Japan's Debt Crisis is a Warning for America

So over the last couple of years, people have been talking a lot about America's debt crisis. Debt crisis. Here comes the debt crisis. An American debt crisis. We're adding a trillion dollars to the national debt every 100 days right now. The interest payment alone is now one trillion dollars. The US is on an unsustainable fiscal path. They're more than 40 trillion dollars in debt, meaning that the government itself owes more than the entire economies of Europe, South America and Africa combined. By pretty much all conceivable methods, this is just a crisis waiting to happen. But what about if I told you that there's a country that's in an even worse position? Japan has this massive debt. The government is ridiculously indebted. Debt to GDP in Japan is already the highest across G10. This shows the debt to GDP ratios of the world's major countries, effectively how much money the government owes compared to the size of their economy. Europe's average stands at around 81%, while in America it's closer to 122%. But then there's Japan. At 236%, it has the highest debt to GDP ratio of any major economy in the entire world. For nearly three decades, people have known about this. But those same people thought that Japan was just different. That they'd pioneered a new way for a country to operate, having mountains of debt and somehow being just fine. But what happens when that changes? For 30 years, Japan has run an experiment that the rest of the world is only now beginning to understand. Money was, quite literally, free. And trillions of yen flowed out of Japan and into pretty much everything, from Australian bonds to British stocks. But most importantly, above all, into American debt. That cheap money funded American deficits. It propped up American asset prices, kept American borrowing costs low. But now that money is coming back to Japan, Japanese interest rates have now spiked to their highest level in 31 years. And by 2029, the interest on their debt alone is set to eat up one in every three dollars that the government spends. And it would only take a couple percentage point increases beyond that for the interest costs to be equivalent to all of the country's tax revenue combined, effectively making them bankrupt. Japan has often been described as being a decade or so ahead of the rest of the world in all sorts of ways, from their futuristic transport, to even their pending demographic crisis. But as the world's leading economies find themselves drowning deeper and deeper in debt, it increasingly looks like Japan, rather than being unique, is just early. And that raises a crucial question. Can a country that spent decades building up massive amounts of debt survive in an era where those payments are no longer free? This is the impossible crisis which could break Japan and then America next. Just for a second, imagine you could go back to the 1980s. Over the last 40 years, Japan, a country literally flattened by the second world war, had rebuilt itself into the second largest economy on earth. And by the end of that decade, it looked set to overtake America itself. Investors from all around the world were desperate to get in on the gold rush, and billions of dollars of international money was flowing from all over the globe into this one country. For Japan, it was something of a golden age. But under the surface, the first signs of the crisis that we're seeing today were just beginning to emerge. This graph here shows the interest rate on long-term government debt between Japan and the United States. Essentially how expensive it is for them to borrow. And from the 1980s onwards, the Japanese rate has sat far below the American one. Which seems kind of weird, right? America, after all, was a bigger economy. It was already the global reserve currency. And so it should seem like a safer bet to investors. However, at the time, Japan's economy was booming, remember? And investors were so desperate to get a piece of it, meaning they were willing to lend to Japan for a much lower return than they could have earned somewhere else in the US. By itself, that's not a bad thing. But as we'll eventually find out, cheap borrowing has a habit of getting countries into a lot of trouble down the line. So at the same time as interest rates were falling, all that money flooding into Japan also had a second side effect. Massive asset inflation. Now, this is a bit of a simplification. But in effect, because the amount of money being pumped into the country massively outweighed the amount of stuff that that money could buy, it meant that demand was outstripping supply. And prices only went one way, up. By 1989, the Tokyo stock market alone accounted for 42% of the value of every stock market on Earth combined. Things were beginning to get a bit ridiculous. At its peak, the grounds of the Imperial Palace in central Tokyo, about one square kilometre of land, was estimated to be worth more than the entire US state of California. But as the saying goes, everything that goes up must eventually come down. On the 29th of December 1989, the Nikkei, Japan's stock market, closed at just shy of $39,000. It was an all-time high. But just eight months later, the stock market's value had halved, erasing over $2 trillion in wealth. And over the next 18 years, it would go on to lose more than 80% of its value, putting all of that progress that Japan's economy has made in jeopardy. Now, typically speaking, when a crash