Updated: Nov 7, 2019
By: Tuomas Salmi
Published: August 6th, 2019
It is not a secret that Japan is addicted to debt. In 2018 the amount of debt Japan had accumulated was roughly 236% of it’s GDP. Even Greece that experienced a debt crisis and had to partly default on this debt, only had accumulated debt about 170% of its GDP – which is nowhere near Japan.
Japan is undeniably the biggest debt nation of our time – but so what? Why should we care? We know that the Bank of Japan has the power to provide capital to financial institutions AKA print money. In addition, the debt that Japan has created is largely held by Japanese institutions and individuals. If the Japanese hold their own debt and the Bank of Japan can always print more money, why should we be worried?
To know the answer to that question one only needs to look at Japan’s history. Many people are not aware that Japan de-facto defaulted on its debt in 1946.
After the war Japan had accumulated debt that was roughly 200% of its GDP at the time. There are many ways for a country to default on its debt, and the method Japan chose in 1946 was the inflation way. Inflation means rising prices or decreasing value of money – depending on how you want to look at it. During this hyperinflation in -46 the amount that Japan had racked in debt started to diminish in real terms – making it easier to pay back. But for the regular citizens this was a disaster. Savings that had been accumulated for many decades were to lose most of its value and even trying to buy essentials like food was a real challenge, due to the soaring prices. In addition, the bank accounts of individuals were frozen, meaning you couldn’t withdraw but only a small sum of money every month.
Life was difficult during the after-war years, but let’s return to the present day. Japan is not in a war and the underlying industry seems to be fine, so we can’t really say that history would repeat itself. However, one aspect where the history at least seems to rhyme, is the way Japan has been financing its debt. The one thing that all governments around the world have come to agree is that funding a country through debt monetization always leads to disaster. Debt monetization may sound difficult to understand but it is only a fancy way of saying “printing money”. Because the government doesn’t have enough money to fund its programs, they issue debt, which is just a promise that “if you lend me money now, I will pay it back later with an interest”. If the central bank buys this debt straight from the government – giving government money that the central bank has created from nothing – this is called debt monetization. However, the way that Japan gets around this problem is that the government issues debt which is bought by the financial institutions (banks). It is after this step that the Bank of Japan buys the debt from these financial institutions, so this process is not debt monetization per-se, but ultimately ends up with the same goal. In 2018 the Bank of Japan held about half of the whole national debt in its balance book.
The reason why all the governments today agree that debt monetization is bad, is the reason that it was almost always the step before hyperinflation – the most infamous example being the Weimar Germany in 1920s – when people had to move a truck load of cash to buy a single loaf of bread. Debt monetization is the government digging its own grave – but it is always the citizens that must bear the pain.
The reason why Japan’s financials could lose its balance could come from any possible direction and nobody can accurately predict when this could occur. But as time has showed, it is better to be prepared than to get caught by surprise – like a deer in the headlights. One easy way to prepare for this kind of event is not to hold all your money in the bank. With the age of minus rates, the interest you will get from your deposits is only going to be around 0.01% anyway, so it is worthwhile to think if the risks outweigh the benefits of keeping money in the bank.