The Japanese economy is on the Brink of Collapse (and could bring the U.S. down with it)

The Japanese economy is on the Brink of Collapse (and could bring the U.S. down with it)

So the Japanese economy is on the brink of a major shift and it could bring the US markets down with it. For the past three decades, Japan has faced a persistent growth problem. Its GDP remained flat since 1995, largely due to a shrinking population, low productivity, and weak consumer demand. This long stagnation pushed the country into a quasi permanent recession marked by deflation and near zero interest rates. During this period, the Bank of Japan, BOJ, introduced yield curve control, a policy to cap long-term interest rates and keep borrowing costs artificially low, allowing the government to issue massive amounts of debt with minimal fiscal pressure. Like most governments, Japan rolls over its debt, meaning it doesn’t pay off the principle when bonds mature. It simply issues new ones. As long as interest payments are low, this strategy can continue almost indefinitely. And in Japan’s case, with ultra- low yields, the cost of servicing the debt was negligible. Over time though, this approach caused Japan’s debt to GDP ratio to balloon to nearly 260%, the highest among advanced economies. But now, inflation is returning. As prices rise, bond investors are demanding higher yields to compensate for inflation risk, compounding the issue. Japan’s aging population means more retirees are selling bonds to fund their retirement, not buying them, shrinking the pool of domestic demand for government debt. That said, Japan still has two big advantages. First, over 50% of the country’s debt is owned by the BOJ, which means the central bank could in theory print money to service the debt without relying on markets. Second, almost all of Japan’s debt is denominated in yen. That matters a lot because printing your own currency to repay debt is far less risky than doing so in foreign currency. Injecting new money into the economy by spending can be inflationary, but printing to repay internal debt doesn’t create the same level of inflation, especially if the money stays within the financial system rather than flooding into consumer demand. If this debt were denominated in US dollars, for example, Japan would have to sell yen to buy dollars, weakening its currency and creating a feedback loop of devaluation, inflation, and further money printing, a classic hyperinflation scenario. But because it controls its own currency, Japan is not at risk of an Argentina style collapse. Still, that doesn’t mean the rest of the world is safe. Japan’s ultra- low interest rates have fueled the famous yen carry trade, where global investors borrow cheap yen and use it to buy higher yielding US assets like treasuries or equities. If Japanese yields keep rising, this trade unwinds. Investors sell US stocks and bonds to repay their yen loans, pulling capital out of American markets in the process. So, while Japan may not implode overnight, the ripple effects of rising Japanese yields could be felt far beyond Tokyo.