Japan, with its huge debt and the yen’s slide, is bidding to be the star of the biggest economic and financial crisis in human history.
The political career of Japanese Prime Minister Sanae Takaichi is sinking almost as fast as the yen these days — and the two developments are closely linked. The yen has slipped to 164 per dollar, its weakest since 1986, driven in part by the same economic pressures that are hurting Takaichi’s approval ratings.
A new Mainichi Shimbun poll shows that support for her cabinet has fallen 10 points to 41% in mid-July, falling below 50% for the first time.
However, the yen’s decline is worrisome for three reasons that global markets have largely overlooked.
1. It reveals how much the ruling Liberal Democratic Party (LDP) lacks new strategies to keep up with a faster-growing China.
A weak yen has been the LDP’s main growth driver for 25 years.
And Takaichi’s declining popularity is compounding the problem, as she invests political capital in an unpopular Imperial Household Law — which changes the rules governing both marriage and adoption within Japan’s royal family — rather than focusing on economic concerns.
2. Τhere has been an odd silence from Washington as the yen hits new modern lows.
Given the scale of the current trade war — Trump just imposed new tariffs of 10%-12.5% on most major trading partners — one would expect sharp criticism of Japan for manipulating its exchange rate.
By contrast, the Treasury under Scott Bessent has said almost nothing about the yen.
3. Τhe yen no longer seems to attract the safe-haven demand it once did amid global turmoil.
This may reflect the broader strength of the dollar despite the yen’s weakness — gold is not rising either — but it may also confirm a long-held fear in Tokyo: that global capital is simply bypassing Japan.
China’s Shadow and Geopolitical Pressures
For now, Tokyo’s priority is to stimulate a slowing economy.
Japan is forecast to grow by just 0.5% in 2026 — well below the inflation path the Bank of Japan (BoJ) has been tracking for most of the year.
Since the BoJ raised interest rates to a 31-year high of 1% in mid-June, war with Iran has emerged as a serious risk, threatening to push Japan (which depends on oil imports) into stagflation — a scenario that could prove even harder to manage than the deflation of previous decades.
Despite public statements and periodic intervention, the reality is that Takaichi’s government still wants a weaker yen — not necessarily a plunge to 170/dollar, but a retreat to the $140-150 range would increase pressure on Japan’s $4.2 trillion economy.
China’s Shadow Hangs Heavy
Beijing has spent the past two years exporting excess industrial output globally, intensifying price competition (in economic terms, deflation) that President Xi Jinping’s government has struggled to tame.
A stronger yen would weaken Japan’s ability to compete on price in export trade — which is also being boosted by the explosion in artificial intelligence (AI).
China’s SoftBank Group is now worth more than Toyota, while companies like Kioxia and Taiyo Yuden are also steadily gaining ground.
Regardless of what Takaichi says publicly, she worries that a stronger yen could slow that momentum, along with the broader rally that pushed the Nikkei 225 index above 72,000 last month (it has since fallen to around 64,000, after starting the year near 50,000).
The Politics of Intervention and the Ghost of Takahashi
Still, officials have been vocal about their anger at the currency’s slide without doing much to address its root cause.
Finance Minister Satsuki Katayama continues to warn that she is ready for “decisive action” if the yen weakens too much, and Tokyo did intervene in the foreign exchange market in April and May when the rate exceeded 160.
Controlling the bond yield curve
As Trust Economics notes, without a credible plan to rein in Japan’s skyrocketing debt, these moves are largely symbolic: if the fiscal situation becomes the dominant policy concern, currency management could increasingly give way to yield curve management in the bond market, and how the government handles that balance will shape the yen’s future course.
That’s why past interventions haven’t worked this time around — traders have watched this pattern repeat itself too often to expect any different.
Tokyo still has leverage, even if using it would be risky.
One path involves persuading U.S. Treasury Secretary Scott Bessent to engage in sustained, coordinated intervention.
The most radical option would be to revive the deflationary strategy of Korekiyo Takahashi — the finance minister often called “Japan’s Keynes” — who combined aggressive monetary easing with fiscal expansion, including direct purchases of government debt by the central bank, to pull Japan out of the Great Depression in the 1930s.
Former Federal Reserve Chairman Ben Bernanke has praised the approach, and many economists consider it a precursor to Modern Monetary Theory (MMT). Takaichi’s mentor, Shinzo Abe, had followed Takahashi’s lead during his 2012-2020 premiership, pushing the BoJ toward massive quantitative easing (QE) from 2013.
By 2018, the BoJ’s balance sheet had grown larger than Japan’s entire economy—the largest among the G7.
