After 40 Years, Japan Can’t Keep Buying Our Debt. Are We All in Trouble?

Paul Winkler: Welcome. This is “The Investor Coaching Show.” I am Paul Winkler, talking money and investing, going through the news of the week, the things that have been going on, as well as putting some of that stuff in perspective. Also educating on investing as we go because so much of what we get about investing is driven by an industry that has just gone off the rails in so many ways and has been doing it for so many years that most people don’t even realize it.

The News of the Week

I was actually having a conversation with some people earlier today and talking about their spouses, and they said their spouses are studying the stock market, and they’ve been getting into studying and investing because they just don’t trust anything they hear. And I was like, “Yeah, they’re still getting information from places that are having them do things that are dysfunctional.”

They just don’t recognize it because that is so much of the industry, because it is so driven by transaction. And that’s why the show, the whole idea is just to make this a little bit of a different experience.

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I like to walk through just the news of the week, simply because we hear things, and it’s hard putting it in context. There’s so much to get into. 

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I mean, good grief, the feuds that have happened this week, and everybody’s talking about that. United States versus Europe. There have been crazy AI predictions that I want to get into.

And the U.S., are we still the place to do business? We’ll be talking a little bit about that. Hierarchy traps with 401(k)s, you’re taking distributions. Industry, it’s crazy. The biggest mutual fund companies taking distributions.

You’re trying to pull money out of your qualified account, your 401(k), your IRA, and they’re doing it in ways that you just have no idea what they’re doing, and they’re being called out. One of the absolute biggest mutual fund companies in the world is doing it that way.

So that, and then there’s some fascinating stuff about ChatGPT and getting involved in choosing stocks, and how they have done. I’ll get into some of that.

And America’s biggest lender, where we get a lot of money for things that we finance here in the United States, is starting to change, some things are starting to change there. What are the implications of that?

So just so much to talk about. So I love getting into all of it. And that’s what we do around here. And of course, if you miss any second of the show, you can go to paulwinkler.com, check out the podcast right there.

Where We Get Money in the U.S.

Okay, so the United States. The United States versus Europe. What is it about the U.S.?

Well, I think probably that’s where I probably need to start today. Let’s just start on that whole thing about where we get money in the United States.

There was an opinion article in the Wall Street Journal, and it was discussing, “America’s biggest lender is closing its wallet — and investors and home buyers will feel it.” Now stick with me on this because it may sound like I’m challenging things that I’ve taught here on the show for 25 years, but now I’m not, and I’m going to walk through that, and there’ll be a few times that you’ll feel that way as I go through the show today.

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But I’m going to bring you back to home base because what I’ve taught here, I’ve never had to change. 

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I wrote my first book in 2007, and I didn’t have to change it when I rewrote it in 2017. I just changed the data, and I just said, “Okay, we got 10 years more data in here, so I’ll add that in there.”

And then of course when I just updated it recently, it’s on Amazon, you can get it with 2024 data, I didn’t have to update it because I didn’t have to look at it and go, “Oh gee, that was wrong, that was wrong, that was wrong. I need to redo the whole book and do something different.”

Didn’t have to do that. And the reason I didn’t have to do that is because the general ideas, which are academics, not my ideas, generally the academic research of the past 70-80 years, you just didn’t have to change it because it just makes so much sense. And I’ll talk about why as time goes on here.

But anyway, there’s this whole thing about America’s biggest lender. Who are they? Well, Japan.

And they said they have this quiet subsidy of American prosperity, and it’s almost like America’s prosperity, this is the funny part right here, is completely dependent upon what Japan has done. That’s the reason we’re doing so well.

And that’s what you’d get out it if you read this MarketWatch article, just reading the headline. “The Japanese have been floating America’s boat since the mid-1980s.”

They actually assert here, “Not out of kindness. Not out of stupidity. But because of a deal so sweet that nobody wanted to talk about it.”

Japan’s Debt

Now there’s some truth in all of this, so bear with me. “Now the deal’s going bad,” they said. “Japan’s drowning in debt, its politics are in chaos and it needs its money back. And when your biggest lender starts heading for the exits, it’s time to pay attention.”

Now, number one, the vast, vast, vast majority of U.S. government debt, let me just put this out there, is held by American investors. The vast majority of it. And the top 1 to 2% of America’s population holds the bulk of that as well, just because they have the most amount in savings.

