Japan's Debt Is a Feature, Not a Bug

By Robert Paulson

Every few years, Western economists sound the alarm about Japan's debt crisis. The numbers are staggering: gross government debt around 235% of GDP as of late 2025, the highest ratio among major economies. Decades of warnings have predicted imminent collapse, soaring yields, capital flight, or currency crisis. None of it has happened. The reason is simple. Japan's debt isn't a crisis waiting to happen. It's a brilliantly engineered financial innovation that transforms government borrowing into the world's largest domestic wealth machine.

Think of it this way. Japan took the vast ocean of yen already sloshing around its economy, laid it out flat like vacant land, drew property lines around portions of it, and issued deeds called Japanese Government Bonds. These bonds don't represent new wealth created from productive enterprise. They represent claims on the existing money supply, carved up into tidy parcels that pay regular rent in the form of interest. The government became the landlord of a virtual real estate empire built not on physical soil but on its own currency. And nearly everyone in Japan is a tenant, collecting steady income from these safe, titled assets.

The Virtual Real Estate Empire

Here's where it gets fascinating. Over 53% of all JGBs are held by the Bank of Japan itself as of mid-2025. The central bank bought them with newly created yen through quantitative easing programs. So the government borrows from the central bank, pays interest to the central bank, and the central bank remits most of those profits right back to the government. It's a closed loop. The net cost of servicing that majority portion of the debt is essentially zero. The government is paying rent to itself.

The remaining debt is held overwhelmingly by domestic institutions. Life insurance companies hold around 13 to 16 percent. Pension funds and mutual funds hold roughly 8 to 10 percent. Banks, though less than in prior decades, still maintain significant holdings. Foreign ownership hovers around just 12 to 13 percent, one of the lowest ratios among developed nations. Nearly 90% of Japan's debt is owned inside Japan. This isn't a vulnerability. It's insulation from external pressure and a feature that allows the system to function smoothly without foreign creditors dictating terms.

What does this structure accomplish? It creates a massive pool of safe, income-generating assets that domestic savers, retirees, insurers, and pension funds desperately need. Japan has an aging population with enormous savings and conservative investment preferences. Without JGBs, where would these trillions of yen go? Into riskier equities, volatile foreign assets, or stashed under mattresses earning nothing? The government debt provides the stable, low-risk anchor that the entire financial ecosystem requires. It's not a burden on future generations. It's a subsidy to current generations, recycling domestic savings into dependable income streams.

The Income Flows That Power Society

Consider the mechanics. Life insurance companies promise policyholders future payouts and guaranteed returns. To meet those obligations, they need safe assets that generate predictable income. JGBs fit perfectly. The interest they collect from government bonds flows to policyholders, many of whom are elderly savers relying on these products for retirement security. Pension funds operate similarly, using JGB income to fund retirement payments to aging workers. Banks earn spreads on their bond holdings, supporting their balance sheets and allowing them to lend.

This entire system acts as a quiet transfer mechanism. The government issues debt, institutions buy it, interest payments flow to those institutions, and ultimately real people receive income in the form of insurance payouts, pension checks, and dividends. The government funds its spending on healthcare, pensions, infrastructure, and social services for an aging society, while simultaneously creating the financial assets that fund private retirement security. It's a dual-purpose engine.

Now ask the counterfactual. What if Japan had followed orthodox fiscal advice and refused to issue this debt? What if the government balanced its budget and held debt at, say, 60% of GDP like the Maastricht criteria once demanded of European nations? Japan would have forgone the creation of trillions of yen worth of safe assets. Retirees would have fewer income-generating investments. Insurers and pension funds would struggle to meet obligations. The financial system would lack the stable collateral and liquidity that JGBs provide. The country would be poorer in real terms, despite having a lower nominal debt ratio. Fiscal orthodoxy would have been fiscal folly.

