TOKYO \u2014 What if a political earthquake upends Japan in unpredictable ways and yet very little changes anyway?<\/p>\n
It would be better for Asia\u2019s second-biggest economy if we could dismiss this question out of hand. If we could say definitively that the Liberal Democratic Party\u2019s Sanae Takaichi<\/a> or the Democratic Party for the People\u2019s Yuichiro Tamaki would plot a markedly different path. Sadly, we can\u2019t.<\/p>\n Takaichi, 64, is working to keep in power the same party that\u2019s ruled Japan with only two brief interruptions since 1955. Though she would be Japan\u2019s first female leader, Takaichi is all about resurrecting the mediocre policies of her mentor Shinzo Abe. If he couldn\u2019t make \u201cAbenomics\u201d work in nearly eight years as prime minister from 2012 to 2020, why would Takaichi succeed?<\/p>\n Tamaki<\/a>, meanwhile, also favors giving the Abe era\u2019s fiscal loosening and ultralow interest rates another go. Sure, the 56-year-old talks a good game of boosting workers\u2019 take-home pay through tax cuts.<\/p>\n To do that, though, Tamaki must prove he can do two things. One, stay in office longer than the 12 months most Japanese leaders get in the top job. Two, keep Japan\u2019s bond market from tanking as he adds to the national debt.<\/p>\n The same could be said of Takaichi, who already has markets betting on a weaker yen<\/a> and an end to the Bank of Japan\u2019s tightening cycle. Though Abenomics was weak on increasing competitiveness, innovation or Japan\u2019s stable of game-changing startups, it sure did send the yen tumbling and Nikkei 224 Average stocks skyward.<\/p>\n But given the LDP\u2019s weak election performances of late, its lack of an outright majority <\/a>and the dearth of fresh ideas coming from Takaichi, it\u2019s hard to see her premiership lasting longer than the roughly 365 days outgoing Prime Minister Shigeru Ishiba got.<\/p>\n Tamaki, meanwhile, has a different challenge on his hands. A paradox of Japanese politics is that there\u2019s often limited daylight between dueling parties\u2019 economic views. Some details differ, but little of what Tamaki is offering will seem new, creative or compelling to most LDP voters.<\/p>\n Odds are, Tamaki would be less hawkish on the world stage than staunchly conservative China<\/a> critic Takaichi. But foreign affairs isn\u2019t the animating issue for most Japanese in 2025, even amid US President Donald Trump\u2019s trade war. It\u2019s that inflation is racing ahead of wage gains.<\/p>\n The Trump question surely looms large. But then from the Abe to Ishiba governments \u2014 and the two other premiers in between them \u2014 Tokyo has yet to push back against US policies. Trump didn\u2019t even seem to know Ishiba\u2019s name, calling him \u201cMr. Japan.\u201d<\/p>\n Would self-described Margaret Thatcher super-fan Takaichi, Japan\u2019s \u201cIron Lady,\u201d take on Trump? Or would she pull an Abe and just kiss the ring? True, Takaichi last month hinted at a \u201crenegotiation<\/a>\u201d of the US-Japan tariff deal. Particularly, the US$550 billion \u201csigning bonus\u201d that Trump is demanding. Would she dare? Only time will tell.<\/p>\n Yet the LDP\u2019s relationship with Trump has tended more toward the abusive kind rather than a meeting of equals. The only real way for Japan\u2019s next leader to avoid the political revolving floor that spits out a new one each year is to put some bold reforms on the scoreboard.<\/p>\n Takaichi seems more inclined to double down on a weak yen and increased fiscal stimulus. That\u2019s hardly what Japan needs at a moment when China\u2019s global market share is increasing.<\/p>\n For 10 years now, Xi Jinping has been broadening his \u201cMade in China 2025\u201d scheme. It aims to increase China\u2019s global footprint <\/a>in artificial intelligence, biotechnology, electric vehicles, renewable energy, semiconductors and other technologies of the future. It means that even as China grapples with deflation, a giant property crisis and weak demand, it\u2019s still multitasking enough to raise its tech.<\/p>\n In Japan, leaders are too busy struggling to keep their jobs to do their job. Japan is lagging in the tech \u201cunicorn\u201d and AI races, while its labor productivity is still among the lowest in the Organization for Economic Cooperation and Development.<\/p>\n China\u2019s massive public investments in industry mean that, even as Tokyo dithers, China is commodifying many sectors in which Japan long thrived: cars, ships, electronics, batteries, robots, semiconductors, petrochemicals, weapons, you name it. As China speeds up Asia\u2019s economic clock, Tokyo politics is moving at its own plodding pace.