like this occurs, there is a pretty simple school of thought for what governments should do to rectify it. Simply, spend a ton of money. When a recession hits, people naturally start spending a lot less. Partly that's because people just lose their jobs, and partly because that people think if they might lose their jobs, chances are they're going to start saving up for the eventuality that that might happen. But because people stop spending, businesses also get a lot less revenue, which means that they need to lay off workers, which ends up making this whole thing a bit of a self-fulfilling prophecy. So, typically speaking, the government will step in, plugging the spending gap, to make sure that the economy avoids this downward spiral. Of course, the real risk to all of this is that the government is having to spend a lot of money at a time when tax revenues are falling, which means that their only real option is to borrow, adding to a growing pile of debt. However, at the time in Japan, this wasn't really a massive concern. Firstly, because at the time, the country owed less than 54% of its GDP, so concerns weren't really on anyone's radar. And secondly, and even more importantly, all of that spending should, at least in theory, grow the economy enough to pay back the debt down the line. After all, America has pretty much used exactly the same model to get out of every recession it's had since the 1930s. So, understandably, Japan tried to do exactly the same. The only problem was, well, it just didn't work. By the early 2000s, the Japanese government had poured more than 135 trillion yen into 10 separate stimulus packages, but the stock market was still roughly 80% lower than it was at its peak. But while the economy hadn't grown at all, the amount of debt the country owed certainly did. From 1990 to 2010, the country's debt to GDP ratio exploded from 54% at the beginning to over 178%, giving them the highest level of national debt in the developed world. This was really just the first big step towards the debt crisis that we're seeing today. And even at the time, it was already starting to cause problems. Remember, the whole big government spending model only really works if you get the economic growth which you can then use to pay back all of that debt. But that didn't work. Now, there's lots of different reasons for this, but part of it was because a lot of that money ended up flowing to companies that probably shouldn't have survived in the first place. And also because around this time, the Japanese population began to get a lot, lot older. As you're probably aware, Japan today has one of the oldest populations in the world. On average, there are only about two working age people for every person who's retired. This trend took hold around the start of the 21st century, which was when the population first began to plateau and decline. Now, there's obviously a ton of different consequences about this, but one of the most obvious is simply that a huge amount of the country's existing resources needs to go to looking after an existing and growing older population, rather than building things which would actually grow the country going forward. So, you've got a situation where the government borrowed a ton of money to make its way out of a recession, but for a couple reasons, basically out of its control, it didn't work at all. That left Japan with a massive pile of debt, worth about $150,000 for every working age person, which by 2012, brought the total up to 197% of GDP. Now, with hindsight, it's easy to say that all of this spending clearly wasn't working, and they needed to just try something else. But remember, at the time, this was the economic orthodoxy. For pretty much 100 years beforehand, everybody had done the same, and it basically always worked. And by this point, the country had been stagnant for more than a decade, and they were starting to get desperate. So in 2012, they elected a man called Shinzo Abe, and he basically won on a single promise, to get the country growing again. He called his plan Abenomics, and it was basically broken down into two parts. Firstly, rather bizarrely for a country already swimming in debt, to have the government continue to spend enormous amounts of money. And secondly, to get the Bank of Japan to pin interest rates down to zero, making all of the money that the government had spent in the past effectively free. In effect, it was the same as what Japan had already been doing for years before, but just this time, it was on steroids. The first package in early 2013 was worth around 20 trillion yen, equivalent to around 4% of the country's entire economy. That level of spending would continue year after year for over half a decade, a lot of which went towards building physical infrastructure like this, known as the, forgive me, Chuo Shinkansen. It's a magnetically levitated bullet train linking Tokyo to Nagoya and Osaka, capable of travelling at 603km per hour. And in 2016, Abe's government handed the rail company behind it a 3 trillion dollar yen loan, roughly 20 billion dollars, in ultra-cheap state-backed money, to help build it. And the full cost of this line would quickly balloon to around 11 trillion yen, almost 4 times the initial budget. This was exactly the kind of thing that the money was going towards. But at one level, that was kind of the point. His whole plan was to just break the rules and spend way more money than anyone had done before, all on the grounds that