This Sunday's Japanese election might appear distant to British observers amidst domestic political turbulence, but the stakes could not be higher for the global economy. The outcome may trigger a worldwide financial crisis reminiscent of the UK's "Liz Truss moment" in 2022, according to analysis by David Stritch.
A Fragile Political Landscape
The Liberal Democratic Party has maintained uninterrupted governance in Japan for nearly seventy years, yet current Prime Minister Sanae Takaichi operates with a precarious one-seat majority. This slender advantage has significantly hampered her ability to advance fiscal policies through her own party, compelling her to seek a stronger public mandate through this weekend's election.
Fiscal Expansionist Agenda
Prime Minister Takaichi champions a fiscal expansionist approach, advocating for increased state intervention in an economy that has battled persistent deflation and sluggish growth since the early 1990s. Her policy framework includes targeted tax cuts to boost consumer spending, strategic investments in artificial intelligence and other key industries, and enhanced military funding.
These proposals gained legislative traction when she successfully pushed through a ¥21.3 trillion (approximately £99 billion) budget in December last year. With an extraordinary 70 per cent approval rating—unprecedented for Japanese leaders in recent decades—and the LDP holding a 91 per cent probability of securing a majority according to Polymarket predictions, Takaichi appears politically formidable.
The Global Risk Factors
Japan carries the world's highest relative national debt burden, with a staggering debt-to-GDP ratio of 230 per cent, equivalent to 1.3 quadrillion yen (£6 trillion). The government plans to expand its fiscal deficit from -1.4 per cent to nearly -4 per cent by 2027, raising serious concerns about financial stability.
This situation bears alarming resemblance to the United Kingdom's experience in 2022, when Prime Minister Liz Truss attempted similar expansionary policies. The immediate consequence was the pound plummeting to its lowest historical level the following day, accompanied by gilt yields reaching their highest point since the 2008 financial crisis.
Potential Global Contagion
The international implications of Japan's election could prove far-reaching. Japan represents 5.4 per cent of global equity markets, issues $12.4 trillion in sovereign bonds worldwide, and serves as the foundation for carry trades estimated to provide over $1.3 trillion in global liquidity. A significant bond selloff could therefore trigger devastating consequences across international financial systems.
Ten-year Japanese bond yields have already climbed to their highest levels since 1997. Should Takaichi secure a stronger majority and pursue more aggressive fiscal loosening, adverse market reactions could precipitate serious economic turmoil.
Comparative Vulnerabilities
A Japan-centred market meltdown similar to the Truss episode could potentially reduce global foreign direct investment by up to $160 billion annually. The United Kingdom alone holds £102 billion in Japanese foreign direct investment that might face selloff pressures, while diminished global liquidity could spark crises in multiple markets simultaneously.
Nevertheless, Japan possesses certain structural advantages that Britain lacked during its crisis. Japanese government bonds have an average maturity of 9.9 years, compared to the UK's 14.4-year gilt portfolio average. This shorter maturity profile makes Japanese public finances more adaptable, whereas Britain's longer-dated debt proved particularly vulnerable to post-pandemic selloffs amid high inflation and spending.
Mitigating Factors
Japanese bonds benefit from deeper demand pools that help maintain lower yields. Additionally, the Bank of Japan holds approximately 50 per cent of national debt, compared to the Bank of England's 30 per cent ownership of British debt. This substantial central bank ownership provides some protection against dangerous market runs, though it does not eliminate risk entirely.
Prime Minister Takaichi is effectively gambling not only on electoral success but also on whether Japan's economy can withstand the shock therapy she proposes to revitalise growth. The world watches anxiously as Sunday's vote approaches, aware that the consequences may extend far beyond Japanese shores.
David Stritch serves as senior FX analyst at Caxton.
