World Debt Crisis: Japan, Leading the Global Bursting of Financial Bubbles

In the 1990s, a new school of thought emerged in public fiscal policy, known as the Modern Money Theory (MMT), first advocated by scholars focusing on public finance needs. This theory, which gained traction during economic crises and resource allocation challenges, has been a significant factor in Japan's economic journey.

The MMT assumes that a sovereign state that emits its own currency cannot "debt" itself in its own currency and has no financial limits for spending. This assumption led to a period where money debt, including government bonds, was essentially "free" in terms of nominal cost in Japan.

This approach was coupled with the zero-interest rate monetary policy, first used in Japan during this time. The policy resulted in the Carry Trade, a financial strategy involving massive volumes of government bonds, providing an unconditional basic income for bondholders due to zero interest rates. Asset inflation (stocks, real estate) had been at historic highs for years due to the zero-interest rate money flood.

However, these developments, increasingly fueled by demographic developments and resource scarcity in the labor market, have created an insoluble dilemma for central banks in the face of persistent inflation. The combination of MMT, zero-interest rate monetary policy, and the resulting misallocation of assets has set the stage for a potential crisis.

Japan's bond markets are starting to demand higher risk premiums, challenging the assumptions of MMT. If Japan continues to refrain from raising interest rates to control inflationary trends, or eases further with more "money printing," bond markets will react by increasing capital market interest rates, making debt unsustainable at record levels.

The partial collapse of the Carry Trade in August 2024 was due to Japan's reluctance to combat inflation through interest rate hikes. If interest rates are raised in Japan, the historically unprecedented debt will become more expensive. This move will significantly impact the yen carry trade, further worsening the income situation of bondholders and the already weak economy.

In the 1980s, Japan experienced economic depression due to an aging population, unaffordable real estate for the middle class, and increasing public debt. The immediate collapse due to a deflationary spiral was prevented by the first state debt binge in Japan.

More recently, in 2021/2022, the first signs of inflation in "real consumer life" appeared, driven by the Ukraine war, lockdowns, and energy price speculation. If Japan continues on its current path, it may face a "Liz Truss Moment" - an extreme spike in yields.

Japan's economy is under strain due to Trump's tariffs. With the MMT-justified debt orgies that finance the "rescue" of the fiat money system, Japan is likely to be the first "sinner" in this regard. MMT advocates for active fiscal intervention to achieve full employment and control demand and inflation. However, the question remains whether these measures will be enough to steer Japan away from its current economic predicament.