Japan, as you can see below, is the world’s largest holder of US debt. What happens if, and when, it has to call up that debt?
“It would send shockwaves through global markets—driving up interest rates and making borrowing far more expensive for everyone. And because Japan has its fingers in so many pies, it wouldn’t just rattle Wall Street… it could light the fuse for the next global recession,” writes International Man analyst Lau Vegys.
Those “pies” that Vegys is talking about include not just bonds, but stocks, real estate and corporate debt.
Why would Japan need to liquidate some of these assets?
Firstly, the economy is contracting, its population is shrinking with a birth rate the lowest it has been since 1947, with 30% of its people over the age of 65.
If these trends continue, Japan will lose about 20 million people or 16% of its population by 2050. Fewer workers mean less economic growth, and a steadily ageing population means more spending on retirement benefits, health care and other state-funded services.
The one solution it has is to borrow money to keep the economy afloat, but that’s not feasible for very much longer – it already has a debt-to-GDP rate of 260%, the highest in the developed world.
Japan has kept its interest rates at zero or close to it for decades, but which encouraged all sorts of bad behaviours, not least of which was the “carry trade” – this is where investors borrow cheap money in Japan and invest it in higher-yielding bonds in the US or the developing world. It’s easy, almost free money.
As Vegys points out: Imagine you're a trader who borrows 10 million yen when the exchange rate is 100 yen to the dollar. That gives you $100,000 to play with. You dump this money into U.S. Treasury bonds yielding 4%. After a year, you've pocketed $4,000 in interest. And it gets even better—if the yen has weakened to 105 yen per dollar, you only need $95,238 to repay your loan. You've profited not just from the interest rate difference, but also from the currency move.
The problem with this is the carry trade only occurs when Japan’s interest rates are close to zero and the yen remains weak. In 2024, the Bank of Japan raised interest rates from negative to 0.25%. That pushed the yen up against the USD by 10% in a matter of weeks.
What happened next was unprecedented: The Bank of Japan, already holding 50% of government debt, was left as the only buyer at the subsequent bond auctions.
Japan imports 60% of its food and nearly all of its fuel energy, so the BoJ has to be cautious in raising rates, which would strengthen the yen and make it more attractive to invest at home. This would hammer the USD as America’s biggest creditor nation would suddenly have little incentive to invest in US bonds. It would crush America’s credit standing and drive up borrowing costs.
In short, the preconditions for a market meltdown. The last Japanese stock market downturn lasted 13 years and only surpassed its previous high in 2021 after 31 years. That’s a whole generation right there.
This is why many analysts are bearish on bonds, and bitcoin is beginning to look like a much safer bet for the long term.
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