Will Japanese sell-off lead to US debt collapse?

Profligate government spending has institutionalized multitrillion-dollar annual deficits that have driven up interest rates and sent Treasury markets to the brink. Now Japan is on the brink of a $400 billion sell-off of U.S. debt that could snap the back of the Treasury market and devastate Americans’ finances.

The source of Japan’s liquidity emergency is the state-owned Government Pension Investment Fund, which holds the social security reserves of almost every Japanese worker. As the government seeks to prop up the falling yen, it plans to sell American assets and buy Japanese ones.

The amounts here are not trivial: the fund is over $1.5 trillion, of which $400 billion is in U.S. Treasury bonds. This conversion from dollar-denominated assets to yen-denominated assets means throwing into the market an amount of Treasury bonds equal to about 20% of the federal government’s annual net debt.

A 20% increase in Treasury supply is huge when yields are already around 5% and poised to rise. Higher yields increase the amount of interest that must be paid to service our $35 trillion federal debt.

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Last month, the Treasury Department spent a record $140 billion in interest alone to maintain its debt program. By comparison, that’s more than three-quarters of the personal income tax revenue collected in June.

For interest only.

If Japan starts selling its U.S. Treasuries, the problem will get worse: increasing the supply of Treasuries will make it harder for the U.S. government to sell more and finance its massive budget deficit. The only way to get more people to buy Treasuries will be to offer higher interest rates, which will cause interest on the debt to rise even faster, heading toward $2 trillion a year or more.

Many countries, such as Russia, have already sold all of their Treasuries. China, the second-largest foreign holder of U.S. debt, is selling in handfuls, selling a third in the past five years. If the largest holder, Japan, sells in these conditions, it would be the equivalent of a margin call from the U.S. Treasury—the moment a bank asks you to put up more cash or cuts you off.

People around the world are losing confidence in the ability of the federal government to repay debt and no longer see the dollar as a safe asset. In just 3½ years, the dollar has lost a fifth of its value, erasing trillions of dollars in wealth for bondholders around the world.

This kind of backdoor default is why some Japanese banks have already begun liquidating their Treasury bond holdings. One is the country’s fifth-largest bank, Norinchukin, which sold $63 billion worth of Treasury bonds.

The even larger Japan Post Bank has assets worth more than $550 billion, mostly in the form of U.S. bonds, which could soon also go up for auction.

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The sell-off doesn’t stop there. As the Japanese Government Pension Investment Fund spills over into all other pensions in Japan, another $800 billion in U.S. assets could also be looking for a new financial home.

Even as nearly every Treasury buyer is selling, including the Federal Reserve, the federal government is increasing borrowing to cover growing deficits. Financial markets are staring down the barrel of rising interest rates and a massive outflow of liquidity.

If the Treasury is cornered and forced to pay higher yields, things will fall apart quickly. We will fondly remember 8% mortgage rates and limited bank failures in the spring of 2023, because things will be much worse.

Of course, the government could circumvent this whole collapse by simply cutting spending and getting on the path to fiscal stability. After all, margin calls don’t happen if investors think the investments are still good.

Unfortunately, our government shows no signs of such fiscal responsibility.