So you look at that and say, “Well, okay, I can take that with a grain of salt.” I remember teaching a class at one of the universities, I can’t remember. I’ve done some stuff at high schools but in universities as well. But I remember, I think this one was at a high school.

I was teaching a class for finance. One of the teachers there asked me to come in and teach, so I did that. And I pointed out how little of America’s debt is held by outside owners.

And you could tell visibly that most of the kids and the teacher, I think as well, were really surprised by that. But we think because we hear this in the media that so much of our debt is held by these outside interests that we think, Oh, we’re just beholden this and this is going to be terrible if they decide to do that. 

And I pointed out, I said, “Hey, if any of these people called their debt and said, ‘Hey, we want all our money back,’ they would be sinking themselves because they would increase the supply of bonds.”

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What do you do when you increase the supply of anything? You drop the price that people are willing to pay for it. 

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So they would be basically shooting themselves in the foot. But I digress. So they’re saying you need to pay attention.

So, “Look at Japan today: government debt at 235% of GDP,” which is gross domestic products of the country’s output. “That’s like owing your annual salary times 2.3 to Visa,” they say in this article.

Now, first of all, I said to my wife, I said, “What is ridiculous about this?” And she’s like, “I don’t know.” And I said, “Think about it this way.”

I said, “What does Japan pay to borrow money?” And she goes, “I don’t know.” I said, “You probably know more than hardly anybody else.”

But it’s just over 1% for their 10-year bonds. So it’s not much. Their interest rate is super, super low.

What do they pay for 30 30-year debt? It’s just below 3%. So you look at their debt and the interest rate on it is super, super low.

What do you pay or what does the average person pay on their Visa if they have outstanding debt? Twenty to 30%? How do you compare 1 to 2% to 20 and 30%?

I mean, it’s not even close. It’s a terrible comparison. Now the reason I point that out is because if you are somebody reading an article like this, it could scare the living daylights out of you reading this kind of thing.

It’s “The world’s coming to an end, everything’s going to fall apart. Oh my gosh, this is terrible. It’s like Visa.” No, it’s just bad math.

History of Japan as a Lender to the U.S.

“Picture this: 1945.” They said, “World War II,” and this is an interesting history lesson right here on how we got there, where Japan is such a big lender to the U.S. and the U.S. Economy in general. Big, not compared to other lenders, but just overall.

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I mean, they do lend a lot of money. They buy a lot of government bonds and they finance a lot of things here in the United States. 

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It says, “Picture this: 1945. World War II is over. America’s got the guns. Japan’s got the ruins. The U.S. cut a deal — military protection for economic cooperation.”

So the U.S. is going to protect Japan because their military’s decimated and not able to rebuild, and as long as they have economic cooperation, hey, we got a deal here. “But the real magic trick came later. For the next 40 years, Japan rebuilt itself, accumulating dollars and using them for its own development. Japan went about making tin toys to Toyotas.”

So they had cheap radios and world-class electronics, and at first, their cars were garbage. If you want a piece of junk car, it was made in Japan, that equaled to junk. And that was it.

I mean, it was like back when I grew up, you didn’t want anything from there because it was no good, but they got really, really good and their quality became second to none. And then you’d go through consumer reports, and all your five-star cars were Japanese, and all your two-star cars were American-made.

So then they had, “The Plaza Accord of 1985 — five finance ministers in a New York hotel room deciding to dismantle Japan’s export machine. Japan signed on too, thinking they could manage it. They couldn’t. The yen shot up 50% against the U.S. dollar.”

So if you’re, let’s say, an economics major, you’re learning about the differences between different currencies, you know that when your currency is really, really strong, I mean, it’s very, very valuable versus another currency, it makes it really hard for you to export to other countries. So if you have a weak currency, that’s why China was always talked about as a currency manipulator, because if they could manipulate the value of their currency down, they could cheapen their exports, and they could really do well doing that.

But if all of a sudden, your currency has gone up and you’re a country that’s really small and you’re really dependent, relative to the United States anyway, you’re really dependent upon being able to export things, that’s a problem when your currency’s really, really strong. So their currency shot up 50% against the dollar. And in two years, “Japan faced a choice.”

It was either, “Watch its economic miracle turn into a pumpkin, or get creative.” And they decided to get creative.

“Instead of converting,” they said in the article, “their mountain of trade-surplus dollars to yen (which would’ve pushed yen even higher),” made their problem even worse, “the Japanese did something beautiful. They started buying U.S. Treasury bonds. Mountains of them. It was perfect.

“The U.S. got to keep borrowing. Japan got to keep exporting. Nobody had to mention that the whole thing was a shell game. As economists have long warned, this recycling machine couldn’t last forever.”

Three Major Shifts in Japan

“But that’s a problem for the next guy. For the next 40 years — from 1985 till now — this recycling machine has been running nonstop. Japan made our Walkmans.” I love it. The writer says, “Google it, kids.”

I remember being in college, man. I lived by my Walkman. If you didn’t have that, you were in big trouble back then. It was the only way to walk around with your music. Then you had iPads and iPods, and then of course then your phones double as doing that now.

But anyway, “Here’s the beautiful part — Japan would loan these dollars back to the U.S. by purchasing Treasury bonds. It’s like paying your bartender with an IOU, and then having them loan you money to keep drinking. Genius!”

Everything worked. Everybody’s back, they were scratching each other’s backs.

But then they had three major shifts, they said. Demographics, and that has been a huge problem in Japan, where the population’s aging, aging, aging, and since they don’t have immigration, this immigration policy is like, that ain’t going to happen.

Then all of a sudden what happens is you don’t have a younger population, and as much as you cajole the younger generation into having kids, if they just decide they’re not going to have kids, you’re sunk. And elderly Japanese people, they like eating food rather than eating Treasury bonds.

That’s why I always think it’s so funny about gold. People talk about that all the time. “I’m getting gold. I’m claiming it.”

I’m going, “Yeah, you know what? If the stuff hits the fan, you’re not eating your gold.”

That’s a problem. And that’s the point that they’re making here. It says people don’t eat their Treasury bonds.

“Second, debt. At 235% of GDP, Japan’s government debt makes America’s national debt look positively prudent.”

I’ve said that for years. People say, “How much debt is just absolutely unsustainable?”

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Nobody really knows the number for that because sometimes debt can get super, super high compared to GDP. 

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And if you look at interest rates and if interest rates are low, that’s telling us that, well, maybe it’s not as big of a problem as we’re making it out to be.

And the third is politics. And they have that the prime minister is hanging by a thread, only a 21% approval rating. So that’s a problem as well.

Is It Time To Panic?

Now the question they ask is this: Is it time to panic? Because people can go in, they can panic. They say, “Well, what if they stop buying bonds? You could have interest rates spike.”

Well, this has been something that’s talked about. Back when I was doing economics, we talked about this, that government borrowing was going to crowd out everything, and that our national debt was going to make it so that businesses couldn’t borrow at reasonable interest rates.

Well, the funny thing is that never happened. But I’m telling you folks, this has been warned about since I got out of school 40 years ago, and it ain’t happened yet. But this is something that comes up every once in a while and it just scares people.

And I just want you to get that a lot of times you are being played by Wall Street.

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The reason is that Wall Street benefits when you panic, and then all of a sudden, you start to make changes in the way you do things. 

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So I just want you to keep that in the back of your mind when you read articles like this. Now, homeowners with adjustable-rate mortgages could see interest rates jump. Car loans, you could have interest rates.

So they’re saying all this stuff, but what’s the other side? And the other side is that you could channel foreign capital into productive assets rather than government debt.

You have assets, and that could be channeled into something else, could create jobs through infrastructure, technology investment. This money may come out of bonds, but it may go into things that are actually more beneficial, because you think about it, how beneficial is it when you just have a loanership going on versus ownership?

And when you have capital available for things, that could actually create more economic growth in a country, is in essence what they’re saying here, which I think is right on. That is not often thought about in regards to how this stuff can play out.

And then they say you could, “Establish a model for unwinding other financial imbalances with Germany, South Korea and Saudi Arabia.” But here’s the interesting thing that’s not being talked about in this: What are the differences between how the U.S. handles some of these things versus Europe? What’s going on in Europe right now?

U.S. Versus Europe Savings Rates

That was actually a topic of conversation this week on the financial channel. So check this out regarding U.S. versus Europe. Just listen to what’s happening with one versus the other savings rates.

Audio Clip: We have a lot of areas where if you look at us versus Europe. I don’t know if you saw it, when we talked about op-ed in the FT yesterday, one of the things he says, Jim, is that Europe is removing critical barriers to capital.

PW: Now, number one, before I move on, removing critical barriers. What has been the problem forever, U.S. versus international? And it has gone back and forth throughout the decades.

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Whenever you have too much government interference, you have growth stymied. 

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There’s a problem. Countries don’t grow when governments interfere too much. And they’re talking about that, that’s been changing. And a lot of investment managers in the United States have been so U.S.-centric that they’ve been missing this aspect of what’s been going on around the world.

Audio Clip: Faster permitting. How about the savings rate in Europe is three times our savings rate, which I thought was very telling. David, you remove some of the cross-quarter, you do remove, you get better governments that are more pro-industry.

And you have this NATO budget that is just supercharging Europe. Amazing.

PW: Yes.

Audio Clip: Well, as we know, and have said many times, their markets have performed very well this year. Much better than ours. Especially when you think about our weakened dollar situation.

PW: So we look at Europe and say, “Wow, there are a lot of good things going on here.” But notice what he said in there, savings rates, three times. So what did they save into?

They may be saving in equities, they might be saving into fixed income investments, but is it possible that that could be a source of some of what’s going away here with Japan? And we’re looking at it and we’re making it into a big problem that maybe it’s not.

But if you bring some of these changes over there, what could be the economic impact all around the world? And I’m not saying, “Hey, let’s go invest all in Europe and all that.” We’ve already been there. I’ve already been there.

And this is something I tell people, you’ve got to be someplace before this kind of stuff happens. And it’s been happening pretty significantly all year long, and you just don’t know when these changes are going to come about or how they’re going to happen. It’s news that drives so much of markets, and you’ve got to be there before it happens.

So unfortunately, what we have a tendency to do as investors is we tend to be behind the eight ball, and we tend to invest in things that we see trends in, and we’re chasing things all the time. And I see this quite often, and I’m going to talk about that in just a second, where I saw this pretty significantly over the past couple of weeks.

I saw something that an investment manager was doing, and it made me angry that they were doing this particular thing that is one of the biggest reasons that investors really have struggles choosing investments, which is because they break this one rule of investing. And they follow this one myth of investing that I’ll just talk about briefly right after this, so stay tuned.

Auditing of Client Returns

So when I look around and I say, “So what are the huge, huge mistakes that investors, in general, make? What are the big mistakes that they tend to make?”

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One of the biggest mistakes that they tend to make is looking at the track record.

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And you have John Bogle, a well-known investment guy, and here’s basically what he had to say about track record and looking at past performance, as in choosing investments.

John Bogle: The other myth is that there’s some way of picking managers in advance or picking managers for the future based on what they’ve done in the past. There is absolutely no evidence that performance persists over the long term.

If you look at the best 10 managers in a given, say, 10-year period, the chances that they will end up above average in the next 10 years are about 50/50. Half will, half won’t. Why would people want to bet that way?

PW: I think he’s being too kind. That 50/50 is way too kind, because I have actually seen where it’s 6%. I’ve seen the odds being very extremely low that they’ll be in the top half. And the reason that they don’t end up in the top half is because of the expenses of doing that.

Now, one of the things that I had actually seen, it was that you have auditing of investment portfolios and where you can audit investment firms. Investment providers can actually have the returns of their clients audited.

And there was one such one that was actually given to me this week, and they work with very high-end wealthy investors. And what they did was this. So I said something to the guy, I said, “Well, they actually have auditing of their returns.” And the guy goes, “I’ll check.”

So he went and checked, and indeed, they did have auditing of their returns on their client portfolios. And I said, “Admirable. Really good that they did that.”

So I started looking at it and I said, “Well, what were the years for the auditing?” And I noticed that it started in 2010. That was when the auditing of client returns started.

And I’m like, “Well, wait a minute. How long has the firm been around?” Let’s just say a whole lot longer than that. A whole lot longer.

Now, why is that significant? Well, because if you look back over the past 25 years, you had a major market downturn from 2000 through 2002. You had a major market downturn in 2008, early 2009. How convenient to start your auditing of your client returns in 2010.

And you see that, and I see that, with insurance companies a lot. For example, insurance companies will actually come out with a product, and you’ll look at the brochures, and you go, “Wow, look at how this product performed versus the S&P 500, for example.”

They’ll do this all the time. And they’ll pick a period of time that a strategy that they could have employed using options and features and put some calls and things like that would have actually done better than a certain segment of the market.

And then they will put a brochure together. And the idea is that they put a product together based on what the brochure is going to look like.

Seeding of Funds

Then another thing that you’ll see is mutual fund companies may have dozens upon dozens of funds that are investing in a certain segment of the market, like large U.S. companies or small U.S. companies. And they’ll have dozens of funds in one area of the market.

Now I’ll use large U.S. companies just as an example because most people would be familiar with the S&P 500. Got 500 companies roughly that make up the S&P 500, sometimes a little bit more, sometimes a little bit less. But they’ll have that many companies.

You go, “Well, let’s just see. We don’t know which companies in these 500 are going to do better than others.”

So what they’ll do is they’ll have multiple mutual funds, maybe even a dozen of them, that are investing in that one area, and they’ll have slightly different weightings of different companies in there. And then what they’ll do is whichever ones have the better performance over a 10-year period, those are the ones they advertise.

Or they’ll have another thing that they’ll do, which is called seeding of funds. And I’ve talked about this in the past as well. It bears repeating.

They’ll open up a mutual fund. They’ll open up a multitude of mutual funds, they’ll seed it with a little bit of money, they’ll put a little bit of money in Fund A and Fund B and Fund C and Fund D and Fund E. And then what they’ll do is they’ll watch which fund out of those five funds, let’s say, A through E, dwell, and then they will actually take those, whichever fund had the best return, and they’ll go public with it and they will advertise its performance.

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The mutual fund managers will do this because why? Because it attracts you, the investor who doesn’t know any better. 

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And you’ll look at it and go, “Well, they got a 10-year track record or a 15-year track record.” I mean, I think about Bill Miller. Legg Mason and Value Trust. Fifteen years in a row, he beat the S&P 500.

“Clearly, this person has the golden gift. They really know what they’re doing.” And then proceeded to lose a significant amount of the investor’s money that was investing with him.

Why? Because the past performance didn’t bear out. It didn’t continue.

Looking at Past Performance

Now there are studies of pension plans where pensions will take mutual funds that perform really poorly and they’ll go, “We got to get rid of these people. They’re stinking up the joint. Let’s get rid of them.”

And they’ll look around for funds that did better during the past 5, 10, 15 years, 20 years. And then they’ll go and fire the poorly performing managers and they will put the money with the better performing.

And it’s funny, when you look at the studies, what it looks like. The top line, which is the ones that performed well in the past, which is when they weren’t in those funds, they didn’t own them, go down, and they perform poorly.

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The ones that performed poorly in the past that they did own and got rid of, end up going on to perform well. 

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And it’s almost comical when you see the research, how those two lines cross each other, and you go, “What on earth is going on here?” It’s basically that it is a ruse when people are looking at past performance. And what you’re doing quite often is you’re giving up on areas of the market that yeah, maybe they don’t perform well.

You might have value stocks, even though 96% of 20-year periods, value does better than growth, if you have a period of time when growth does better, anybody that happened to own a little bit of growth in that period of time looks like a genius. And the investor who believes that it is skill that actually caused the outperformance will chase after that.

And this is what we see time and time again, and it is one of the first of three myths that I teach every time when we do a class.

When people first become clients, I want you to go through this. I know you don’t want to learn all this stuff and I’m not going to make you learn everything, but I want you to understand what these myths are because if you don’t know the myths of investing, you will get sucked in by them at some point in the future because they are so attractive.

They sound right. They seem to make sense. But what they end up with most of the time is the destruction of the investor’s portfolio.

Advisory services offered through Paul Winkler, Inc an SEC registered investment advisor. The opinions voiced and information provided in this material are for general informational purposes only and not intended to provide specific advice or recommendations for any individual. To determine what investments are appropriate for you, please consult with a financial advisor. PWI does not provide tax or legal advice. Please consult your tax or legal advisor regarding your particular situation.