When Japan's new Prime Minister, Sanae Takaichi, took office, she pledged that her priority would be improving the Japanese economy. However, her previous statements on Taiwan, as well as possible new handling mistakes, could have a significant cost not only for Japan, but also for the Asia-Pacific region, and even globally.
The analyst Dr. Dan Steinbock, in his article in Modern Diplomacy, notes that on October 21, Takaichi, president of the ruling Liberal Democratic Party (LDP), was elected as the country's 104th prime minister, the first woman to hold the highest office.
Just a month later, in her first speech to Parliament, Takaichi, 64, stated that Japan might become militarily involved in a conflict between China and Taiwan. These positions caused a diplomatic crisis, with Japan-China relations collapsing to their lowest point in recent years.
For Steinbock, this crisis did not happen suddenly. Takaichi needs a geopolitical conflict to shift attention away from Japan's deep, chronic, and structural economic problems.
Political shift to the hard right
Instead of maintaining cooperation with the centrist Komeito party, Takaichi formed a coalition government with the center-right Nippon Ishin party. After 26 years, the LDP's coalition with Komeito ended, leading the LDP to a clear strategic and ideological shift to the right.
Initially, the popularity of the Takaichi government was at very high levels of acceptance, from 65% to 85%, registering one of the best starts for a Japanese government in the last two decades, especially among young and middle-aged voters. Citizens overwhelmingly prioritize issues of inflation (84%), economic aid (64%), social benefits and security (53%), and national security (47%). Everyday issues far outweigh military matters.
Only 17% of Japanese approved the appointment of Hagiuda Koichi to the position of executive deputy secretary of the government. In the past, he had been at the center of a "slush fund" scandal, and after the assassination of Abe, the LDP's ties with the controversial Unification Church were re-examined. Hagiuda maintained close relations with the organization, which provoked negative reactions.
At the same time, both Takaichi and Hagiuda participate in the nationalist and far-right non-governmental organization Nippon Kaigi. The organization promotes the revision of Japanese post-war history, the re-deification of the role of the emperor, the degradation of gender equality, official visits to the Yasukuni Shrine, and denies historical crimes such as the forced prostitution of "comfort women" during World War II.
The Nippon Kaigi has a strong presence in the Japanese parliament, and six Japanese prime ministers have been members. Takaichi's ultimate goal is the complete normalization of the Nippon Kaigi and the deepening of military cooperation with the US.
Sell off in Japanese bonds
Following all this, the tremors are significant, especially in Japanese government bonds, amid growing speculation of an early interest rate hike by the Bank of Japan. The yield on the 10-year government bond rose to 1.875%, the highest level since June 17, 2008. At the same time, the yen strengthened to 155.37-37 per dollar, up from 156.28-31 at the same time on Friday.
In a speech, BOJ Governor Kazuo Ueda stressed that the central bank would make an "appropriate decision" on whether to raise interest rates at its policy meeting on December 18-19. In a subsequent press conference, he warned that delaying the rate hike could boost inflation and cause market confusion.
Structural economic malaise
Recently, the Japanese government approved a support package worth $135 billion to tackle the high cost of living and boost growth, with strategic investments in semiconductors and artificial intelligence. Takaichi was pushing for a "responsible fiscal policy," but it is unclear how she will balance fiscal prudence with new spending.
Japan has the world's largest public debt, approaching $10 trillion, more than double the size of its economy. The reason the economy has not collapsed until now, despite the enormous public debt, is that most of it is held by domestic investors and interest rates remained low. Although the debt/GDP ratio has decreased since the first phase of the pandemic, Takaichi's new fiscal moves may reverse the trend.
Economic stagnation, population contraction, and demographic aging, combined with years of stimulus packages and increased social benefits, further increased the debt pressure. For Steinbock, the new fiscal expansion involves serious risks: rising interest rates and a weak yen, resulting in a new wave of inflation, loss of investor confidence, or even capital flight, with broader economic side effects.
The persistent LDP contradiction
The first signs indicate increased anxiety in the Japanese markets. Yields on 10-year JGBs recently climbed to 1.835%, a level not seen since 2008. The yen temporarily weakened to $157.90 against the dollar, while bets on a BOJ rate hike show procrastination despite inflation at 3%.
If the credibility of monetary and fiscal policy erodes, the weakening of the yen is likely to trigger a new wave of price increases, reducing the effectiveness of the support packages. This would force the Takaichi government to push for more stimulus, pressuring economic and financial stability in the medium-to-long term. This is the great contradiction that Abe managed to control, but Takaichi is starting from a more fragile base, with clear signs of currency weakness.
Takaichi's ultraconservative profile
Takaichi, who comes from a middle-class family with two working parents, grew up in a particularly conservative environment. She studied at university and worked in the US as a congress fellow for Democratic Congresswoman Pat Schroeder. Returning to Japan, she developed a career in TV Asahi television and entered politics in the early 1990s. Although initially elected with a liberal starting point, she moved to the LDP after the elections.
The support of Shinzo Abe brought her to the position of political successor as early as 2010. Her right-wing identity was symbolically linked to visits to the Yasukuni Shrine, and in 2011, she was even photographed with the leader of a small Japanese neo-Nazi party, Kazunari Yamada.
After three unsuccessful bids, the fourth made her Japan's first female prime minister, at a time when the US-Japan alliance is considered by Takaichi to be a pillar that can enter a "golden age," as she herself stated at the American naval base in Yokosuka.
Three potential scenarios
Today, Takaichi faces three potential developments.
In the first scenario, she will pursue careful de-escalation of tensions through dialogue. Japan remains deeply dependent on Chinese tourism, seafood exports, and raw materials such as rare earths, while China is its largest trading partner, accounting for more than 20% of Japanese trade flows in 2024. De-escalation would be supported by the US for reasons of regional stability, but it is not Takaichi's ideological goal, but rather an economic necessity for public opinion.
In the second, prolonged instability will be maintained with waves of minor tensions and confrontational rhetoric without a complete rupture. This would allow China to maintain economic pressure, the Takaichi government to normalize increased military spending and alignment with Washington, while the markets would punish the country with persistent uncertainty and pressure on the GDP.
The third scenario, full escalation, would mean a further breakdown of diplomatic relations and increased military presence, with possible naval operations in disputed waters. Takaichi would commit even deeper to the Taiwan issue, crossing China's red line. Although the Trump administration tends to regionalize conflicts, a full escalation would drastically hurt Japanese growth, reduce the effectiveness of the economic package, undermine business and investor confidence, and increase the risk of capital flight.
Decisive weeks for markets and diplomacy
China's decision to refer the issue to the UN forces the Takaichi government into a defensive diplomatic position. The coming weeks will be crucial, as new mistakes could accelerate geopolitical and economic erosion.
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