fiscal deficits, greater monetization, and greater inflation will occur.

However, the status quo in Japan — if left unchanged — will see to it that the funding deficit widens materially. As debt continues climbing and GDP continues falling, the growth in the debt-to-GDP ratio accelerates. The combination of a rising yen and stagnating corporations will result in the structural trade surplus deteriorating over time (which is why the BOJ will try to get the yen to decline somewhat). Additionally, debt service and social security spending will continue growing as percentages of the federal budget — all without any increase in interest rates. So there is a widening funding deficit that must be made up for with some combination of debt issuance and/or monetization. The combination of large fiscal deficits, funding shortfalls, and private sector dissaving will ensure that Japan must seek investors on the international markets. Consequently, the (natural) domestic demand base for JGBs is falling, while the government’s need for foreign investors is rising. Although some have suggested that the Bank of Japan could devalue the yen, what would happen to the cost of imports if it did? (Remember that Japan imports virtually all of its raw materials, such as energy and hard commodities.) If it chopped the yen in half and many of its input costs doubled, could its export companies be competitive? What would happen to the balance of trade (all else being equal)?

While the underlying economics will change gradually over time, the crisis will erupt when the bond market breaks from the past. When the market realizes that the status quo has changed, rates will rise and force the government’s fiscal budget to explode, creating a sequence of cascading events. Watch closely to see what the major Japanese banks do with their JGB holdings. In addition, watch pension fund managers. The stewards of capital changing their policy allocations will determine when the status quo shifts.

So, when does Japan breach the event horizon? No one can say for certain, but after 22 years of operating in limbo, the event horizon now appears to coincide with the investment horizon of investors. Perhaps the BOJ will find a devaluation of the yen too irresistible to pass up, a move that will reset Japan’s current course in one fell swoop. Or perhaps the bond market will decide for them.  At any rate, one thing is clear: change is coming to Japan.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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About the Author(s)
Ron Rimkus, CFA

Ron Rimkus, CFA, was Director of Economics & Alternative Assets at CFA Institute, where he wrote about economics, monetary policy, currencies, global macro, behavioral finance, fixed income and alternative investments, such as gold and bitcoin (among other things). Previously, he served as SVP and Director of Large-cap Equity Products for BB&T Asset Management, where he led a team of research analysts, 300 regional portfolio managers, client service specialists, and marketing staff. He also served as a Senior Vice President and Lead Portfolio Manager of large-cap equity products at Mesirow Financial. Rimkus earned a BA degree in economics from Brown University and his MBA from the Anderson School of Management at UCLA. Topical Expertise: Alternative Investments · Economics

47 thoughts on “The Japanese Debt Crisis (Part 2): When Does Japan Cross the Event Horizon?”

  1. “So, what causes rates to rise? Rates rise when the market senses a paradigm shift.”

    Wrong. Rates rise when the Central Bank decides to raise them. The market has little control of rates, especially on the short end of the curve. The BoJ decides what rates will be. The market only has minor influence on the long end. (explained here: )

    I read both parts of your post, and your premise is built on flawed understandings of the modern monetary system.
    Japan’s not going to face a debt crisis, even if debt/gdp gets to 500%. The only “crisis” they can face, as a currency issuer is one of inflation. However, as you said, given the deflationary pressures of a weak economy, that is unlikely to happen.
    The only issue going forward with an aging population will be who will create all the goods and services (supply) to meet all the demand. If that does not stay stable or grow, then Japan will be facing inflationary pressures. But given the weak economy (weak demand), this should be of little worry to Japan.

    Also, all public debt is private sector savings. Its not “debt” in the sense that you understand debt to be. A sovereign currency issuer’s “debt” cannot be compared to a currency users (people, businesses, states, Eurozone nations).

    Also, on that “tax/revenue” issue: An issuer of currency can NEVER run out of “money”. That is operationally impossible. They can always just issue more. Obviously there is a constraint to this (inflation: More money chasing fewer goods/services), but as I explained above, that is unlikely to get out of hand.

    What Japan (and most of the world) needs is aggressive monetary and ESPECIALLY fiscal policy. They need to increase the level of net financial assets so the population can start spending again. This actually will cause some inflationary pressures as the economy grows. And that’s what will send rates up, once the BoJ sees inflation rising.

    I have to give you credit for laying out a nice detailed argument though. Also, I see you went to my current school (UCLA) for Business school ;)…Go bruins!

    1. Armo,

      If you believe that a central bank of any nation is “independent” and raises rates any time they wish then you truly are an ostrich with your head in the sand. Japan will run into severe problems in the near future and the author identified them in a very concise manner. Read it again and throw away your econ text books at UCLA. Have you heard of Kyle Bass?

