Japan is grappling with the world’s largest debt burden, a complex issue rooted in economic decisions made decades ago. The crisis originated with the spectacular collapse of the late 1980s asset bubble, which saw unchecked speculation inflate real estate and stock prices to unsustainable heights. The subsequent crash left the Japanese economy in a prolonged state of stagnation.
To counteract this slowdown and fund public services without increasing taxes, the Japanese government resorted to significant borrowing. Concurrently, the Bank of Japan implemented ultra-low, and at times negative, interest rates to incentivize borrowing and spending, and to manage national debt costs. This strategy, however, alongside the increasing costs associated with an aging population and expanding healthcare systems, contributed to a persistent cycle of mounting debt and stagnant economic growth.
For many years, Japan’s low domestic interest rates fueled a significant outflow of capital. The ‘yen carry trade,’ where investors borrowed cheap yen to invest in higher-yield markets abroad, became a cornerstone of global finance, contributing to sustained low borrowing costs worldwide and injecting liquidity into international markets. As Japanese interest rates begin to rise, this strategy’s profitability is waning. Nevertheless, Japan’s vast foreign asset portfolio, which includes substantial holdings of US Treasuries, is predominantly composed of long-term investments, suggesting that any unwinding will likely be gradual rather than a sudden sell-off.
A closer examination reveals that while Japan’s gross debt is around 250% of its GDP, its net debt is closer to 140%. This figure is more favorable than that of other major economies. Crucially, about 90% of Japanese government debt is held domestically, and its long average maturity provides a buffer against rising interest rates. The country’s financial stability is further underscored by consistent A-level ratings from major credit rating agencies. Japan’s extensive debt situation is a product of historical economic imbalances, persistent structural challenges, and demographic realities, with its investment patterns significantly influencing global financial conditions.
