At the end of 2012, japan's central government was 997 T JPY in debt.

That's more than 200% of GDP, and more than $80,000 per capita. There's little chance it being ever paid back, and unfortunately, things are about to get a whole lot worse. In order to understand why, let's look at how the government accumulates debt in the first place. Each year the government receives money from households and corporations in the form of taxes and other revenues. if then(?) spends that money in the economy on public services and other commitments. If the government wants to spend more money than its revenues, it has to borrow the difference. It does this by issuing debt securities (IOUs). Investors buy them, the government gets the money at ease(?), and investors receive interest. But when the outstanding debts get too large, investors start to worry that they won't get their money back. This is where the central bank comes in. The central bank lowers the interest rate, which basically means that it prints money until interest rate hits its target. Satisfied that their investments are safe, investors keep buying governmet IOUs, which means that the government gets to keep spending more than it earns. Sounds great right? Well there's a catch. Overtime, continual interest rate suppression and money printing sets up an inescapable trap. Here's how it works, imagine the goverment's outstanding debt is a big box of fixed (?), then each year it has to pay a small slice of the box in interest. You can think of this as a tray that has to (?)fill with incoming funds. In normal circumstances, tax revenues fill the interest expense tray and go along the way to (?) funding other expenditures, then investors fund what's left. (A short while later...) Now when the central bank lowers the interest rate, the tray become shallower. This makes it easier for the government to fill the tray with its core revenues stream, allowing to grow its other expenditures. (A long while later...) Overtime, the interest expense tray gets shallower and wider and expenditure grows substantially. Now even a small increase in the average debt cost, the height of the tray, increase interest expense to the extent that it takes up all the tax revenue. And when it does, the government has to borrow everything it spends. (A short while later...) This only widens the interest expense tray, investors catch on and sell their bonds raising interest rate further, and soon enough the government finds that its core revenues stream meets only a fraction of its interest liability (that) even the printing press can't help now. If the central bank tries to grow tax revenues, investors sell their bonds to account for inflation. This pushes up average debt cost, such after total interest rises faster than tax revenues. so in the end the situation remains the same, and the government inevitably default. So here is where Japan fits into this framework: At the end of 2012 fiscal year, Japan's debt was 23 times revenues. So let's look at this in terms of our tray analogy, this means that 1% increase in average debt cost increases the overall interest expense by 23% of tax revenues. Now 23% of tax revenues are already being spent each year, so the average debt cost is only about 3% away from the point that which interest consumes the entire tax revenues. So it all comes down to this: Can the government keep its debt cost from rising to 4%? Well, in order to answer this question it's important to distinguish between japanese investors and foreign investors. Let's start with japanese investors. The last 20 years have been very challenging for them since almost all prices have been going down, the exception has been government bonds. So, as you can imagine, a large part of local investable funds are already invested in them. This means that new investable funds would have to buy the goverment's new bonds. Since investors represent households and corporations, these new funds would have to come from their new savings. The problem is that the new savings are declining. The population is aging, so households are more likely drop(?) down upon savings than create them, and the balance of the trade is deteriorating making it difficult for corporations to generate profits.

Basically the new savings of households and corporations are less then what the government needs to borrow, so the only option is for foreign investors to get involved. But they are used to receiving higher rates of return. So as external investors found more and more of the government deficit, the average debt cost may rise to the critical level of 4%. But it gets worse: The bank of japan recently started targeting 2% inflation. The problem with this is that japanese investors had come to view falling consumer prices, deflation, as real return. So when consumer prices fell by 1% per year, and they got a nominal yield of 1%, they called it 2% real yield. But the bank of japan's new policy is going to flip the polarity of this calculation. So even to get back to where they were, investors will have to charge the government a nominal rate of 4%. Combine this with Japans increasing reliance on external capital and you can see how easy the average debt cost could reach the critical level of 4%, and once that happens, its game over.