by doing so, it would finally break Japan out of that stagnation trap that it has found itself in decades earlier. So over the next decade, Japan's debt to GDP ratio would once again start quietly climbing, and continue to over 220% of GDP. Now, it's important to keep in mind here that this kind of spending is totally unprecedented. The European country with the highest debt to GDP ratio is Greece, and theirs is only around 150%, 80 percentage points lower than that of Japan. At the time, economists were terrified that this would trigger a debt crisis. What happens when lenders start to lose faith that a government can actually pay back what it owes? To keep lending, they demand higher interest rates as compensation for the risk. When that happens, they demand a higher interest rate to keep lending. But those higher rates make the debt even more expensive to service, which makes the government look even shakier, which pushes lenders to bond higher rates still. It becomes a spiral, and it can end with a government being forced to default, or even beg for a bailout, which is more or less what happened to Greece. But despite what people predicted, at least at the time, this never really happened in Japan. Take a look at this graph here, you might remember it from the start of the video. Since the 1980s, Japanese interest rates have been way lower than those in America. By 2015, they were approaching zero, which meant that the government could literally borrow money for free. One of the key reasons for this is the simple fact that Japan is a nation of savers. An aging population, with a huge number of people putting money aside for retirement, and all that saved up cash needed somewhere safe to go, which keeps interest rates exceptionally low. So despite the fact that they owed way more in total debt, because interest rates were so low, the cost of financing that debt was basically nothing. But while Abenomics hadn't caused the debt spiral many predicted, it also didn't create the economic growth that they'd hoped for. By 2016, average incomes were basically the same as what they'd been in the 90s. That meant the whole system was something of a house of cards. The moment interest rates started to rise, Japan would start having to pay real money on the biggest debt pile any country had ever built. And a couple of years ago, that's exactly what happened. In the aftermath of the pandemic, Japan, like pretty much every other country in the world, experienced a massive wave of inflation. Now in response, most other countries simply got their central banks to go and raise interest rates. The idea being that when that happens, borrowing money for things like business loans, mortgages, or even credit cards becomes more expensive. And so as a result, people and companies just borrow less, which caused spending across the economy, encouraging businesses to cut their prices to compete for the demand. But for Japan, doing this would have created an enormous problem. Remember, the government already owed $170,000 for every single working person, meaning that even a small move in interest rates would add up to billions upon billions in extra costs, money that the government simply didn't have. Japan was essentially caught between a rock and a hard place. Sure, it could raise rates and risk crippling its own finances, or it could leave them where they are and let inflation run ruin. For almost four years, it has chosen the second option, holding rates down and hoping that the inflation would ease on its own. But by 2024, this issue had just become too impossible to ignore. Prices had climbed by more than 10% over the preceding few years, and the pressure was building from every direction. Major unions had started demanding large pay rises just to match that. And so in March of that year, the Bank of Japan finally blinked. It scrapped the cap on bond yields that it had defended for eight years, and began, slowly and cautiously, to let interest rates rise. Even now, they're still in the early phases of this. From that first move in 2024, the central bank's interest rate has crept up to just 1% by June 2026, still lower than the rest of the US, or most of Europe. Okay, so that pretty much brings us to today, where you've got a country which has built up the biggest pile of debt in the world during a time when interest rates were zero, on the assumption that they'd stay that way. But now, for the first time in decades, those rates have begun to rise. And as you might expect, it's putting the country in an exceptionally dangerous position. The most direct risk comes from the cost of servicing the debt. For most of the 2010s, interest payments stood at around 8 trillion yen. But in the last year or so, that number has shot up to 13 trillion. And according to the government's own projections, by 2029, it's projected to hit 41 trillion, which would mean that 1 in every 3 yen the government spends would go back to paying the interest of its debt. To try and moderate this risk, the Bank of Japan has been buying up debt at key moments to slow the pace at which interest rates are rising, averaging about 2.1 trillion yen of bonds bought every month. In theory, that's making the government finances look a lot more manageable, at least for now. But it's also creating a second, potentially even bigger problem, currency devaluation. Now, international currency markets are by themselves really quite complicated. But if you're going to know one thing, it's that