      1. Right. The severe debt crisis is right around the corner! Its on the horizon!

        This crap was said in the 90s, 00s, and now is being said in the 2010s. Its probably going to continue into the 2020s.
        As long as deflation stays a threat to Japan (very possible given their weak policies), People shorting JGBs are going to get BURNT.

        The author’s arguments are built a a flawed premise. Japan isn’t going to have any debt or inflation crisis at any time soon. If the past 20 years isn’t enough proof, then YOUR’E the one being an “ostrich with your head in the sand”.

    2. Tres Knippa says:

      Armo Trader,

      Let me get this straight. An undergraduate political science major at UCLA can tell the author of this article “your premise is built on flawed understandings of the modern monetary system”?

      I suppose this is no surprise coming from someone who would use such flawed logic as to suggest the answer to job growth is an expansion of the public sector employment base. Learn that idea from the fabulous success that is the State of California?

      Let me give you a quick lesson that you may have missed in the poly sci department of UCLA.

      Increase in GDP= Increase in population+ Increase in productivity.

      By all means, please elaborate on how higher taxes, never ending expansion of government, growth of public sector debt, or zero interest rate policy accomplishes any of the changes in the above mentioned equation.

      What genius taught you a never ending money supply was a good thing? Did it work in Argentina? Did it work in Germany? How about Zimbabwe?

      The Japanese Government Bond market won’t ever break? Let me ask you a simple question….who in the world is going to want to own a yen denominated asset once the BOJ prints a never ending supply of money needed to support a faltering bond market?

      You want to know the most chilling thing you wrote? “all public debt is private sector savings”. This makes me want to vomit. What gives the central government the right to borrow against private sector savings to fund the spending habits of profilgate politicians? Can you imagine the positive change to productivity if those private sector savings were invested rather than lent to the central government. Debt is a headwind to economic growth, plain and simple.

      Jot this down somewhere so you don’t forget it. Growth comes from the private sector and cannot be engineered from a large central government. Individuals, corporations, municipalities, and federal governments cannot spend more than they take in. Not ever. Not in any case in history. It is not any different this time than the last. There are two pretty famous professors at Harvard and the University of Maryland by the name of Reinhart and Rogoff who you might want to look up.

      Tres Knippa
      Member, Chicago Mercantile Exchange
      Owner, Kenai Capital Management

      1. 1) “An undergraduate political science major at UCLA can tell the author of this article “your premise is built on flawed understandings of the modern monetary system”?” <~~~~ Umm, ya. Just because I don't have the credentials like a PhD doesn't mean I can't debate econ. I read probably more econ everyday than most econ students.

        I LOVE how you keep taking shots at the fact that I am majoring at poli sci at UCLA. Funny stuff.

        2) Your'e making SO many assumptions about me/my beliefs in that paragraph. Who say's I want public sector employment expansion to be leading the job recovery? I don't.

        Most of the stuff you talk about in that comment are so badly flawed, that I dont know where to begin.

        – "Growth of public sector debt" = That just means growth in private sector savings.
        If you actually KNEW the formula for GDP you would know that if you line up accounting identities, you would get
        (S – I) = (G – T) + (X – M) <–This mean Private sector savings = Government deficit + foreign sector balance. That means if the government reduces its deficit, if its not coming from the foreign sector, then its coming from the private sector.

        3) "What genius taught you a never ending money supply was a good thing? Did it work in Argentina? Did it work in Germany? How about Zimbabwe?"

        If you knew your hyperinflation history and how reserves actually work (banks are never reserve constraint, so the increase in excess reserves are not inflationary at all), you would know why Argentina, Germany and Zimbabwe HAD hyperinflation.
        A lot of these cases had to do with Foreign denominated debt. Which means they borrowed in currencies in which they had NO ability to issue. So If the US had big debt denominated in Euros, Yen, Yuan, I WOULD be worried for hyperinflation. But we DONT. Our "debt" is denominated in Dollars.

        This is ALL explained here:

        4) Again by definition, private sector net savings = public sector deficit. If you can't understand that, then I can't argue much else because that is a basic fundamental reality.
        Also, the Gov does NOT borrow money from the public sector. They just issue it. Nobody "funds" the government besides a bunch of keystrokes managed by the Fed (directed by the Treasury).

