Japan has a…special way of measuring deficits, leaving true borrowing understated by excluding major obligations like pensions and local government debt, and counting planned bond issuance as income. But Japan isn’t the only country facing debt issues.
Japan has run an annual deficit of 7-10% for decades, making it the most indebted country in modern history. The U.S. and Europe are on a similar trajectory, though. The U.S. has interest payments that rival defense spending, thanks to the demographic situation. Europe has the same people problem, a weaker tax base, and has to ramp up defense spending to deal with Russia.
While Japan might be first through the gate, this is a global issue. Budget cutting alone isn’t going to solve any problems, but existing economic models simply can’t square this circle.
Hey all, Peter Zeihan here. Coming to you from home in Colorado. Whether it’s craps on inside. Anyway, a lot of people have written in about what’s going on with financial markets specifically Japan. For those of you who don’t follow this sort of thing, there’s been a bit of a challenge in the bond market recently. We’ve got a number of countries ranging from the United States to Germany to Britain, that are issuing record amounts of debt.
That’s something that’s only going to continue in the future. But, we had a scare when it came to Japan specifically recently. So I thought it was worth digging into that a little bit. Japan doesn’t run their numbers in a normal way. So normally it’s like here in the United States or really in any other advanced country, if you spend more than you take in in taxes, you issue bonds which are sold on the international market, and that generates debt that goes into your overall stock.
And the figure that we normally go for is, deficit spending as a percent of GDP, which based on your country, can be anywhere from 1 to 10% based on the circumstances. As a rule, whenever that number is higher than your economic growth for the year, your debt load is going to increase and it will put pressure on your economy.
Year after year after year, growing, growing, growing, growing. And in the United States and a lot of advanced countries, we now have debt levels that are over 100% of GDP, which has reached the point that it is a constant drag. So in the United States, interest payments on that debt is one of our biggest outlays. We spend as much as that we do on defense, and is absolutely making economic activity for everybody higher because it increases borrowing costs.
So the difference between, say, a 4% and a 6% mortgage is a mortgage payment that’s about 50% bigger. So you can see how that could really hurt really, really fast. Japan. Japan does their numbers differently. According to the IMF, their deficit spending is roughly 2 to 3% of GDP on any given year. But the IMF follows the Japanese way of producing the statistics, and it doesn’t count inter government transfers as potential debt.
And they also count things like Social Security payments or what we would call them here as income, as opposed to something that needs to be put into a box and really shouldn’t affect the math at all. The Japanese say that their deficit spending is in the vicinity, typically of 4 to 5% of GDP, which, considering they’ve averaged less than 1% growth for the last 35 years, is really, really bad.
But that’s also not very honest, because when the Japanese do their budget, if they’re doing deficit spending, they don’t count that as deficit spending because it was planned. So if they’re issuing bonds, they actually count that as income. So their core deficit spending doesn’t count at all according to them. They only counted as deficit spending if it’s a supplemental budget that they have to do later in the year for, say, construction or stimulus or whatever it happens to be.
So in reality, Japan’s budget deficit has been in the 7 to 10% range for almost 30 years now. And so their total national debt as a percent of GDP, everything accrued is about 230 to 240% of GDP, well over double what we have here in the United States. And that doesn’t count local government debt, and it doesn’t count pension arrears, and it doesn’t count the bankrupt nature of their social security network.
You throw that all in your somewhere between 400 and 500% of GDP, making Japan by far the most indebted country in modern history. Which isn’t to say that the rest of us are not catching up. The four most prolific spenders for administrations in American history are Barack Obama. Trump won Biden and now Trump two. And each one has spent more than the last.
So, for example, despite the personnel gutting of the federal government, early last year in the Trump administration’s second term, we’re actually now spending more on the government than we ever have before. And that’s before you consider increases to spending for things like homeland security, defense. So we’re absolutely moving in the wrong direction. We’ve been north of 5% of GDP spending for over a decade now.
Not just Covid, but overall. And we’re showing no sign of going the other direction. Part of this, like with Japan, it’s a pension issue. We’ve had the baby boomers go from the biggest taxpayers we’ve ever had to the biggest tax takers we’ve ever had as they retire. That’s something that’s not going to improve for at least the next 10 or 15 years, until they pass on.
And the new generation, my generation, Gen X, are the retired class because we’re a small number, elsewhere in the world, the situation is also getting worse. Specifically, in the case of Europe, they have the same demographic problem that we have here in the United States that we have in Japan. But unlike the United States, where we have a large cadre of millennials who are filling out the numbers and in time will repair the tax base.
Most European countries don’t have a population bloc of size in that number. So you’re just looking at the numbers getting worse and worse and worse and worse every year. Unless you just decide to liquefy old people somehow, which would be just as complicated. In addition, after 70 years of slimming down the defense budgets, especially in the last 30 years in the post-Cold War era, we’re now in a situation where the Europeans are actually facing a hot war, at the same time that the Trump administration is threatening to withdraw American support.
So we’re seeing these countries needing to build a more normal military force. And that does not mean expanding their military spending from 1% to 2% of GDP, or even 5% of GDP. Like the Trump administration has recently arm twisted them to do. They need to get closer to 10 to 30% of GDP, because they need to build up the institutions, in many cases from almost scratch in the next few years to prepare for a war with the Russians.
That is very, very expensive. And the only way they can do it is by basically ignoring all of their budget and deficit laws that are entrenched in the eurozone formation. Bottom line is, there’s a huge amount of debt out there already, and all signs point to getting bigger and bigger, and bigger. even if there’s sufficient political will to cut the budgets in places where perhaps you can find some fat to trim the structural nature of the environment demographically and strategically, is arguing for far bigger deficits moving forward.
Does this mean we’re going to have a debt crisis? I don’t know. We haven’t had a real country have a real debt crisis in a long time, and certainly not in the current era we’re in, where the United States is by far the largest economy, which means I also can’t tell you what will happen on the other side of this.
All I know for certain is the combination of globalization and rapid aging means that the economic models that underline everything that we understand about finance, capitalism, socialism, fascism, whatever you want to call it, they’re all based on the population getting bigger, and that is no longer true. So we are going to have to find a new economic model.
And in that sort of environment, I don’t know what is going to happen with debt. I can only point to an example that Japan has provided us in the past, something called Tokyo Side, where basically the emperor just walks out, waves his scepter around, declares that every debt is null and void, and everyone starts over. That would liquefy everyone’s savings account.
It would liquefy everyone’s mortgage and would literally be a disruptive event. But at the moment, that is really the only model that makes any sense. That doesn’t mean that you should plan for that, however. So.
