The Domino Effect of Japan’s Economic Crisis on the Global Economy

Japan’s economic crisis – Japan’s Economic Instability: A Ticking Time Bomb for Global Markets

The third-largest economy globally, Japan, stands on the precipice of a potential economic meltdown. With its staggering debt levels (274% of GDP) and a currency under significant pressure, the ramifications could echo across international markets. If Japan faces bankruptcy, the world will indeed tremble.

The Yen’s Troubling Decline

The yen, while not yet in free fall, has been weakening steadily since 2021. The decline accelerated last month, sparking concerns among the Japanese public, given Japan’s high dependence on imports for over 90% of its energy and 60% of its food. As the yen weakens, Japanese households feel the pinch with soaring electricity bills and an overall increase in living costs.

Benefits and Risks of a Weaker Yen

A depreciated currency can sometimes be advantageous, making a country’s exports more affordable. In the past, Japan deliberately weakened the yen to bolster its export-oriented economy, particularly in electronics and automobiles.

Yet, this advantage has its limits. If the yen continues to plummet, Japan may struggle to pay for crucial imports, leading to widespread poverty despite strong export performance. This is a hallmark of emerging market currency crises, yet Japan isn’t an emerging market. A crisis here would send shockwaves through the global economy, disrupting the Western financial system and straining global supply chains.

Global Consequences of Japan’s Economic Collapse

A sudden downturn in Japan would cause immediate distress among Western companies, disrupt global financial systems, and destabilize the geopolitical balance in Asia, potentially edging the region closer to conflict. Japan’s economic stability is crucial to maintaining the current global economic structure.

The Factors Behind the Yen’s Weakness

Understanding why the yen is losing value requires a look at supply and demand. Investors seek the yen to buy Japanese products or invest in Japanese assets like bonds. A slump in bond demand, however, has driven capital outflows, weakening the yen further. Investors seek better returns elsewhere due to Japan’s historically low interest rates.

Japan’s Low Interest Rate Policy – Japan’s economic crisis

Since the mid-1990s, Japan’s nominal interest rate has hovered near zero. While other economies have responded to inflation with aggressive rate hikes, Japan has only enacted a modest increase, partly due to decades of deflation.

Despite a recent inflation surge since 2021, the Bank of Japan hasn’t regarded 3% inflation as dangerous and has maintained low-interest rates to avoid exacerbating the chronic economic stagnation. However, this has widened the interest rate gap between Japan and other developed nations, driving investors away from Japanese assets.

Reluctance to Raise Interest Rates – Japan’s economic crisis

Raising interest rates seems like a logical response to stabilize the currency, but the Bank of Japan remains hesitant. Any significant hike could hurt the economy and deter further investments, potentially worsening the currency crisis. The central bank is also wary of triggering a recession, particularly as Japan struggles with a shrinking population and sluggish productivity growth.

The Shadow of Fiscal Dominance

Japan’s massive public debt complicates the picture further. Officially, it exceeds 261% of GDP, although much is held by the Bank of Japan. Still, servicing the debt requires interest payments on over 130% of GDP, posing a significant fiscal burden. Raising taxes to cover higher interest costs could further erode consumer demand, while austerity measures could reduce support for businesses and the elderly.

The Need for Drastic Measures

Should the yen’s value continue to slide, Japan may resort to direct intervention. With over a trillion dollars in foreign exchange reserves, the Bank of Japan could intervene to buy yen and support its value temporarily. However, this strategy cannot resolve the fundamental issues driving the currency depreciation.

Ultimately, Japan might consider imposing capital controls, restricting the flow of money out of the country. China used this tactic during its 2015 market crash, and Russia adopted similar measures following Western sanctions in 2014. But enforcing capital controls without preexisting mechanisms is challenging and may not fully plug the gaps.

Conclusion

Japan is at a crossroads. As the yen continues to weaken and the debt crisis looms, policymakers face tough choices that could dictate the nation’s economic future. Either Japan raises interest rates, triggering a recession and reducing public spending, or it imposes strict capital controls that restrict investment. Whatever path it chooses, Japan’s actions will have significant global implications, possibly unsettling international markets and altering the global economic landscape.

Japan’s economic crisis

Have Dynamic Spillovers and the Connectedness of Trade Policy Uncertainty Changed During the COVID-19 Pandemic and Sino–US Trade Frictions? Lets explore how trade policy uncertainty among the United States, China, Japan, and South Korea has been influenced by significant global events. I specifically focus on two events that shook the world: the COVID-19 pandemic and the escalating tensions between the U.S. and China. Supply chains and resources are indirect causations.

Key Aspects:

1. Trade Policy Uncertainty (TPU):
   • I examine how unpredictable changes in trade rules and tariffs (TPU) between these four major economies could affect each other.
2. Geopolitical Factors:
   • Global Geopolitical Risks: This includes political conflicts and tensions affecting the world.
   • North Korea-Specific Risks (GPRNK): The impact of North Korea’s actions on its neighboring regions.
   • Stock Market Volatility (EMVID): Unpredictability in stock markets due to infectious diseases like COVID-19.

Findings:

1. Spillovers and Their Impact:
   • I find that during the COVID-19 pandemic and worsening U.S.-China trade tensions, trade uncertainties in one country increasingly spilled over into others.
   • Specifically, the U.S. is a net receiver of these spillover effects from the trade uncertainties of all the other economies.
   • China, in particular, is impacted by COVID-19’s unpredictability.
2. Different Impacts on Each Economy:
   • Both China (TPUCN) and the U.S. (TPUUS) are vulnerable to COVID-19’s influence on trade policies, with China more severely impacted at higher levels of uncertainty.
   • Japan is affected less by global geopolitical risks and COVID-19 but is particularly vulnerable to tensions from North Korea.
   • South Korea remains relatively resilient and immune to both pandemic-induced volatility and North Korea-related geopolitical tensions.

Why This Matters:

The research provides crucial insights into how sensitive international trade relationships are to global events. Understanding these patterns will help policymakers and businesses better anticipate and adapt to future disruptions in trade policies and markets. By identifying which regions are most vulnerable and which are more resilient, my work aims to guide strategic decisions in global trade.

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