        How about you jot this down?
        Yes, while growth comes from the private sector, that cannot come if the public sector does NOT provide the necessities (Net financial assets, which means deficits) to sustain that growth.
        Your assumption that Individuals, corporations, municpalitie and Federal governments are the same are just baseless.
        The Fed gov has the ability to issue money, thus it can never run out.
        The previous three do not. That is essential to understand, and if you don't see that, there is not point in arguing because we'll just be going around in circles.

        You should look up the works of Warren Mosler and the UMKC's econ department.

        1. Tres Knippa says:

          Great news. By all means, please elaborate on how confident you are in your short JGB put position. JGBs are never going down right? Please get short all the JGB puts you like and there will be some of us willing to take the other side of your trade. Isn’t the market great? You have an opinion? Jump in, the water is warm.

          Best of luck to you and the other Keynesians.

          I find your arguments reasonably amusing but somewhat well thought out from a political perspective. If you are ever in Chicago, by all means, please be my guest on the floor of the Chicago Mercantile Exchange. I can promise you that you will never stand in a room with a larger range of education levels and income……………incidentally, in the trading world they are not necessarily correlated.

          Best of luck.


          1. Phil says:

            @Tres Knippa If you knew your economics, you’d know that TheArmoTrader is espousing a Modern Monetary Theory position, which has a completely different set of theoretical underpinnings than the Keynsian crowd. For a start they treat debt levels as being of great significance to the economy, rather than the neutral triviality that the Keynsians grant it.

            Go read the posts at pragcap, you might find them enlightening, even if you disagree with them.

    3. Bill O'Connor says:


      really ? can you show me where Ireland-Portugal-Greece-Italy-Spain central banks decided to raise their rates ?

  2. Mr. ArmoTrader,

    Perhaps you overstate your case. Newton’s third law states that for every action, there is an equal and opposite reaction. In economics, we call them trade-offs. Just because central banks have “controlled” interest rates historically, does not mean that they will control them in the future. Moreover, it also does not mean that central banks have not caused distortions or problems in the past. In fact, they have – big time. The only question for us to resolve is “What are the trade-offs?”

    I am more interested in the trade-offs or consequences of their actions, rather than succumb to a mistaken belief in their supreme power. Markets are and always will be the final arbiter of events, so there will be market and/or economic events that central planners can not control, no matter how hard they try.

    To understand this, consider the composition of just how low rates have been “engineered” globally in the past 20 years or so: trade imbalances, fiscal deficit spending, total debt growth and central bank intervention. Central banks directly control only 1 of these 4 activities (setting of discount rates and/or intervention into bond markets) and directly influence credit creation with rates (low rates is partly why the world is grossly over-indebted right now). However, fiscal deficit spending and trade imbalances are largely outside their control and these factors have been significant as well.

    For instance, persistent trade imbalances (e.g. Japan’s trade surplus and the US trade deficit) have enabled the surplus countries to buy the sovereign bonds of their trading partners, while deficit countries ramp up total debt levels to enhance aggregate demand (due both to incremental demand from low rates as well as fiscal deficit spending). These are not small potatoes – the US trade deficit alone has generated about $5 trillion of foreign owned capital over the past 20 years – much of which ended up in sovereign US Treasuries – bidding up bond prices and down yields. Do you think that this game can go on forever?

    The “free” exchange rate mechanism is supposed to enable trade imbalances to rectify themselves due to the movement of exchange rates. Central bank/government behavior blocks the free trade of currencies, so balance in trade can not happen. So, what are the trade-offs? Where does it manifest itself? Short answer: Debt. Even your favored theory of MMT proposes that countries should print-as-they-go due to the printing press. Had governments never issued a dime in debt, the only difference today is that prices would be a lot higher. However, they all have debt which absorbs the inflationary power of excess spending and printed money over time. But like a levee in a flood, at some point the tidewater is much too great. And in the case of Japan, it all flows through their federal budget in circular fashion. So, whether it is a debt crisis, a currency devaluation or an inflation crisis, it’s all a difference without distinction.

    1. Sorry but I’m going to have to disagree. Central banks, as the monopoly issuer of reserves, control rates. Its easy to see this if you just look at the overlay of the FFR, 1 year rate, and 10 year rate.
      As you see, the short end of the curve is basically the FFR. The 10 year, although not as correlated, still follows the trend. And as long as the US continues being the monopoly issuer of reserves/dollar (meaning no gold standard, no “Eurozone” monetary union in North America,etc), the Central bank WILL continue to control rates. Not the market. Your assumption is based on thinking from the “gold standard era” where markets did control rates, similarly to what is happening in Spain/Italy/Greece – a TRUE debt crisis (even with the ECB is taking steps, which just postpones the crisis, not solves it).
      You have NO choice but to believe in their “supreme” power because the realism of the modern monetary system hold true- that the CB controls rates because they control reserves because they are the monopoly issuer of the currency.

