This past week's US-Japan collaboration connected shoring up the Japanese yen leads to the question—what's wrong? Why is the Japanese yen getting truthful weak, and is location something incorrect pinch the Japanese economy?
Japan has 1 of the largest debt-to-GDP ratios and is peculiarly disadvantaged owed to the Iran War driving up lipid and power prices. At the aforesaid time, its exertion manufacture has a batch to offer, but not without tradeoffs. Here, we're exploring immoderate of those tradeoffs: interest rates versus debt, investing successful the early while managing concerns astir overspending, and managing nationalist ambition alongside user value concerns.
Japan's economical challenges
A full-blown overview of Japan's system is beyond the scope of our writing. Instead, we'll database immoderate of the larger challenges and initiatives tied to Japan's economic improvement earlier exploring the tradeoffs.
Japan has 1 of the largest debt-to-GDP burdens successful the world, astatine complete 200%. Prior to last week's US-Japan rate intervention, its rate mislaid complete 10% of its worth this year. Prime Minister Sanae Takaichi is moving connected a growth-oriented agenda, but facing challenges arsenic inflation hovers astatine 1.7% and peaked astatine 3.7% successful May 2025[1]. Worse still, a 1.7% ostentation complaint hides the challenges faced by Japanese consumers: nutrient prices person accrued 3.2%, pinch food and seafood increasing astatine 6.9% this past year[2]. While substance and power prices person been flat, this is only because they are actively subsidized by the government.
Against the ostentation backdrop, Prime Minister Takaichi's support standing dropped from 69% in June to 57% successful July. Specific criticisms target her attempts astatine fighting cost-of-living value rises, pinch 71% disapproving of her administration's strategy[3]. The challenges are partially retired of Japan's control: global power prices person skyrocketed, starring to important increases for power imports.
This is the discourse that Japan's authorities finds itself in, and galore of its options travel with achy pros and cons.
Tradeoff: raise liking rates to conflict inflation, and hurt consumers
Japan's charismatic liking complaint is group to 1%, which was reaffirmed successful the July 30/31 Bank of Japan meeting[4].
Higher liking rates should thief trim inflation[5] and promote much saving. More importantly, higher liking rates trim the use of the carry trade, wherever investors get successful Japanese yen (paying the comparatively debased section liking rate), waste the yen by converting it to different currencies, and past buying world assets. This enables investors to use from debased Japanese liking rates while arbitraging higher rates and returns elsewhere. Since specified investors waste yen, they thrust the value of the yen down, which increases costs of different imports, for illustration power and food.
While expanding liking rates is seen arsenic the sensible cardinal slope policy, location are issues with this. First, higher liking rates besides summation the costs of borrowing for consumers—mortgages, car loans, and different products go much expensive, potentially driving further dissatisfication pinch Takaichi's policies.
Secondly, higher liking rates lead to little valuations for existing bonds, arsenic yields request to lucifer what enslaved buyers get successful the markets today. This tin lead to losses connected bonds already purchased. Japan's 4 largest life insurers person mislaid astir $96 cardinal successful Q2 2026 based on existent rises successful liking rates[6]. While consumers can beryllium forgiven for not shedding a tear for trillion-yen corporations, losses driven by liking rates were why Silicon Valley Bank collapsed successful 2023[7]. Raising rates slow could beryllium the lesser of 2 evils.
Tradeoff: summation user support, and increase debt
The Takaichi management is driving policies that thief trim day-to-day costs for consumers. It is aiming to trim taxation connected nutrient from 8% to 1% arsenic of April 2027[8], which will costs astir $32 billion[9]. To guarantee precocious lipid prices don't construe to significant user value increases, the authorities has been releasing lipid from its reserves to headdress gas prices astatine ¥170/liter, and further earmarked $19 cardinal to subsidize substance costs[10].
All of the supra drives increases successful debt. Japan's existent twelvemonth authorities fund is astatine $780 billion, and $83 cardinal (10.7%) of the fund goes to paying liking connected its existent debt[11]. These costs are expected to emergence astir 50% over the coming years[12]. When accounting for debt servicing and indebtedness rollovers, Japan's authorities is spending 25.6% of its fund to service and negociate its debts[11].
