Does Japan have any reason to ever repay its debt?

Question

https://fortune.com/2015/02/26/japan-economic-time-bomb/

Takatoshi Ito, an economist at Columbia’s School of International & Public Affairs, argued at a panel discussion on Monday that unless the Japanese government can raise its sales tax to north of 15%, from its current 8%, Japan’s economy will suffer a fiscal crisis sometime between 2021 and 2023. That’s because as Japan’s population continues to age, its famously high savings rate will have to fall, and the Japanese public will no longer be able to absorb the large amount of debt the government is assuming.

Unlike Greece, the Japanese government can print as many yen as it wants to pay its debts—debts that are largely owned by the government, Japanese banks, and citizens. So there’s no reason Japan would have to default on its debt. But all that money printing, argued Ito, will lead to an inflation crisis and a serious decline in the Japanese standard of living.

https://fortune.com/2015/02/26/japan-economic-time-bomb/

Does Japan have any reason to ever repay its debt? Greece had a much lower debt-to-GDP ratio, but its debt wasn't denominated in its own currency, and that led to a crisis, but it seems like as long as the debt is financed in its own currency, Japan can keep issuing debt and doesn't even have to repay it, to repay it means it will have to print a lot of money, which may lead to inflation, so why not just keep on piling debt indefinitely? Now, the question is when Japan's population will shrink to let's say 1 million versus 120 million, will it have to print money at some point? I was thinking it doesn't have to do anything since the Japanese have more assets and wealth at hand than there's government debt, but maybe I am wrong?

Answer 1

You can't go into debt when there is nobody who is willing to lend you money.

When a country doesn't repay its debts, then the bag-holders are the organizations and private people who lent money to that country in form of buying government bonds and now don't receive their coupon. This will usually result in the credit rating agencies to penalize the countries credit rating. Which means that investors will demand much higher interest rates for future bonds or not invest into the country at all.

That means that it basically becomes impossible for the country to take on infinite debt.

Answer 2

A small detail, not repaying debts means a default. But Japan can try to repay old debts by taking new debts.

There is a widespread consensus that having some government bonds on the market is a good thing. In a healthy market, profit depends on risk. Bonds provide a low-risk, low-profit 'safe haven' for some investors and a baseline to compare other investments.

How much debt is appropriate, and how much debt is unhealthy? That depends on the perceptions of the markets, and on the underlying numbers. Japan is known as an aging society, but Japan is also known as a wealthy and technologically advanced society.

The Greek problem was not just the level of debt, it was an economy which could not cope with the exchange rates set for the Eurozone as a whole. A non-Eurozone country in a similar situation could have devalued their currency, that is, making all their citizens with savings in the local currency poorer.

Answer 3

Does Japan have any reason to ever repay its debt?

I would distinguish between ever repaying any particular debt, which it does on a routine basis, and ever becoming completely government debt free, which it has no particularly good reason to do so long as it can service its overall debt load.

At a mechanical level, if you create money to pay debt, you also create inflation and inflation drives up the interest rates on the debt, which makes that debt more challenging to service, until current government revenues can pay debt service and also provide basic governmental services, even with higher taxes.

Aside from the gimmick of creating money to pay outstanding debt, more fundamentally, government debt is about someone voluntarily foregoing current consumption in order to allow the government to spend more than its current tax revenues and other revenues permit, in exchange for greater capacity to consume due to interest on the debt.

What is sustainable in the long run requires projections of (1) future needs for government spending (which is decreased by declining population but increased by a needier aging population), (2) future GDP (which is increased by growth in per worker productivity and decreased by declining working population), (3) the future tax burden (which is a policy choice), and (4) future interest rates (which depend upon creditworthiness and the rates offered by others of comparable creditworthiness in the future).

For example, if you increase tax burden (which decreases the ability of the people taxed to consume) you can afford to borrow more.

Another important factor is the stability of government revenues and expenses. The less predictable these are, the greater a risk there is to maintaining a large debt service load that could pose a disproportionate strain if revenues fall dramatically while expenses rise (as is often the case in a serious recession economy). If recessions are likely to be infrequently and mild, maintaining a fairly high debt load is workable. If recessions are likely to be frequent and severe, carrying a high government debt load is reckless and likely to become a problem.

In this regard, one of the things that Japan's government has going for it is that a lot of the societal needs provided by government in some countries are provided by businesses to a greater extent in Japan. Quite a bit of Japan's social safety net is in the private sector and that makes government spending less cyclic than many countries, which makes carrying a higher debt service load relative to government revenues more viable.

Taking out the right amount of debt also requires government to assess how important it is to make an investment now so as to receive the real world economic benefit of that investment relative to how important it is for taxpayers to have the ability to spend that they would have if the government didn't take on that debt service. Mostly, this varies based upon the benefit that is available from government capital investment at a given them. At some point, for example, the marginal benefit of new investments in transportation infrastructure and educational facilities may decline, but the marginal benefits of new investments in hospitals may rise, as the transportation network is built out and there are fewer younger people and more older people.

In practice, predicting these various future scenarios requires considerably talent and has big impacts, which is why we pay economists and other finance professionals good salaries to help us determine these things.

Answer 4

Question

Does Japan have any reason to ever repay its debt?

Short Answer

1. The most important thing isn't debt. They are cashflow and growth. Cashflow, the short term ability to service the debt, so you can avoid a default. Economic growth so the future will look better than the present.
2. Inflating the debt away might sound good on paper. In reality it hurts your economy, stifles growth and doesn't save money. It's among the worst things you could do.
3. U.S. GDP in 1865 after the civil war was 120 million and its debt was 2.6 Billion: a debt-to-GDP ratio of 2166%. It took over 40 years to pay off, but the U.S. never defaulted (see end of this answer for details).
4. U.S. GDP in 1939 prior to ramping up war production was $88.6 Billion. After prioritizing the economy towards the war effort for several years, the U.S. National Debt in 1945 was $258 billion dollars: nearly 3x its peacetime GDP. It wasn't a crisis because governments grow their economies over time, and have much longer time periods to pay off debt.
5. The tried and true method for getting one's national debt under control is to hold spending constant (so as not to hurt growth), and grow the GDP. An economy growing at 2% will double in 35 years; one growing at 7% in 10 years. (US economy in 2023 by some estimates is currently growing at 6% annually.) It took the UK and France 40 years to pay off WWII debt. It took the U.S. 46 years to pay its revolutionary war debt. If your economy is growing even modestly, and you can service your debt, all things are possible.

Answer

The idea of deflating your currency by just printing more has been used before to address foreign debt. Germany's Weimar Republic's plan to deal with punitive WWI peace terms comes to mind. The resulting inflation the citizenry experienced was pretty significant. Note the man below going to purchase a loaf of bread.

Such an action would result in restricted access to future credit. Governments require access to credit. Lack of access hurts their economies and kills future growth.

Suffice it to say defaults are very bad. They are economically unthinkable. We still see them in countries governed by "unsophisticated" officials. Japan isn't among them. I say unsophisticated because a governmental defaults aren't beneficial. It would immediately hurt the economy, contract GDP, cost decades of economic growth, and ultimately not save any money.

Creditors have long memories. Not even a bloody revolution absolves a country from its debt. China's CCP found that out as they were held responsible for the debt of the Chinese Republic they overthrew in 1947. Britain insisted China's CCP pay their predecessor's debt as part of the Hong Kong repatriation. Defaulting doesn't mean you don't have to pay off that debt; every year the debt is not paid, the interest accrues. Only now your economy is smaller and it's not growing much either.

Nobody wins in a default. Both borrowers and creditors are incentivized to avoid them. Debt can be restructured, and accommodations can be made. Interest rates can be adjusted. Debt forgiveness isn't off the table.

Anyway, between the:

• U.S political situation
• China's real estate market
• Japan
• Greece
• Italy
• France

We will likely see something play out soon. Nothing will change order into disorder like a default, or near default.

Question From the Comments:

The issue is that paying off a debt of this size has never been done before (Japan's national debt is 9 trillion, or 260% of GDP).

Perhaps true, but still misleading. As I'm sure you know, a country's ability to repay its debt is not measured by the size of the debt alone, but the size of the debt divided by the size of its economy.

The U.S. National debt in 1865 was $2.6 billion. The size of the economy in 1865 was 120 million and contracting. That's a debt to GDP ratio of 2,166%. The U.S. had to go off the gold standard, institute an income tax, issue multiple rounds of bonds, change currencies, pass a constitutional amendment (fourteenth, section 4), and it still took 40 years to pay all that off.

In the U.S. Constitution the fourteenth amendment, section 4 was specifically passed to block those who would advocate for defaulting on this massive civil war debt. It still remains in place today.

Fourteenth Amendment, Section 4:

The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void.

Answer 5

Yes, should Japan ever default on its debt, the following would happen

• The central bank would default
• many life insurances (hold 20% of the dept would default)
• Potentially banks would default (hold 13% of the dept)
• public pensions + pension funds would take a hit (~7% of the debt)

Even if the last point is definitely survivable on its on when taken at face value, I see political implications of taking $15000-$25000 from every person's pension fund, especially when combined with the hit on insurance products. (And this does not include direct financial effects via money which pension funds hold indirectly via banks, etc.).

The secondary effects of Japan not paying its dept would be near catastrophic for the country. The yen would not be considered a safe harbor any more, and investors would look for stable competitors. In combination with a dwindling population, that would have a bad, bad, bad dynamics.

Answer 6

It works until it doesn't

As long as people are willing to buy Japanese government debt, there's no problem and they can keep issuing debt for whatever purpose.

But if one day they stop - and anyone who's followed financial markets will know market sentiment can shift quickly - then what?

Answer 7

Japan can keep issuing debt and doesn't even have to repay it

Not repaying your previous debt (default) will mean that when you want to borrow more in the future, lenders will require higher interest rates and, in the most extreme case, refuse to lend altogether.

to repay it means it will have to print a lot of money

Printing money can be done, but the cost of printing money is inflation (or hyperinflation).