      Also, your understanding of deficits/debt is erroneous. All debt/deficit is, is private sector savings. Its an accounting identity. If you take the public debt that HAS to equal total net private sector savings (there’s also the foreign sector, but to keep it simple here will not go into that).

      Public debt is NOT like private debt. To understand why Japan has been buying bonds, think of it like this.
      They sell us Item X. They receive US dollars, which are credited to their “reserve accounts” (basically a checking account) at the Fed. Japan can either Buy US products with these Dollars OR ‘save’ them. If Japan decides to save them, a rational actor will decide to save them in the best way in which they can earn interest. So they decide to buy US bonds (aka public debt). So what the Fed does is transfer the dollars from their ‘checking account’ to their ‘savings account’ (where they earn higher interest). Same goes for Japan.
      The fiscal deficit (spending=printing) of a country borrowing in their OWN currency is nothing but an accounting process & monetary operation, in which they offer the private (and foreign) sector higher yields in which to SAVE in.
      So if one sector is Net saving (a surplus), one sector MUST be in a deficit. Given Japan’s situation in which the private sector is net savers (and usually, this SHOULD be the way you want things, unless a foreign sector surplus can cover that deficit ran by the private sector), the public sector is in a deficit.
      This chart shows the balances of the 3 sectors of the economy in Japan. Note that this has to equal to Zero.

      The matter of fact is, Japan does not borrow in dollars (or the US does not borrow in Yen). They “borrow” in their own currency, so a debt crisis is operationally impossible (unless caused politically, like lets say, restrictions on spending based on an arbitrary number, aka the debt ceiling).
      The only “crisis” Japan can face is one with deflation (depression) or inflation. Only in the latter scenario would Japan need to do any “austere” reforms (aka cut spending/raise taxes, in order to lower Aggregate demand and in turn inflation). But given the weak domestic demand and deflation resulting from it, this is the LEAST of Japan’s worries (and the US).

      As for the “What are the trade-offs?” question regarding central banks controlling rates. The trade off is that the private sector gets low rates. Now, as you said, there can be negatives that come with this (in a booming economy, this could HELP lead to bubbles- which create excessive private debt which hurts the recovery like it is right now in the US-, but not necessarily). There are also positives with low interest rates in a weak economy, in which refinancing/borrowing gets cheaper thus leading to a faster recovery (however, since we are in a rare care of the balance sheet recession, this has not helped much in this recovery, but thats another debate).

      But to just conclude, CBs control rates, as evidenced by Japan over the past 20 years! Not to sound offensive, but people have made the SAME argument on Japan for 2 decades now (and you even mention this). They will make the same arguments for the US too, where a “fiscal debt crisis” is right around the corner (despite ALL the evidence/fundamentals saying there isn’t).


      1. rick says:

        Armo trader,

        Educate yourself here about what has changed and what will continue to pose significant headwinds for Japan. The trade didn’t work primarily because of the chart on page 8.

      2. Damien Golding says:

        Despite all the logic reasoning behind Japan going under I do agree in ways that Japan is definitely a lot safer than initial figures seem to show.

        News always compares Japan with other nations with similar levels of debt compared with GDP such as those in Europe, but does not take into account the huge differences in society.

        Japanese debt is primarily controlled within Japan.
        Japanese society works very hard with high employment rates doing real jobs, not the jobs that are created by governments for statistical reasons.
        The Japanese public generally do not invest outside of Japan regardless of interest rate changes.

        I believe these points above have a huge impact on how Japan is much safer against future debt issues.
        Just think about how Japan is compared to Greece in GDP to debt but the fact is employment in Greece is extremely low compared to booming trade in Japan despite what figures say I can tell you as a resident in Japan that compared to places like England, jobs are very abundant.

        My main worries in future issues of debt are that it is not under control and that the shrinking population puts a burden in pension, real estate companies and debt per person, but I also believe even the worst will not be anyway near as bad as countries in Europe, especially because debt is generally controlled within Japan meaning the worst is that investors in Japan lose their saving/investments and they have to start earning all over again.

  3. Jim says:

    Did you just quote a physics law when it comes to what is essentially monopoly money?

    This article could have been written in 1995, or 1998, or 2000, or 2002, or 2004, or 2006.

    I always ask one question whenever I read these “debt crisis” articles about Japan, US, UK etc.

