Is Japan about to have a Liz Truss moment?
Japan’s upcoming election could trigger a global economic crisis similar to the UK’s “Liz Truss moment” due to the country’s high debt, plans for fiscal expansion by Prime Minister Sanae Takaichi, and the potential for a bond selloff, says David Stritch
The Japanese election this Sunday may seem remote to British observers – especially with so much political drama at home. That is, until you consider that what’s at stake may just be the global economy.
The Liberal Democratic Party has governed Japan for a nearly 70 unbroken years. Despite this, current LDP Prime Minister Sanae Takaichi has just a one-seat majority, which has left her struggling to get fiscal plans past her own party.
So, she’s now turned to the nation to try and win the mandate she needs.
Takaichi is a fiscal expansionist, believing in the state taking a more active role in the economy, which has been dogged since the early 90’s by the twin spectres of deflation and sluggish growth. She supports targeted tax cuts to stimulate consumption, strategic investment in key industries such as AI and a stronger military. These ideas were made policy when she pushed a ¥21.3 trillion (£99bn) budget through parliament in December of last year.
Takaichi is sitting on a 70 per cent approval rating, unheard of for Japanese PMs in recent decades, and the LDP has a 91 per cent chance of achieving a majority on Sunday, according to Polymarket.
But how does this affect us?
Japan is the most relatively indebted nation in the world, with a debt-to-GDP ratio of 230 per cent, or 1.3 Quadrillion Yen (£6trln). With a -1.4 per cent fiscal deficit they intend to expand to nearly -4 per cent by 2027. Compare this to a similar situation in the UK in 2022, when Prime Minister Liz Truss attempted to implement similar policies, only to see the Pound fall to its lowest ever level the following day.
Powder keg
This is why the consequences of Japan’s election could extend well beyond the shores of Japan.
Sunday’s election could prove a powder keg that the entire world is underestimating. Truss and Kwarteng’s fiscal adventurism ended with the Pound at rock bottom and Gilt yields at their highest since 2008. The rest of the world was relatively insulated, but with Japan accounting for 5.4 per cent of the world’s equity market, $12.4 trillion of the world’s sovereign bond issuance and being the home of the carry trade that is estimated to provide over $1.3 trillion in global liquidity, a bond selloff could have drastic consequences across the global economy.
Ten-year Japanese bond yields have already climbed up to their highest rate since 1997, and should Takaichi be returned with a stronger majority and a renewed desire to loosen the purse strings, the ramifications of an adverse market reaction could be very serious.
A Truss-style market meltdown centred around Japan would likely triggering crises in other markets
Practically, a Truss-style market meltdown centred around Japan would see global foreign direct investment fall potentially by as much as $160bln annually, a potential sell-off of the £102 billion worth of Japanese FDI within the UK and a serious reduction in global liquidity, likely triggering crises in other markets.
Source: Bloomberg
Japan does have some advantages that the UK did not however, for example, an issue that has hamstrung the UK to a great degree over the past decade has been the considerably longer maturity of UK bonds compared to the rest of the world. The average maturity of a UK Gilt portfolio is 14.4 years, making UK public finances much more rigid compared to the more nimble 9.9 years maturity of Japanese government bonds. This is crucial as high inflation, coupled with high spending has crippled demand for longer-dated debt since the pandemic and the UK was especially exposed to sell-offs of long-dated Gilts.
So Japanese government bonds are more sheltered, given they have a considerably deeper pool of demand that acts to keep yields low. Furthermore, the Bank of Japan owns a much greater amount of Japanese debt (50%) than the Bank of England owns British debt (30%). This limits the potential of very dangerous runs, although it doesn’t eliminate the possibility entirely.
Nevertheless, Takaichi is rolling the dice, not just on a successful election, but also on whether the Japanese economy can survive the shock therapy she’d like to administer to bring it back to life.
David Stritch is senior FX analyst at Caxton