Why You Should Be Afraid Of Japan

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If you want to terrify Tim Geithner or Ben Bernanke, just start talking about Japan. Frankly, you should probably feel afraid when you hear about Japan's economy.

You know: Economic superpower gets into a financial bubble. The bubble pops, and now — 20 years later — the country can't seem to get itself back on track. Just this week, Standard & Poor's downgraded Japan, telling the world they're worried about the country's long-term ability to pay back its debt.

This wasn't some sudden thing; Japan's economy has been in trouble for years.

In 1995, Japan's economy was seven times bigger than China's. Since then, China's economy has grown a lot — it's now bigger than Japan's. And Japan's economy has actually shrunk a bit.

As its economy was shrinking, Japan's government spent like mad. So its debt is now twice as big as its GDP. There is one country in the world in worse debt shape: Zimbabwe. The highly indebted countries you keep hearing about, like Greece and Ireland, have much smaller debt burdens than Japan.

The future does not look bright. Japan's population is tilted towards older people, so they have to think about huge pension payments in the coming decades.

Investors are still lending lots of money to Japan at reasonable rates. The country does not seem on the brink of an acute fiscal emergency. At the same time, it doesn't seem likely to break out of its long term chronic economic illness.

If all this sounds a bit eerie — like a premonition of where the US might be headed — there's reason to be concerned, and reason to be not so worried.

The U.S. debt is increasing. But, when you compare national debt to GDP — a key measure of a nation's debt risk — America's still in much better shape than Japan. The U.S. economy is growing — slowly, but much faster than Japan's. And while we have all those retiring baby boomers coming, we are not as tilted towards the old as Japan is, especially since we're more open to immigration.

The standard view is that it took an awful lot of really bad decisions by Japanese government and central bank officials — an endless stream of lousy moves for twenty years and more — to get where they are today.

Let's hope Japan is like Lindsay Lohan from the perspective of the casual drinker: Not an inevitability, but a cautionary tale of where things can go when they get out of hand.