While much of the focus from both crypto and traditional markets is directed at the U.S., a recent analysis from a prominent economist indicates it may be time to shift our gaze eastward.
Japan is on the brink of a potential debt crisis, but an impending recession in the U.S. might offer a temporary reprieve for the land of the rising sun, according to Robin Brooks, a senior fellow in the Global Economy and Development program at the Brookings Institution.
Japan’s debt-to-GDP is concerning
For many years, Japan has boasted the highest public debt-to-GDP ratio among advanced economies, consistently maintaining levels above 200%. However, post-COVID, characterized by extensive fiscal spending, investors’ appetite for such high debt ratios has diminished.
Compounding the issue, Japan’s inflation, as indicated by the consumer price index (CPI), has surged since mid-2022, reaching rates not observed since the 1980s. This trend aligns with persistent global price pressures.
Rising inflation has driven up government bond yields and increased the cost of additional fiscal borrowing. These combined factors have spotlighted Japan’s staggering debt-to-GDP ratio of approximately 240%, essentially cornering the government into a challenging situation.
Brooks encapsulated this dilemma in his recent Substack post: “The bottom line is that exceptionally high government debt is putting Japan in a dire position. If Japan maintains low interest rates, it risks further yen depreciation, which could lead to uncontrolled inflation. Conversely, if it stabilizes the Yen by allowing yields to rise, this could jeopardize Japan’s debt sustainability.”
“This catch-22 suggests a debt crisis is closer than many anticipate,” he added.
Rising debt concerns may prompt investors to seek alternative financial havens, such as cryptocurrencies, particularly stablecoins. Japanese startup JPYC aims to launch the first stablecoin pegged to the yen later this year.
The yen has gained nearly 7% to 146.50 per U.S. dollar this year as expectations for Federal Reserve rate cuts have incited a widespread sell-off of the dollar.
However, a broader perspective reveals a different narrative. Since 2021, the yen has fallen by a substantial 41%, adding to domestic inflation.
Meanwhile, the 10-year Japanese bond yield has surged to 1.60% from almost zero in 2020, marking its highest rate since 2008. The 30-year yield has also reached multi-decade peaks. In essence, investors are requiring a greater premium to lend to the government amid rising fiscal concerns.
A U.S. recession might provide temporary relief
Japan could experience some relief during a potential recession in the U.S., characterized by consecutive quarterly declines in GDP. In such a scenario, investors globally may shift their assets into government bonds, driving yields down. (Bond yields and prices move inversely).
This decrease in Japanese yields could afford Japan some much-needed time, according to Brooks.
“It’s conceivable that the U.S. enters a recession, causing U.S. and global yields to decline. This would buy Japan some time. However, ultimately, the only viable way out of this catch-22 is for Japan to cut spending and/or increase taxes,” Brooks observed.
Yet, the lingering question is: will Japanese citizens accept higher taxes and spending cuts? Only time will reveal the answer.