    How is it possible for a country to ever go bankrupt or face any crisis when it “owes” money in the same currency it alone has the power to issue? Japan, US, UK, etc can always “service” the debt no matter how high it gets. There is a theoretical limit to this when runaway inflation can take hold but none of these countries are even close to that point. Japan is going thru a deflationary period. The US/UK are FAR from operating at full capacity.

    Yes, and it will go on forever. We benefit from this trade imbalance since we get tangible goods for paper money. The foreign nations sit on sterile cash they want a return on so they demand treasuries. This is why the “debt” is so high. The tradeoff is that by wanting cheaper items produced abroad we’ve killed our own manufacturing base since we cannot compete on a price basis.

    If the markets controlled everything, why is Japan’s borrowing rate so low relative to it’s debt levels? Why are people tripping over themselves to lap up US and Japan debt? If the event horizon was looming, wouldn’t the market be pricing that in? Especially since the doomsday predictions have been going on for 2 decades now?

    At some point, empirical evidence has to trump theory and predictions.

  4. Chris says:


    Thank you very much for a very detailed well thought set of arguments. I thoroughly enjoyed reading it.

    You have succinctly argued as I would that unsustainable fundamentals do not sustain themselves. The MMT mumbo jumbo and assorted Keynesian ivory tower theories work….until they don’t. The key lies only in timing but not in structure.


  5. Mark says:

    One thing that I didn’t see mentioned that is important is the real estate bubble that led to the deflation. Part of the reason that the government has been able to issue so much debt is that homeowners (and real estate investors) have been paying down the mortgages on their underwater properties. As property prices continue to drop, many properties stay underwater or nearly so. Mortgage debt has been shrinking as government debt has been expanding. When the real estate market bottoms out, it will become more difficult to grow the government debt. However, with an aging and shrinking population demand for real estate will remain low and will fall below replacement cost. The Fukushima disaster has put further downward pressure on real estate prices, at least regionally.

  6. Jussi says:

    I think it is quite clear that CB will keep the rates down and able to do if necessary.

    There will be no hyperinflation without higher demand. Why would anyone raise the prices without enough demand? Japan needs if anything more demand and less horror stories. Kill the zombies.

  7. genauer says:

    All these people, who think that governments can print money forever,
    and ask for evidence to the contrary are like people who jump from the 93rd floor and at 17th floor proudly declare: so far this has worked beautifully.

    Why are Greece, Ireland, Portugal under IMF / ECB supervision?

    Why is Argentine again resorting to capital controls and plain stealing (YPF), private pensions, oil companies, etc, if they could print all the money they need ? Preparing for the second criminal default in the near future, which will hit a lot harder than the last in 2002.

  8. Jim says:

    Why are Greece, Ireland, Portugal under IMF / ECB supervision?

    Do you have any clue what the difference is between the monetary systems of those countries and Japan, US, UK etc?

    Here’s a clue: what makes the US states different from the federal government?

    If you don’t you just came to a gun fight with a plastic spoon. Go educate yourself a bit.

  9. 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.

    1. Will keep this short.

      1) Its not Government spending (even though Gov spending is needed in the beginning to get the dollars into the economy (private sector) that essentially needed. Its DEFICITS. How you get to deficits, is a matter of discussion where we can have some good logical debates. But what we cannot debate about (because of the accounting identity fact) is that the government deficit is equal to the private sector savings. Both sectors cannot run a surplus, its impossible (unless the foreign sector is running a deficit, but for the US, it is not)

      2) are central banks more powerful than markets? <– Yes
      If ECB wanted right now, it could lower all EZ nations' bond yields to 1%. However, that is unlikely given Germany's unwarranted stance on inflation and their ability to politically control the ECB. However, thats another issue, one that does not pertain to the operational realities of the monetary system.
      Same would go with the FED/BoJ. They could keep rates at 1% forever (10 year yield). However, there are consequences to that. Once the economy normalizes, inflation will pick up, thus the FED will be forced to raise rates (because of rising inflation, NOT markets)

      You brought up Nat Gas/oil. Imagine a nat gas producer who could produce (read "print") Nat Gas at the press of a button (read "keystroke) [Lets assume He would be the only one in the world, because there is truly only 1 issuer per currency].
      He could keep Nat Gas prices at whatever price (lets say 50 cents) forever by just producing NatGas with the push of a button right?
      But obviously there would be "trade-offs". He would be selling NatGas at a cheaper rate than what he could. He keeps it low for now to get people to convert to Nat Gas. Once people start switching to NatGas, he would then be forced to raise prices so he would stay in business (because lets assume $4 is the breakeven point…That breakeven point for inflation is more complex than this simple scenario, but you get my point).