\u00a0<\/p>\n All this leaves Japanese markets in limbo. Though Nikkei 225 stocks recently hit all-time highs, the bond market is deeply troubled by Tokyo\u2019s fiscal trajectory<\/a>. The price for either Takaichi or Tamaki to win power is almost certain to be budget-busting tax cuts. With a debt-to-gross domestic product ratio of around 260%<\/a> and Japan\u2019s population shrinking at a record pace<\/a>, bond shortsellers have government bonds in their sights.<\/p>\n Inflation remains well above the BOJ\u2019s 2% target, and continues to outpace increases in incomes.<\/p>\n \u201cJapanese wage growth is stuttering,\u201d says Stefan Angrick,\u00a0Japan economist at Moody\u2019s Analytics, pointing out that average monthly cash earnings rose just 1.9% year over year in August, well below consensus forecasts. \u201cWith wage growth stumbling and inflation proving sticky, the Bank of Japan will find it hard to justify a rate hike in the near term.<\/p>\n The trouble is, \u201cthis wage malaise isn\u2019t new,\u201d Angrick says. \u201cPay growth has been underwhelming for months.\u201d<\/p>\n The fact that pay growth is slowing, Angrick adds, \u201cis hardly surprising, given the shocks hitting the economy this year.\u201d US tariffs and threats or an escalating trade war are damaging manufacturing, creating uncertainty and delaying investment in capital and workers. <\/p>\n At the time, he says, \u201cit\u2019s striking that underlying wage growth hasn\u2019t proven more resilient, even after three years of \u2018shunto\u2019 wage negotiations producing multi-decade record results.\u201d<\/p>\n Against this backdrop, Ishiba\u2019s exit comes as little surprise. He struggled to articulate a compelling vision for the economy<\/a> and failed to resonate with the public, who were struggling with cost-of-living challenges. Ishiba, a fiscal conservative, repeatedly dismissed policy options, whether from the opposition or his own party, as too populist.<\/p>\n That seems sure to change in the days and weeks ahead. The Japanese government bond (JGB) market has had a chaotic 2025. Starting in mid-May, turmoil related to Trump\u2019s tariffs quickly ended up on Japanese shores, with government\u00a0bond yields<\/a>\u00a0spiking in headline-grabbing ways.<\/p>\n The volatility culminated with a failed 20-year bond auction. In May, the typically routine sale of US$6.9 billion issues maturing in 2045 drew the least interest since\u00a02012. The \u201ctail,\u201d gap between the average and lowest-accepted prices, was the worst since 1987. Suddenly, #JGBCrash was trending in Asian cyberspace.<\/p>\n Tokyo ended up sending shockwaves<\/a>\u00a0back toward the US. In late May, US Treasury Secretary Scott Bessent expressed concern that turmoil in Japan was pushing US yields higher, the way Treasury market turmoil had unnerved Japan earlier that month.<\/p>\n That same month, Ishiba hardly helped things by saying that Japan\u2019s deteriorating finances are \u201cworse than\u00a0Greece<\/a>.\u201d It put Japan in\u00a0global headlines<\/a>\u00a0for all the wrong reasons at the worst possible moment.<\/p>\n Ishiba was making a more nuanced point than that. His argument was aimed at lawmakers planning to cut taxes. Ishiba framed it as a luxury Japan couldn\u2019t afford, given its lack of fiscal space. Yet his gaffe went viral in market circles \u2014 in the worst possible ways. No doubt it drew the attention of credit-rating companies everywhere.<\/p>\n The risk of surging bond yields may limit the next government\u2019s latitude to loosen fiscal policy. If Takaichi gets the top job, \u201cmarket participants will then likely shift their focus to potential economic stimulus measures\u2014 including the possible removal of the temporary gasoline tax \u2014 and the passage of a supplementary budget,\u201d notes Sho Nakazawa, analyst at Morgan Stanley MUFG.<\/p>\n Yet the global headwinds zooming Japan\u2019s way also complicate the BOJ\u2019s ability to continue hiking rates<\/a>. Of course, Japan should be hiking rates and leaving 24 years of quantitative easing in the rearview mirror.<\/p>\n Zero rates have done far more harm than good. Ultra-loose monetary policy removed all urgency to create more economic energy from the ground up, rekindle innovation and attract more foreign talent to augment an aging, shrinking workforce. It took the onus off CEOs to invent, restructure and take risks.<\/p>\n Now, the BOJ is struggling to find an exit from QE. In January, Governor Kazuo Ueda managed to hike rates to a 17-year high of\u00a00.5.%. Since then, the BOJ has held rates steady amid concerns about\u00a0US tariffs<\/a>\u00a0slamming growth. At present, even Japan\u2019s government thinks the economy will grow just 0.7%, at best, in 2025.<\/p>\n The BOJ has been tapering its bond purchases. And now, stocks, too, as the BOJ throttles back on its titanically large holdings of exchange-traded funds.<\/p>\n