currencies are in large part valued based on the interest rates which international investors can earn by holding that currency. Let's say that you're a Chinese investor and you've got a billion yen tied up in Japanese government debt, earning around 1% of interest per year. You notice that in America, you could buy effectively the same assets, US treasury bonds, but rather than earning 1% a year, you'd be making 4%. So you decide to sell up your yen and shift your money over to US dollars. Of course, pretty much every other investor is thinking the same thing, so you end up with a massive sell-off of Japanese currency, causing its value to crash. And this is exactly what's been happening. Over the past 5 years, the yen has lost around 50% of its value compared to the dollar, the biggest reduction in value of a currency in any developed country in the world. Things have gotten so bad there that the country's currency is now worth less than the Turkish Lira. Now, you might think that doesn't particularly matter to anyone beyond a small set of international currency traders, but that couldn't be further from the truth. Remember, Japan is an island with very little land to farm and almost no oil, gas, or coal of its own. It has to import a huge share of the basics that keep the country running. Japan produces only about 38% of the food that it actually eats, meaning roughly 60% of everything the country consumes comes from abroad. And for energy, the picture is even worse. The country produces just 15% of the energy that it consumes, making them massively reliant on places like China and America to fill that gap. Now, imagine that the yen falls in value from 100 yen being worth a dollar to 200 yen being worth a dollar. Internally, nothing about the Japanese economy has changed, but it now costs double to import the things from abroad, which, when you rely on foreign countries for 85% of your energy, is a pretty big problem. All of this raises an important question. Can anything be done to save Japan from this total crisis? Well, luckily for Japan, they do actually have a lifeline available. Take a look at this graph here. On the bottom, it shows the total amount of debt that different countries have compared to their GDP. It's the one we looked at earlier, and as you can see, Japan is way out here, with almost double the amount of debt of any other country in the world. But equally important is something known as net debt, which is shown on the y-axis. This is basically the total amount of debt a country's government owes, minus the amount of assets that they own. And as you can see, by this metric, Japan's debt is still high, but it's within the range of what would be considered feasible for an advanced economy. So, what exactly are these assets? For Japan, the biggest single chunk is the Government Pension Investment Fund, which is basically a reserve pool of cash which backs Japan's public pension system. At roughly 1.8 trillion dollars, it's the largest single pension fund on the planet. On top of that, the government holds huge foreign currency reserves, stakes in public corporations, and even key national infrastructure. So, in theory, Japan could sell off a bunch of these assets, and use the cash which is left over to pay down a massive chunk of the debt which they already owe. And if they were to literally sell every single one of these assets, it would bring down their total debt to around 140%, which again, is high. It's pretty much still one of the highest in the world, but it's more manageable. The thing is, actually doing this is obviously really unpopular, and it also might be basically impossible. That 1.8 trillion dollar pension fund isn't idle government cash. It's the fund that pays out pensions to tens of millions of retirees, and selling it off to pay down an abstract debt number that most people never really think about is a pretty tough sell for the government. Similarly, the whole point of having the foreign reserve savings is that if a currency crisis does occur, you can use it to protect the value of the yen. Selling those off in order to pay down the debt would remove a massive safety net, which they're currently in desperate need of. Unfortunately for Japan, all of those assets are already serving an important function, and selling them off would be painful. At the same time, the alternative is a world where in a few years time, 30% of the Japanese budget, every single year, is going to get eaten up just paying back the interest on the debt, and that isn't really sustainable either. So, this is obviously not a desirable situation for a rich country like Japan to find themselves in. But the thing is, in many ways, the rest of the developed world is on the same path. Take America, its government debt now exceeds $39 trillion. Interest payments on that debt passed $1 trillion for the first time last year, more than the entire US defence budget, up from around $300 billion about 5 years earlier. Europe's average government debt sits at around 81% of GDP, well below Japan's 236, but the direction of travel is the same. Interest costs are rising, as older, cheaper debt rolls over, and most governments are still spending much more money every year than they bring in. For pretty much the entirety of the last decade, every major economy borrowed huge amounts of money, effectively on the bet that interest rates would never rise. That hasn't happened, but we're only just now beginning to see the consequences.