      The Same goes for the FED. They can keep Rates as low as they want forever, however, there will be inflation costs later which they would need to combat by raising rates.

      3) I read ur post, no need to re-explain here…but I disagree with some of your analysis. Again, as long as Japan (the BoJ) can issue Yen, there will be NO crisis (barring exogenous events).

      To conclude:
      In the end, all that matters is if they can issue currency or not. Yes, there is CONSTRAINTS (inflation), but that is more of a complex issue then just "monetary" reasons.
      Enjoyed the debate Sir.

      1. Jeff says:

        Another great post. Thanks for the clear and concise points.

  10. Frank Ashe says:

    I’m with ArmoTrader – there’s a lot of fuzzy thinking going on in the main article and replies:

    * ” For starters, the underlying unit is currency (e.g. yen, dollars, etc.) which itself changes.” How does the currency itself change? What do you mean?

    * “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?”
    I was under the impression that government spending in Japan was keeping up aggregate demand, because the private sector was winding down their balance sheets (see Koo’s idea of a balance sheet recession). In which case there is no concept of crowding out that Rimkus is implying.

    * “Surplus countries like Japan have used their CB to lower rates, stimulate debt and regulate banks into buying more JGB’s.”
    A bank buying a JGB is more like an interest rate swap than a purchase. Rather than leave money in the BoJ earning a floating rate of interest, a bank accepts a fixed rate of interest for a known length of time. In both cases the government is the counterparty – either the Treasury or the BoJ. If in the future nobody wants to do the swap (buy the bond) then the cash just sits on the BoJ balance sheet and gets 0% interest.

    Japan has problems, but the analysis is deeper than this.

  11. Frank Ashe says:

    Ooops! Almost forgot.

    Figures 1 and 3 are misleading – a logarithmic scale must be used.

  12. Anders says:

    Ron Rimkus – interesting article. But don’t you agree that the changing demographics are only really relevant in terms of production vs needs/wants of real goods and services? Sure, Japan has an ageing population. But as long as the real goods and services produced by Japan are sufficient, there is no ‘real’ issue. The only question becomes how do you ensure that aggregate demand isn’t excessive in view of the productive capacity of the country. This is an inflationary point.

    You speak of the central bank as if it has the upper hand usually but not always. I’d contend that it ALWAYS has the upper hand, simply because it can impose the “explicit yield ceilings”, in Bernanke’s term, and make unlimited purchases of bonds to enforce those yields (as the SNB is doing to protect the EUR CHF floor). Large scale purchases by the BoJ – even larger than at present – could indeed lead to inflation; default is not something that BoJ could be forced into.

    Whichever way you look, the story is entirely about inflation. And the point here is: you can always raise taxes to curb inflation. Reduce income with tax, and the issue of “too much money chasing too few goods” goes away.

    Whilst we have all learned to expect monetary policy to be the primary tool to prevent inflation, in fact we are going to have get to used to fiscal policy being more important, because higher debt levels mean that raising rates is going to be increasingly problematic.

    This is “fiscal dominance”; not a normative doctrine, but an observation about how economies have evolved.

  13. Hi Anders. I think I agree with everything you’ve said. I am not particularly concerned about a default, per se, as some comments have intimated for the reasons outlined. I am concerned about the value of JGB’s and the levels of Yields on JGB’s / interest rates, the value of the Yen and an inflationary spiral. I don’t claim to know how exactly it will manifest itself. My point is simply that the status quo is changing and it will affect the national debt, the Japanese economy and the Japanese people (i.e.JGB’s) in a material way. Exactly how and where it manifests itself will depend in large part on the future actions of the Japanese Government and the Bank of Japan.

    1. Frank Ashe says:


      I agree with your comments that “the status quo is changing and it will affect the national debt, the Japanese economy and the Japanese people (i.e.JGB’s) in a material way.” I think this much is obvious.

      But then you move onto a comment such as: ” I am concerned about the value of JGB’s and the levels of Yields on JGB’s / interest rates, the value of the Yen and an inflationary spiral. I don’t claim to know how exactly it will manifest itself.” One of the points that ArmoTrader was making is that when you try to map out what will happen then you need to look at a path that maintains the simple macroeconomic identities and takes into account the way that fiat money behaves at a macroeconomic level in a modern banking system.

      When this is done you find that the debt/GDP ratio is not an important concept. However, even if it’s not an important concept we still have that debt as a major factor in the economy. As an exercise in how to think about these concepts in a modern money sense, consider this case of dissaving:

      The aggregate of Japanese pensioners wish to sell a certain amount of JGBs, say Y1bn. This will require the buyers to electronically shift Y1bn from their bank accounts to the pensioners accounts. The bond sales are settled electronically too. Who are these buyers and why do they have Y1bn in cash earning 0%? (Note that you can’t assume they sell other assets, as this just shifts the question back one step – who has the cash?) Note that the government (BoJ) could be the buyer. What are the implications in this case?

      Why do the pensioners have to sell bonds? The rolling maturity of existing bonds gives a very high cash flow to the holders of the bonds, over 10% a year of the stock of JGBs mature each year.

  14. Anders says:

    Ron – I do agree this is uncharted territory, but just trying to elicit any points of disagreement; I suppose there are three separate things:

    1. do you at least believe that Bernanke’s ‘yield ceilings’ idea would work to limit yields, even if it meant potentially unleashing inflationary forces (which one would need to look to fiscal policy to restrain)?
    2. I trust you would be dubious about the ability of fiscal policy to restrain inflationary forces, but is this more because you believe it does not work, or that institutionally politicians won’t implement the requisite tax increases in time?
    3. It sounds like you do believe inflationary forces are inevitable. Here you and MMT obviously differ; MMT might concede that excess liquidity would lead to asset price booms, but wouldn’t see a stick-to-flow effect of increasing asset prices to higher aggregate demand.

    On #1, I see very little discussion on this particular point; BB himself doesn’t seem to have written any formal paper on yield ceilings.

    It might seem academic since BB hasn’t I believe mentioned it explicitly since Jackson Hole in 2002 (and a follow-up speech in 2003); but when I look at the equation:

    “public debt/GDP = F(nominal growth, primary budget balance, prior period debt/GDP, interest rate on debt)”

    it seems appropriate to rearrange it to define that interest rate that marks the threshold of stable debt/GDP. In other words, I think fiscal sustainability is going to be seen more and more as managing down interest rates – so yield ceilings simply have to come back on to the agenda.

    Best wishes

  15. Leon says:

    Thank you Ron for this insightful article. Can you offer to explain why the market worked against the BOJ’ recent QE on the 27th besides for reasons of expectation.



  16. Chris says:

    Just a small detail: Japan’s debt service ratio is 23% of total government expenditure (see Figure 4.1) NOT 23% of GDP…. more like 4.8% of GDP. Makes a bit of a difference….

  17. sanjay says:

    armo, you have very very poor understanding of economics. you do not need to be an economic expert or rocket scientist to know principle of money.

    The author is right! Japan cannot keep issuing debt to its own people in terms of yen. Debt is debt does not matter where you it comes from!!

    Even if they devalue their yen by 50% and write off all internal debt, they will still go belly up at this rate!

    Japan imports more than it exports. If they keep devaluing the yen. The exports will be cheap and they will have to pay massive price to import goods!
    Dont you see why greece is fighting to be in euro? what about zimbawbe? and our own california?

    And just because export become cheap, does not mean there is a bee line to buy japanese products. Whatever japanese can do koreans have done better, taiwan and china are catching up quick.

    The case in point is sony/sharp not number one any more. It is samsung and lg who are ruling the world. has the stock market come back from the slump even after 2 decades? Hell no and they cannot!

    This is what your learnt at UCLA? Some mumbo jumbo convoluted theory of yours? I am sure you still owe lot of debt on your tuition to that
    deemed school! It is no berkley ok?
    This is common sense and you do not need to be an expert in economics to understand their mess!
    America is following suit as well!

    And on top of it, you are giving attitude to the author.

    I could not expect any better than an undergrad from that ok school UCLA!

    First I should bitch slap your sorry ass before indoctrinating some basic economic principles.
    dig it?

  18. sanjay says:

    author is right!
    Add to that:
    a) japans population is growing old
    b) japan has limited land and hence housing price can be only so much up!!
    c) the wages have stagnated for long
    d) the yen has been devalued by nearly 50% in the last 2 decades
    e) whatever japan can do other asian countries have also emulated and have even bettered in certain areas.
    Japan was the master of re-engineering( they killed US electronics hardware industry), korea and taiwan are killing them at their own game.

    f) only china can bail out japan, when the problem escalates to unprecedented heights in about decades time.
    A global economic meltdown in the offing here with all developed countries defaulting on their debt. This will ensu war or massive write off( commodity and stock collapse to reboot again) to reboot.

    There will be re-balance of economic power for sure!

    It is inevitable china will be the economic superpower as others are broke( germany will be allright) and followed by india to an extent.

