Japan's Debt Trap
Japanese long-term yields have risen sharply, but they're still way too low
The 30-year government bond yield has risen sharply this year, up from 2.3 percent at the start of the year to just below 3.0 percent now. The market narrative is that temporary causes - regulatory changes for Japanese lifers - are behind this rise and have run their course. But it’s worth remembering that Japan’s debt is 240 percent of GDP, so long yields - even with this rise - are still way below where they should be.
One interesting factoid is that Japan’s 30-year government bond yield is now at exactly the same level as Germany’s, but for debt levels that are wildly different. Germany’s gross government debt in 2024 stood at 64 percent, which is far below Japan. The relationship between debt and yield levels isn’t a simple one. It’s clearly upward-sloping - as debt levels rise, so do yields - but Japan remains a big outlier relative to the rest of the world.
The reason for this outlier status is the continued presence of the Bank of Japan (BoJ) in Japan’s government bond market, which keeps yields artificially low. If markets were allowed to set Japan’s 30-year yield, it would presumably rise much further, perhaps to as high as 6.0 or 7.0 percent, which would push Japan into a fiscal crisis.
There’s several key conclusions. First, government bond markets - given high debt levels also many other places, not just Japan - are heavily manipulated with the goal of preserving the fiscal status quo. It’s thus important not to see these yields as a market price. They aren’t. Second, de facto central bank yield caps create bad incentives for politicians and makes needed debt reduction less likely. Things will get worse before they get better, meaning indebtedness will rise. Third, this only increases pressure on the BoJ and other central banks to remain active in capping yields, a vicious circle that exists in many places, but is most pronounced in Japan. Fiscal dominance of central banks is rising and the BoJ is at the pointy end of the stick.
Dear Robin,
Thank you very much for keeping your insights open access! I benefit immensely from this as a student. I had a silly (and maybe a stupid) question about what you wrote:
Why would we should be so worried about debt reduction if default is pretty much impossible? A huge chunk of Japan’s public debt is in its own currency. Additionally, much of this debt is owed to Japan’s own central bank. Doesn’t this pretty much mean that paying these debts is transferring your money from your right pocket to the left? I absolutely see your point about the vicious cycle. But in theory, Japan can kick the can down the road and roll over this kind of debt for an eternity. And as Keynes said, we are all dead in long term. So my question is, if we can take advantage of this situation, fund the economy’s components that are in need of public investment, create jobs as well as growth, can we really see this situation as a vicious cycle? Wouldn’t this kind of public policy would also prevent the rise of extreme political movements?
Like I said, I am only a master’s student. So forgive me if I oversimplify some core concepts or unaware of some foundational aspects of the matter.
Japan has a +$3.7 trillion net international investment position. Would that help keep their own borrowing yields in check despite high govt debt to GDP ratios?
(NIIP ¥533.05 trillion or $3.7 trillion at the end of 2024, according to Ministry of Finance data quoted by Bloomberg)