Japan faces a monumental debt challenge, with a gross debt-to-GDP ratio soaring to approximately 250%. This economic quandary has deep historical roots, primarily stemming from the collapse of the asset bubble in the late 1980s. Fueled by excessive credit and speculative investments, asset values, including real estate and the Nikkei 225 stock index, experienced an unsustainable surge. When this bubble burst by 1992, it plunged Japan into a prolonged period of economic stagnation.
The aftermath saw both individuals and corporations prioritizing savings and debt reduction over spending, leading to decreased tax revenues. To maintain government operations and stimulate the economy, authorities opted for increased borrowing rather than tax hikes. The Bank of Japan implemented aggressive interest rate cuts, even to negative levels, to encourage spending and manage borrowing costs. However, coupled with an aging population and escalating pension and healthcare expenses, this created a persistent cycle of stimulus-driven debt and weak growth.
Historically, Japan’s low domestic interest rates spurred investors to seek higher returns abroad, leading to the prominent ‘yen carry trade.’ This strategy involved borrowing yen cheaply to invest in overseas markets, a practice that helped suppress global borrowing costs and provide ample liquidity internationally. While the era of easy carry-trade profits is now diminishing as Japanese yields begin to rise, the substantial foreign assets held by Japanese investors, including US Treasuries, are largely long-term holdings unlikely to be sold off rapidly. Despite the high gross debt, Japan’s net debt stands at around 140%, significantly lower than its gross figure. Furthermore, nearly 90% of its government debt is held domestically, with long maturities mitigating immediate risks from rising interest rates. Rating agencies still consider Japan a stable investment, maintaining A-level ratings. The nation’s substantial debt is a complex outcome of decades of policy, structural issues, and demographic trends, with a significant, albeit evolving, impact on global financial markets.