Japan's Debt Spiral

I was struck by an article today on how much Japan will spend next year servicing its debt. In its next fiscal year the Japanese Ministry of Finance (MOF) expects to spend ¥25.3 Trillion on interest. That’s about $260 Billion, or just over 4% of its GDP. By contrast, the U.S. spends just over 2% of its GDP servicing its Federal debt (although that’s only about half of our total indebtedness; America too has its debt problems).

The big question around Japan’s fiscal outlook is, at what point does this become unsustainable? When does the burden of financing the debt require more debt, in a type of fiscal Rubicon? It’s hard to say definitively. By most historical measures Japan’s situation is already beyond repair. However, a crisis has so far been avoided. This is in large part due to the fact that their debt is domestically owned. Japan is borrowing a lot of money but it is doing so from itself.

It does lend support to the theme of a weakening Yen though. Higher domestic inflation and a negative real return for the savers who own Japanese bonds probably represents the best chance for a drama-free resolution. Shorting the Yen continues to be a trade with lots of optionality – as well as being aligned with stated government policy it may benefit from any number of other macro-economic developments including faster U.S. GDP growth, unfavorable interest rate differentials and perhaps higher energy prices due to growing turmoil in the Middle East.

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