Why It's Sustainable (And Brilliant)

The critics obsess over the 235% debt-to-GDP ratio. They ignore the fundamentals. Japan issues debt in yen, a currency it controls. The Bank of Japan can always create yen to buy government bonds. Default is impossible unless the government chooses it, which would be absurd. The real constraint is inflation, not insolvency. And Japan spent decades battling deflation, not inflation. Even now, with inflation at 2.9% in November 2025 and 10-year JGB yields around 2%, the real cost of borrowing is minimal. Inflation erodes the real value of outstanding debt while nominal GDP growth supports the tax base. The system is self-reinforcing.

Foreign investors barely participate, so Japan faces no external debt trap. There's no risk of sudden capital flight or foreign creditors demanding austerity. When the Bank of Japan holds over half the debt, interest rate risk is internalized. If rates rise, the government pays more interest, but the central bank receives it and remits it back. The net fiscal impact is muted. This is financial engineering at its finest, creating a controlled environment where debt serves public purposes without the traditional risks.

More importantly, this model represents a sophisticated abstraction layer on top of the real economy. Japan's actual wealth comes from its advanced manufacturing, technology exports, services, and productive capital. But the economy grows slowly due to demographics and maturity. In that context, how do you provide income security to a massive elderly population without endless real growth? You create a financial layer that generates income flows independent of underlying economic expansion. Government debt does exactly that. It takes the money supply, repackages it as bonds, and distributes interest income to those who need it most.

Think of it as a way to monetize the trust and stability of the state itself. The government's ability to tax, to enforce contracts, and to issue currency becomes the bedrock asset. JGBs are shares in that bedrock, paying dividends in the form of interest. It's no different conceptually from a REIT that owns buildings and distributes rental income, except the underlying asset is sovereign power rather than physical property. And because the sovereign can issue its own currency, the asset is effectively infinite and self-liquidating.

The Critics Have It Backwards

Conventional wisdom treats government debt as a necessary evil, to be minimized and worried over. Japan proves the opposite. Debt, properly structured and domestically held, is an asset creation mechanism that benefits society. It transforms idle savings into productive financial claims. It funds essential services while generating income for key demographic groups. It stabilizes the financial system by providing safe collateral and liquidity. And it does all this without imposing external dependency or fiscal crisis.

The countries that should be envied are not those with low debt ratios and balanced budgets. They're leaving wealth on the table. If your population has trillions in savings seeking safe returns, and your government can borrow at low rates in its own currency, why wouldn't you create more debt to meet that demand? The alternative is forcing savers into riskier assets, depressing returns, and failing to provide the income security that an aging society requires. Japan understood this instinctively. The debt isn't a failure of fiscal discipline. It's a triumph of financial architecture.

Critics point to slow growth, stagnant wages, and demographic decline as evidence of failure. They have causation backwards. The debt didn't cause those problems. It mitigated their impact. Without the government's willingness to borrow and spend, Japan's deflation would have been worse, its financial system less stable, and its elderly population far more economically vulnerable. The debt allowed Japan to navigate a uniquely challenging economic transition with social cohesion intact. That's success, not failure.

A Model for the World

Japan's debt structure offers a template for other mature economies facing similar demographics. Aging populations need safe assets and income. Governments with monetary sovereignty can create both by issuing debt domestically. The key is keeping foreign ownership low, ensuring the central bank can act as buyer of last resort, and using the proceeds to fund services that support the population. Done right, sovereign debt becomes a social wealth fund that pays dividends to citizens through financial intermediaries.

The United States has higher foreign debt holdings and more external vulnerability. Europe's monetary union prevents individual countries from controlling their own currencies, creating genuine debt crises like Greece experienced. Japan avoided those traps by maintaining monetary sovereignty and keeping debt domestic. The result is a system where 235% debt-to-GDP coexists with sub-2% bond yields, stable inflation, and no crisis in sight.

The lesson is clear. Sovereign debt, in the right structure, is not a burden to be minimized. It's a feature to be optimized. Japan built a virtual real estate empire out of its own currency, rented it to its own citizens, and used the proceeds to fund one of the world's most advanced, peaceful, and stable societies. That's not a bug. That's brilliance. The rest of the world should stop lecturing Japan and start taking notes.