    Other asian countries will also do very well( korea,taiwan etc)

    The so called developed countries who are just living on loans cannot sustain the party for long.
    we are seeing what is happening in some countries of europe already.

  19. Red says:

    Your ignorance is showing.

    Do you know that Korea faces the serious concerns of rapid aging and very low birthrate than Japan?

    Why does Korea run a substantial trade deficit (25 billion-dollar) with Japan?
    Because key components in Korean products is almost made in Japan.
    Most manufacturing machinery is made in Japan.

    They have no inventiveness and creative technique.
    Korea’s patent royalty is 5.8 billion-dollar in deficit.
    (Japan’s patent royalty is 7.9 billion-dollar in surplus)
    Korea just import components from Japan and assemble them.
    And they sell them cheaply without any thought of gain to increase one’s market penetration.
    Additionally, they commit a lot of serious patent violation.
    SAMSUNG is sued by many patent infringement.(more than 3800 cases)

    Incidentally, Samsung is 60% foreign-owned company.
    LG is 50% foreign-owned company.
    Almost Korean company and bank is taken over by foreigners.

    Now, Japan have the strongest currency in the world.
    Japan has 1121 billion dollar US Treasury bonds.
    Net external assets is 260 trillion yen.(world’s best)
    Deposit and saving of citizens is 800 trillion yen.(world’s best)
    Japan’s collective assets is 8553 trillion yen.
    Japan is the richest country in the world for the foreseeable future

    The Japanese government recently signed with the International Monetary Fund on to provide $60 billion in emergency loans to the multilateral lender amid the global economic downturn following the sovereign debt crisis in Europe. Other Asian country lie China and Korea do that because they are not true rich countries. In fact, Korea’s financial crises over the last decade have been saved by Japan.

  20. cliff says:

    I think the person arguing that Japan debt is sustainable is missing one large point (when saying Govt debt at any level is ok as long as its in the issuers currency)

    Besides the devaluation impact from the central bank being required to keep expanding the money supply (via bond purchases).. The central bank also has to keep bringing rates down so the interest cost do not get larger than the govt tax revenue..

    The problem here is that as the central bank lowers bond yields (and prices rises) .. prices on other assets also rise on a relative basis.

    In Japan the buyers of JGB are the pension funds / life insurers / banks and postal funds.

    As the population is aging the payouts to the clients of these domestics is increasing and the amount of people investing is decreasing. This would not be a problem if the Govt did not require near zero rates. But at current levels domestic pension funds / lifers and other insurance companies cannot get adequate returns to meet the cash flows required.

    Thus most are losing money and it will be the bankruptcy of a major pension fund or lifer that will lead to the selling off in JGB’s.. and it will be caused by the BOJ (and Govt) leaving rates to low so savers (ie pension funds ect) cant get the returns to survive.

    So low rates are not just about Govt funding costs they also bankrupt pension funds ect.. (see US local govt pension funds that are running into the same issue) The required say 5-7% return to meet payments that had been promised and thats just not possible thus the go bankrupt.

    this is the key problem with zero rates apart from the inflation effect.. It will not work. Market rates should come back so pension fundes ect can pay their holders what they deserve on their savings and the Govt needs to fund it self according to reality and stop stealing these peoples’ money a little at a time to furnish their own interests.

    ie stocks could be a possible alternative but as we have seen the excessive liquidity caused by bond buying keeps stock prices high and yields low,. so even though they are a bit better.,, its not stable enough and the price is always vulnerable because it is only sustainable due to QE.

    Again the central banks should step back let stock prices fall as well (so yields rise and investors can get market returns) IF some institutions. cant survive without zero rates (ie TBTF US banks).. Let them go under guarantee the deposits and move on so any fresh capital the central bank is supplying is going to viable entities that can put it into the real economy … not get waisted on a unviable entity that can only survive buy borrowing at zero from the central bank (thus stealing the funds from pensioners ect..

  21. Julien says:

    Thank you very much for this very interesting debate.
    I read all your posts with great interest even though my level in economics is very low comparate to everybody and I’m not a native english speaker.
    There is no conclusion to the debate, but gathering all your info, I conclude that Japan can issue as much money as it needs to support its economy with two limits that are going to lead to a collapse of the country :
    – the population shrink to 0 (until that point the country can print money)
    – the population start growing again (leading to inflation, and debt problem)
    Did I understood it right ?
    Thank you for your answers.

  22. Sid says:

    If the BoJ continues to monetize Japanese Govt Debt, interest costs start to overwhelm Japanese Government, is it really possible for BoJ to forgive Japan’s debt in part? After all, the asset purchases have been done from money created out of thin air.

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