Government spending has institutionalized trillions of dollars in annual budget deficits, driven up interest rates and left the bond market volatile. Japan is now on the brink of selling off $400 billion in US debt. This could overwhelm the U.S. Treasury market and devastate Americans’ finances.
The source of Japan’s sudden need for liquidity is the state-owned Pension Reserve Management Agency, which holds almost all Japanese workers’ social security reserves. The government wants to shore up the yen’s sharp decline, so it intends to sell American assets and buy Japanese ones.
The amounts here are not trivial. The fund has more than $1.5 trillion, of which $400 billion is U.S. Treasuries. This conversion from dollar-denominated assets to yen-denominated assets means releasing onto the market an amount of U.S. Treasuries equivalent to about 20% of the federal government’s annual net borrowings.
A 20% increase in the supply of Treasuries is a huge deal when yields are already around 5% and poised to rise further. Higher yields increase the amount of interest we must pay to repay the $35 trillion federal debt.
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The Treasury spent a record $140 billion in interest alone last month to continue the debt program. Roughly speaking, this represents more than three-quarters of the personal income tax revenue collected in June.
Just for interest.
The problem will get even worse if Japan starts releasing US debt. An increase in the supply of government bonds will make it harder for the U.S. government to sell new bonds to finance large budget deficits. The only way to get more people to buy U.S. Treasuries is to offer higher interest rates, which would cause interest rates on Treasuries to rise even faster, reaching more than $2 trillion a year. Dew.
Many countries, such as Russia, have already sold all their government bonds. China, the second-largest foreign holder of U.S. debt, has been selling off a lot of U.S. Treasuries, selling a third of them in the past five years. If Japan, the largest shareholder, were to sell hard in this environment, it would be the equivalent of a margin call on the U.S. Treasury — the moment the banks tell you to cough up more cash, or they lock you out.
People around the world have lost confidence in the federal government’s ability to repay its debts, and the dollar is no longer considered a safe asset. In just three and a half years, the dollar has lost a fifth of its value, wiping out trillions of dollars in assets for bondholders around the world.
This type of backdoor default has already begun to liquidate U.S. bond holdings, with some Japanese banks including the country’s fifth-largest bank, The Norinchukin Bank, selling $63 billion in U.S. debt. This is the reason why I am here.
Even larger Japan Post Bank holds more than $550 billion, mostly in U.S. Treasuries, which could also soon be sent to the bidding block.
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This is not the end of the fire sale. Since Japan’s Pension Investment Fund influences all other pensions in Japan, an additional $800 billion in U.S. assets may also be looking for new financial home.
The federal government is borrowing more to cover its growing deficit, even as nearly all bond buyers, including the Fed, are selling. Financial markets are facing soaring interest rates and a large-scale liquidity outflow.
If the Treasury is pushed into this predicament and forced to push up yields, things will quickly collapse. We will look back fondly on 8% mortgage rates and limited bank failures in the spring of 2023, because things will get much worse than that.
Of course, governments can avoid this entire collapse simply by cutting spending and putting themselves on a path to fiscal sustainability. After all, if investors believe their investment is still good, margin calls will not occur.
Unfortunately, there is no sign of such fiscal responsibility in our government.
