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On the worthlessness of Japanese government debt

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Yuriko Nakao / Reuters

(Read caption) A man is reflected in an electronic board displaying share prices outside a brokerage in Tokyo, Jan. 6. Japan's Nikkei average rose to its highest level in eight months on Thursday, but a bull market doesn't change the crippling debt faced by the Japanese government, which must spend 60% of tax revenues just paying the interest on the debt.

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Not much action in the markets.

So, how’s our “trade of the decade” doing?

We haven’t checked. But we think we’re onto something. Remember the trade? Buy Japanese small cap stocks and sell Japanese government bonds.

Okay… So it’s not that easy to do. It’s just an idea…a concept… It’s meant to get us thinking about how things work.

In the present case, the Japanese have the biggest public debt in the world – at 200% of GDP. Already, they’re using almost 60% of their tax revenues just to pay the interest on the debt. How do they pay government expenses? They borrow more money!

This is not a healthy situation for the holders of Japanese Government Bonds (JGBs). They’ve got to expect that sometime in the next ten years the government is going to run out of money…or investors will run out of confidence…and interest rates will rise. When they do, bond prices will fall…probably collapse…and JGB holders will lose beaucoup yen.

There is no way that this crazy system of government finance can continue. The only reason it has come this far is that Japanese savers have no idea of what is going on. They’ve been saving for their retirements. And now, they are retiring in record numbers. Japan went over the demographic hump in 2002. Now, its population is falling. And there are more people retiring than there are entering the workforce. These retirees don’t realize that the government has taken their retirement savings and spent the money. They think it is waiting for them, ready to finance their golden years.

They’re in for a shock. And so are investors, when they finally realize that those JGBs are worthless.

Here’s Bloomberg with more on the story:

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Japan’s top government spokesman said the country’s fiscal situation is “approaching the edge of a cliff,” underscoring Prime Minister Naoto Kan’s call for a national debate on raising the 5 percent sales tax.

Kan is “expressing his deep sense of crisis and resolution about the sustainability of social security as the aging population increases under a low birth rate,” Chief Cabinet Secretary Yoshito Sengoku told reporters today in Tokyo. “The supporting fiscal conditions don’t allow for any delays, it’s finally approaching the edge of a cliff.”

The prime minister last night said in an interview with TV Asahi that he would “stake [his] political life” on addressing Japan’s rising social welfare costs and increasing public debt. The day before he said “now is the time” to face these problems.

Japan’s public debt is set to exceed twice the size of the economy this year and reach 210 percent of gross domestic product in 2012, both estimates the highest among countries tracked by the Organization for Economic Cooperation and Development, according to the group’s forecasts.

Now, let’s imagine that we’re right about this. Let’s imagine that governments can’t really run deficits forever…no matter how cooperative the population. They reach a point when the go “over the cliff,” as Japan is about to do.

If that’s so…

…well…where is the US in this story?

Stay tuned…

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