This clip is a visualisation of what is happening in Japan.
The basic summary is this:
- A country enters a debt trap when its interest repayments on its debt are higher than the money it collects in tax revenues.
- Currently, Japan spends 23% of its tax revenue on interest repayments.
- But this takes place at an interest rate of ±1%.
- If interest rates rose to 2%, that figure would rise to 46%.
- If interest rates rose to 4%, Japan would be on the cusp of having to borrow money just to repay the interest that is already owing on their outstanding debt.
- At the same time, the holders of Japanese debt are mostly the Japanese themselves, who have been experiencing deflation of ±1% per year.
- So earning 1% on their investments, while gaining 1% of purchasing power each year through deflation, means that their real return (ie. the growth in real wealth) is about 2% per year.
- Meanwhile, the Bank of Japan, as part of the so-called “Abenomics” set of policies, has announced that it will be targeting an inflation rate of 2%.
- If the Japanese people are going to continue to demand a real return of 2%, they’re going to start demanding interest rates on government bonds of 4%*…*2% real return + 2% inflation = 4%
The hope, of course, is that inflation will encourage the Japanese to spend their money rather than lending it to the government. This should result in more income, better economic growth, and therefore, higher tax revenues.
The other important points that this video fails to point out:
- Japan’s government will only be paying higher interest rates on new debt issues.
- Because most of the government’s bonds are fixed rate bonds, the debt that already stands will continue to be paid down at whatever interest rate was part of the initial deal (so the Japanese government will be winning).
- The only exception to this are Japan’s floating-rate bonds (which the government is no longer issuing), and Japan’s inflation-indexed bonds (the first issue of which took place in October 2013).
- And inflation-indexed bonds are a win, because it means that the government will only pay higher interest rates after the policy has worked. Floating-rate bonds, however, are affected by investor expectations of inflation – so the government could end up paying for inflation that will never take place (in which case, the whole gamble would be pointless).
If you want a catch-up on the history: