With respect to Japan, a funding problem could clearly result from the changing demographics as previous buyers of JGBs become smaller buyers or net sellers. Japan has obviously benefited from ready access to a massive savings base that was shell-shocked enough from the post-1990 collapse to willingly lend to the government at near-zero rates. And persistent deflation + capital gains obviously made the real returns reasonably acceptable to domestic savers.

But as these former buyers of JGBs retire, they will increasingly buy less bonds and/or use the ones they own to fund their lifestyle. And in fact data shows that the savings rate of Japanese consumers is in steady decline. Not only does the demographic dilemma of Japan pose a demand problem for bonds, it will also serve to increase the explicit outlays of the government in the future.

A tipping point should occur whenever the Japanese have to rely more upon the international market to fund their fiscal deficit on the margin–probably at rates 3x what they currently pay–which is a real issue when public debt outstanding is >200% of GDP. Moreover, capital losses by domestic investors in such a scenario could quickly catalyze the once reliable domestic base to become net sellers.

With respect to peripheral Europe, I agree that the issue of real GDP growth vs. funding rate is a big one. In fact I believe that this is the central issue with Greece, Spain, and others. Specifically, without a flexible currency rate, the only way to become competitive from both a fiscal and current account deficit standpoint is to have an internal devaluation.

If you cannot weaken your exchange rate, then the only solution is to make your wages more competitive, which necessarily entails cutting entitlements of an ageing population. Internal devaluations are almost deflationary by definition. Lower wages, less consumer spending, less government spending. All of these processes will diminish real GDP growth significantly in the short term, but need to be done in order to improve competitiveness and real GDP growth in the longer term–otherwise they will not be able to grow out of their debt in the future.

While Greece doesn’t have a funding crisis right now per se, if the market does not believe that it will credibly lower its fiscal deficit, then the cost of funding rises and creates a self-perpetuating cycle. Thus high-debt nations like Greece have to take deflationary measures that will actually cause debt-to-GDP ratios to rise in the short run in an effort to avoid higher interest costs that will further worsen already unstable finances. Thus its a bit of a high-wire act, balancing short-term funding costs and short-term growth versus longer-term growth. Even if Greece makes hard choices to restore competitiveness, will longer-term growth take shape before higher rates become insurmountable and/or before the debt-to-GDP ratio becomes too high for the market to bear?

This is the essence of what the peripheral EU contagion effect is all about. If nations like Spain and Portugal do not begin to take action before debt levels are too high, then they are in a situation like Greece in which the short-term effects of austerity diminish short-run GDP to such a point that the ultimate benefits of austerity come too late. Even if aggregate public debt levels in a country are acceptable now, given the short-run effects of austerity coupled with intermediate-term demographic issues and lower growth profiles, will long-term real GDP growth actually be high enough for these countries to lower real debt, especially given the possibility of higher funding costs?

Typically tipping points occur where parties begin to borrow in order to pay interest — though that is just a rough guide. If the tipping point were clear, it would be well known, and then defaults would be rarer.