The collapse of Japanese bonds and the currency has caused a global earthquake, "closing the door" on fiscal stimulus, precisely as the Japanese economy is collapsing due to the escalating conflict with China.
Japanese Prime Minister Sanae Takaichi, also known as "Abe 2.0," is preparing to unveil the country's largest fiscal stimulus plan since the pandemic era, in a move that enhances her reputation for expansionary fiscal policy, while simultaneously warning "financial actors" and potentially signaling the beginning of the end for Japan's capital markets and economy.
Takaichi's stimulus package, expected to be announced next Friday, will include spending of 17.7 trillion yen ($112 billion) through an extra budget, which is an increase compared to the 13.9 trillion yen presented by former Prime Minister Shigeru Ishiba last year. However, due to its larger size, the additional bond issuance will also be greater than last year, putting more pressure on the country's public finances.
The domino effect begins
Japan, however, is only the first of many countries that are about to unveil giant fiscal and monetary packages, as the global economy is slowing dramatically and politicians, under pressure, try to distribute stimulus checks to their angry voters, disregarding the long-term consequences and inflation (which is why the current collapse of bitcoin is particularly indicative).
The total value of the package, including some elements already scheduled, is expected to reach 21.3 trillion yen, according to a Bloomberg report, citing leaked documents. For comparison, an analogous fiscal stimulus plan in the US would be just over $1 trillion (and its arrival is only a matter of time).
With total private sector spending included, the package's overall impact is expected to skyrocket to 42.8 trillion yen, as the government seeks to address a range of challenges that include "fighting the effects of inflation," spending in strategic sectors, and strengthening foreign policy and defense.
Is Japan in a "Minsky Moment"?
Japan, therefore, is in a situation beyond the so-called "Minsky Moment," where it is obliged to issue huge fiscal spending simply to offset the inflationary impact of previous massive stimulus packages, each one larger than the last, until everything ultimately collapses.
Last week, local media reported that the extra budget would be around 14 trillion yen, indicating that there were last-minute negotiations to increase spending. The latest reports state that the Takaichi government plans additional cash allowances of 20,000 yen per child.
"As a traditional economist, I would say that the size of the package causes concerns that it might overheat the economy," said Kohei Okazaki, chief economist at Nomura Securities. "But according to Takaichi's close advisors, the economy must operate at high temperatures from the start. So, according to their intentions, numbers like these are not surprising at all."
No option
What is certain is that Japan truly may have no other option: earlier this week, data showed that the country's real GDP shrank by 1.8% on an annualized basis for the quarter ending in September, the largest decline in six quarters, and a decrease that has almost certainly put the economy into recession, giving the Takaichi government more reason to spend, while Japan's inflation remains very high.
Simultaneously, the impending increase in spending will add to the largest debt among developed economies. Japan'sgeneral government debt is expected to reach 230% of the country's GDP, according to the International Monetary Fund. With the Bank of Japan (BOJ) having raised interest rates three times since March 2024, the cost of debt servicing is expected to increase, putting further pressure on the country's finances and ensuring that the BOJ will soon return to financing every yen the government needs to keep the country operating.
Economists question whether Japan needs spending on such a massive scale, given the current state of the economy. While the country's GDP shrank in the third quarter, private consumption and corporate investment remained resilient compared to the previous quarter, indicating relatively stable domestic demand despite the blow from US tariffs.
The best part: this is only the beginning. "The current economic package is merely an early presentation of key measures," said Nomura's Okazaki. "The broader development strategy covering 17 targeted sectors is expected to follow, so this spending is not the end."
The "experiment"
But while more fiscal stimulus from Japan is on the way, the question now is whether this signals the end for Japan, a country that has always been the "experimental" model of the global economy, which was doomed by its catastrophic demographic developments, and now its bond markets and currency are collapsing daily.
This is the view of Deutsche Bank's strategic analyst, George Saravelos, who published a note today titled "a little worrying" (available to professional subscribers), in which he states that while most commentators focus on the recent volatility in US stock markets, something much more worrying is happening elsewhere: the Japanese yen and the Japanese bond market are collapsing simultaneously, with the momentum accelerating in recent days.
As Saravelos shows in the following diagram, the yen and the 30-year government bond have fallen by over 5% in recent weeks, which is particularly noteworthy given that global fixed-income markets are rising elsewhere.
This is a problem because Japan's government bond market is the largest in the world as a percentage of GDP. At the same time, Japan's households are among the wealthiest. It is this combination of high public debt and high private savings that has historically kept the domestic capital market stable. But it is the stability in inflation expectations that ultimately keeps the system afloat, according to Saravelos.
Confidence is lost
If confidence is lost in JGBs and the Bank of Japan's commitment to low inflation, the reasons for buying JGBsdisappear, and further capital flight from the country follows.
Saravelos is closely monitoring signs of broader capital flight in Japan's markets in the coming weeks—a characteristic sign would be the transfer of the current pricing to the stock market and bitcoin (at least initially), before all domestic reserves are converted into non-fiat currencies—and the continuing uncoupling of JGBs from global fixed-income market trends.
As Saravelos concludes, the BOJ governor and the government have so far pursued a policy of accepting the recent movements in the Japanese currency and government bond market. But they will find it difficult to remain so calm if the current pricing continues.
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