A popular rebuttal of the idea that the US ought to worry about its surging public debt is, “What about Japan?” America’s taxpayers are currently on the hook for 123% of gross domestic product, exceeding the previous record of 118% in the aftermath of the second world war, and the number is going up. That does sound bad – but skeptics point out that Japan’s public debt stands at 250% of GDP, a level that has held steady in recent years, with no sign of fiscal collapse.
So a debt ratio of 250% seems both affordable and (in the sense that it isn’t exploding) sustainable. Will fiscal masochists please stop wringing their hands about rising US debt?
Unfortunately, various fallacies are packed into that comparison.
Most important, those numbers are for “gross general-government debt,” meaning they exclude certain assets and intra-governmental financial positions. In judging fiscal sustainability, a better basis for comparison is the net liabilities of the consolidated public sector. YiLi Chien and Ashley Stewart, economists with the Federal Reserve Bank of St Louis, crunched the numbers last year and showed that, measured this way, Japan’s public-debt ratio was 119% of GDP in 2022 – exactly the same, it so happens, as the ratio for the US.
The gross liabilities of Japan’s public sector added up to 252% of GDP. This includes government bonds held by the public amounting to 114% of GDP, plus the value of bank reserves at the central bank, currency in circulation, and other loans to the government. The gross liabilities of the US public sector summed to a much smaller 142% of GDP, including 78% in government bonds, plus currency, reserves and unfunded pension obligations for government workers.
By remarkable coincidence, this enormous difference in the countries’ respective ratios of gross public-sector liabilities is exactly matched by the difference on the other side of their balance sheets: Japan’s public sector owns a ton of financial assets, and the US public sector doesn’t. Japan’s public-sector financial assets (including domestic and foreign securities) amounted to 134% of GDP. The equivalent number for the US was just 23%.
Something else it’s crucial to bear in mind: Japan’s public sector gets a much higher return on its financial assets than it pays to its lenders, whereas America’s public sector doesn’t. Japan’s public sector pays essentially nothing to holders of bank reserves and government bonds, while earning plenty on its enormous holdings of domestic equities and foreign equities and bonds. (This has unfortunate implications for Japan’s domestic income distribution, but that’s another issue.) The US public sector’s cost of borrowing is about the same as the return on its smaller pool of assets. In effect, this difference in relative rates of return gives Japan an additional margin of fiscal space. Other things being equal, Japan could support a worse net-liability position than the US could – but right now it doesn’t have to.
Indeed, the US will soon be the one under greater fiscal stress. Japan’s public-sector debt ratio is stable; America’s is rising. The Congressional Budget Office projects big budget deficits over the next decade, assuming current laws stay in force. But current law calls for the tax cuts of 2017 to expire at the end of next year, and both candidates for the presidency say that won’t happen. In fact, both promise an array of new vote-grubbing tax cuts and spending increases.
At some point, perhaps before much longer, this will all unravel. The reassurance purportedly offered by Japan’s experience is delusional. The trigger will be the belated dawning of anxiety about where fiscal policy is heading, together with the rise in long-term interest rates that this realization will induce. Heavy debts plus persistent primary deficits (that is, borrowing excluding interest payments) plus less-than-stellar economic growth plus higher long-term borrowing costs is the formula for fiscal meltdown, and all these components are falling into place. If the US doesn’t care for this future, it should indeed stop wringing its hands about public borrowing and do something about it.
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