Paying for taxation reductions, subsidies, and different consumer-friendly policies is costly and risks making the indebtedness worse. This is why immoderate economists and columnists[13] interest that Japan risks a “Liz Truss” moment wherever enslaved prices vessel and yields soar owed to its inability to negociate its debts.
Japan is heavy reliant connected power imports, which thrust the value of the Japanese yen down—this is 1 of the reasons the US and Japan intervened successful the rate successful precocious July as discussed successful our different post. More imports thrust yen values down, which summation prices for consumers and businesses buying those imported equipment and services. The antidote? Export much aliases go more reliant connected soul production.
How tin Japanese manufacture activity to offset the equilibrium of waste and acquisition challenges the state is facing?
Figure 1: Japan's full power supply, 2024. [original]
Let's commencement pinch energy. The US-Iran war, and resulting assets value spikes, person been peculiarly achy for Japan. Figure 1 shows Japan's full power supply[14]. 83.5% of Japan's power proviso is from oil, coal, aliases earthy gas, astir of which is imported and typically priced successful US dollars aliases different currencies. This is besides slowing down Japan's growth rate[15].
Nuclear powerfulness was mostly seen unfavorably aft the Fukushima disaster of 2011. Surprisingly, Japan besides has very debased star powerfulness uptake. The authorities is now arguing for atomic power improvement to make arsenic overmuch arsenic 20% of Japanese powerfulness by 2040[16].
It's astonishing the number isn't higher, but either way, it will beryllium costly to get there—and will apt require authorities subsidies, planning, and different support.
The aforesaid applies to defense, pinch the Japanese authorities promoting its military buildup—where walk is approaching 2% of GDP—as a measurement to alteration further economic maturation and exports. Japan now produces Patriot missiles[17] connected behalf of the US, and has loosened defense export policies[18] to alteration exports of arms and military equipment. This is strategically important for countering China, and besides helps pinch the equilibrium of waste and acquisition challenges, driving exports to thief the Japanese yen appreciate.
This imagination goes further and gets much ambitious. In June 2026, the Takaichi management proposed a $2.3 trillion public-private finance strategy planned until 2040[19]. The plan[20] covers 17 strategical sectors, from defense and power to quantum technologies, AI and semiconductors, food, and more. The thought is to put successful various early technologies to make Japan little reliant connected imports, turn its exports, and mostly outgrow its indebtedness obligations.
It's an breathtaking plan, and for illustration power and defense, the awesome interest is astir really this will be financed—and whether enslaved markets will beryllium supportive. This caller trillion-yen strategy is not portion of the existent budget, truthful will require more backing and more debt.
This is simply a peculiar situation if the Takaichi administration's fame wanes further or loses powerfulness altogether; successful our opinion, 1 of the worst blunders is to commencement implementing specified a ~14-year maturation strategy only to suffer governmental will and economical wherewithal 2 aliases 3 years into the implementation.
US and Japan supporting the yen, successful perspective
Japan is astatine a crossroads. Inflation, debt, power prices, defense spending, and semipermanent ambition versus short-term economical constraints put it successful a difficult bind. The support for the Japanese yen covered successful our different station (How Japan and the US Supported the Yen Last Week) was not meant to beryllium a semipermanent solution, but a measurement to bargain Japan immoderate time.
Prime Minister Takaichi's support ratings are down importantly from June. There are galore options for Japan successful the coming weeks to statesman implementing its vision. The Iran War is driving power prices up—and this problem mightiness beryllium addressed pinch negotiations betwixt Iran, Oman, the US, aliases others. The Bank of Japan's adjacent gathering connected liking rates is successful September. The timing was correct for an intervention, buying Japan clip to proceed executing connected its existent plan.
This will not beryllium an easy play for the country—and doubly truthful for its government—but promises to group Japan up for an breathtaking semipermanent maturation trajectory. The risks, of course, are if immoderate of this slows down—the Takaichi management losing celebrated support, a tally connected bonds, aliases longer-term continuations of the Iran and Ukraine wars each consequence throwing Japan disconnected its course.
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