About the author: Desmond Lachman is a senior fellow at the American Enterprise Institute. He was a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging-market economic strategist at Salomon Smith Barney.
Prime Minister Sanae Takaichi’s landslide election in Japan Sunday will be consequential for global markets. Her Liberal Democratic Party secured an overwhelming mandate to carry out its agenda of tax cuts and fiscal stimulus, despite the government’s extraordinarily high public indebtedness. That risks inviting a crisis in the Japanese government-bond and foreign-exchange markets, which would reverberate through the world financial system.
That would come at an inconvenient time for the U.S. Under President Donald Trump, the U.S. is on an increasingly precarious fiscal path. It has more than $38 trillion in public debt, making it particularly vulnerable to any fallout from Japan’s policies.
A distinguishing characteristic of Trump’s approach to economic policy is recklessness. Through his One Big Beautiful Bill Act, he has exacerbated the compromised budget situation that he inherited from his predecessor. According to the International Monetary Fund, the OBBBA will keep the U.S. budget deficit at over 6% of gross domestic product for years and will raise the public debt-to-GDP ratio to an Italian and Greek-like 140% by 2030.
There are genuine questions as to how Trump’s government will meet its enormous borrowing needs. Not only will it need to finance a budget deficit of the order of $2 trillion a year, but it will also need to roll over around $9 trillion a year in maturing debt. A key economic vulnerability of the U.S. is that it is highly reliant on foreigners to finance its budget deficit. Indeed, foreigners own $8.5 trillion, or around 30%, of all outstanding Treasury bonds. This makes it all the more difficult to understand why Trump seems to be going out of his way to erode foreign confidence in the U.S. as a reliable debtor by undermining the Federal Reserve’s independence, by imposing punitive import tariffs on our allies, and by increasingly weaponizing economic policy.
It is against this background that Takaichi’s party won the recent snap election. It did so on the promise of fiscal and monetary policy stimulus to get the Japanese economy moving. In addition to the promise of increased public spending of around $135 billion, or 3% of Japan’s GDP, Takaichi also promised to eliminate the consumption tax on food. That tax cut will cost roughly $30 billion.
If Trump’s budget and monetary policies feel irresponsible, those of Takaichi seem to be all the more so. At 230% of GDP, Japan’s public debt is more than double that of the U.S. Meanwhile, with very poor demographics and a sclerotic economy, Japan is less likely to grow its way out of its debt problem than the U.S. It is already running a primary budget deficit; the last thing it needs is more debt. Yet Takaichi’s convincing mandate from the public and her new two-thirds majority in the lower house of parliament will allow her to ride roughshod over any resistance she might get from either the Ministry of Finance or the Bank of Japan.
There are signs that a Japanese bond and currency crisis could be under way in response to Takaichi’s agenda. Over the past year, Japanese bond yields have approximately doubled, with the 20-year yield at 3.15%—a rate not seen since the late 1990s. Meanwhile, the yen has slumped to its lowest level in the past three decades. Inflation is already running at a multidecade high of around 3%. A weaker yen will only make that worse.
Unfortunately, any Japanese bond and currency market crisis has the potential to spill over to the world financial market. A currency crisis in Japan might reverse the Japanese yen carry trade that has to date been a major source of financing to other countries. Japanese investors have sunk large sums of capital into the global financial system in search of higher returns. The prospect that this capital could return to Japan should concern U.S. investors.
Troubling signs are already emerging that a U.S. currency or bond market crisis might be brewing. Over the past year, Secretary Treasury Bessent has been forced to rely on increased short-term issuance to meet the government’s large borrowing needs. Yet, despite the reduction in long-term issuance and a 175-basis point cut in the Fed’s interest rate since September 2024, the 10-year Treasury note yield has risen past 4.2%, its highest since 2007. Meanwhile, the dollar has lost 10% in value and gold has surged by 70% over the past year.
Short of a true crisis, at a minimum investors will respond to Takaichi’s win by increasing scrutiny not just of Japan’s finances and debt, but also of that of other countries with unsustainable public finances. The U.S. will top their list.
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