But even Abe stopped short of fully monetizing Takahashi-style debt. The Risks of Monetary Policy and Warnings
Implementing such a policy now, in 2026, could easily backfire. Twenty-seven years of near-zero interest rates and a weak yen have never revived Japan’s growth engine—if anything, they have dulled the urgency of structural reform.
The loss of competitive advantage
While Japan has been watching developments passively, China has reshaped global manufacturing in much the same way Japan itself did in the 1980s, and Japanese industry still has no answer to competitors like electric vehicle giant BYD or the success of AI model DeepSeek.
All of this leaves the BOJ facing a precarious period as it tries to continue its interest rate normalization.
Thanos Chonthrogiannis, Chief Economist at Trust Economics, points out that the inflation outlook now depends largely on developments in the Middle East and their impact on commodity prices.
If nominal wages fail to keep pace, real incomes and consumer spending could fall significantly, with any further depreciation of the yen simply adding to imported inflation.
Takaichi’s team appears to be learning the wrong lessons from two eras of quantitative easing — the 2000s version and Takahashi’s original model in the 1930s. Modern quantitative easing (QE) dates back to 2001, when then-BOJ Governor Masaru Hayami used it to combat deflation and contain a subprime mortgage crisis inherited from the 1990s.
The approach later spread to the US, Britain, the eurozone and Australia after the 2008 global financial crisis.
However, while these central banks eventually eased their policies, Japan was never fully weaned from monetary support. Despite years of tightening, the BOJ still holds more than half of all Japanese government bonds issued and remains the country’s largest shareholder.
Current governor Kazuo Ueda has made further progress toward moving away from zero interest rates this year than his predecessor Toshihiko Fukui did between 2003 and 2008, when rates finally returned to zero and quantitative easing was reinstated by 2009.
Ueda’s team is expected to leave rates unchanged on July 31. In the long term, however, he is determined not to repeat that cycle.
Ueda’s biggest obstacle may be the LDP itself, which has relied essentially on an economic playbook — fiscal stimulus — for seven decades of almost uninterrupted rule since 1955.
Even senior party officials now privately admit that a quarter-century of zero interest rates has failed, with the yen’s prolonged decline now the price being paid.
Takaichi, however, shows little sign of departing from that tradition. Her economic approach so far seems almost indistinguishable from Abe’s — and, by extension, from the Takahashi model that inspired him.
A “Liz Truss”-style political meltdown
Tensions briefly peaked this month when Takaichi’s government hinted that the Government Pension Investment Fund — the world’s largest pension fund — might repatriate large amounts of overseas capital, a move that would have boosted the yen.
Tokyo has since backed down, fueling concerns that officials will instead rely on the BOJ to restart bond purchases — a move that could backfire if the central bank is seen as complicit in propping up the bond market.
That’s the crux of the argument. Ueda entered 2026 looking like the governor who would finally pull Japan out of deflation, having raised the key interest rate to a 30-year high of 0.75% in December and to 1% last month.
But the Iran war, which broke out on February 28, has upended those plans — sending oil prices soaring and putting pressure on tariffs just as the government is reacting to further monetary tightening.
Takaichi has openly called additional rate hikes “stupid,” and in March lawmakers directly questioned her about whether she was pressuring the BOJ.
While formally independent, the BOJ faces far greater political pressure than its peers like the Fed or the European Central Bank — making Takaichi’s resistance to fighting inflation particularly striking at a time when price shocks from Iran threaten to destabilize the region’s economies.
One untenable factor here is that as China’s growth slows, President Xi may well turn to a weaker yuan to boost exports, using political cover from Tokyo’s own currency-depreciation efforts. That would certainly get Bessent’s attention in Washington.
Another factor is that bond markets are getting nervous. Takaichi is seeking to end excessive fiscal austerity.
Long-term government bond yields have risen sharply everywhere. Markets are losing patience with governments that have been chronically unable or unwilling to reduce public debt.
This is no time to pretend that Japan’s massive debt is not a problem.
Hence the fears of a “Liz Truss”-style political meltdown in Tokyo. In late 2022, then-British Prime Minister Truss destabilized the debt market by attempting to sneak a funded tax cut behind the backs of bond traders, leading to her resignation as prime minister.
The extreme market turmoil remains a cautionary tale for Takaichi as her party considers tax cuts.
With a debt-to-GDP ratio at 260% and a rapidly aging population, Takaichi must tread carefully. This is not the first time global investors have encountered “things are different this time” rumors surrounding Asia’s second-largest economy.
This means anyone betting on a yen rally could regret it by the end of the year – potentially opening the floodgates for financial Armageddon.
