Japan's past miracle is its current crisis (Part 1 of 2)
The Japanese post-war growth model planted the seeds of both its past success and its current crisis. Part 1 delves into the historical background to the present crisis.
In short
Japan’s post-war growth model was built on financial repression: suppressed wages, artificially low returns on savings, and an undervalued currency that continuously transferred wealth from households to industrial exporters.
Once the model had become unsustainable for the US, the 1985 Plaza Accord forced a rapid yen appreciation. Tokyo’s response produced the largest asset bubble in modern history. When it burst in 1990, corporations spent two decades paying down debt rather than investing, leaving government as the only borrower. Public debt has exceeded 250% of GDP ever since.
The Bank of Japan spent twenty-five years inventing unconventional monetary tools — zero rates, quantitative easing, negative rates, yield curve control — none of which broke the deflationary trap, because the trap was structural, not monetary.
Two slow erosions went unaddressed: a demographic collapse that is shrinking the tax base while expanding pension obligations, and the displacement of Japan’s automotive sector by Chinese electric vehicle manufacturers
This is the first of two pieces on the fiscal and monetary crisis now bearing down on Japan; and, through Japan, on anyone holding dollars, euros, or exposure to global equity markets. Part 2 (which will be published on the 13th of May) analyses the crisis itself: the Hormuz shock, Sanae Takaichi’s fiscal gamble, and the trilemma Tokyo cannot escape. Part 1 is the historical foundation that makes Part 2 fully legible.
You can read Part 2 without reading this first. But the history changes what the current crisis feels like. Understanding how the growth model was built, how the bubble formed, how the lost decades set in, and why the problems Japan was facing were ignored for so long, will give you a lot of context.
Part 2 without Part 1 is a satisfying meal, but this is the context that gives it flavour.
In 2016, the executives of Akagi Nyugyo, a mid-sized Japanese ice cream manufacturer, lined up in dark suits in front of a camera and bowed. They bowed deeply, in unison, in the formal manner reserved in Japanese corporate life for genuine institutional shame. The occasion was an apology. After twenty-five years of holding the price of their flagship popsicle, the Garigari-kun, at sixty yen, they were raising it to seventy. Ten yen. Roughly seven cents. The commercial that followed was not parody. It aired nationally, in earnest, and the country understood it as a sincere act of remorse.
To a Western reader, the scene is faintly absurd. Imagine a chief executive solemnly bowing on prime-time television to apologise for raising the price of a Magnum by a few cents. It would be unthinkable, because in the West price increases are simply what happens, the background hum of a normally functioning economy. In Japan, by 2016, raising a price had become a confession of failure, a betrayal of an implicit social contract that prices, like wages, do not move.
How does a country arrive at this? Japanese culture certainly plays a part, but the story is as much economic.
To understand this peculiar phenomenon, let’s rewind to the late 1980s. At the peak of the asset bubble in 1989, the grounds of the Imperial Palace in central Tokyo were valued more highly than all the real estate in the state of California. The Nikkei closed the year just under 39,000. Japanese banks owned nine of the ten largest banking institutions in the world by assets. Mitsubishi Estate had bought Rockefeller Center. Sony had bought Columbia Pictures. Newspapers in Washington ran cover stories speculating, in tones of mild panic, about whether Tokyo would overtake New York as the financial capital of the world.
Twenty-seven years later, the country’s companies were apologising for a modest price increase. Ten years later, it is facing a fiscal and monetary crisis with potentially profound consequences for the global economy.
Any rational observer would conclude that something had gone profoundly wrong in Japan. And the story of what went wrong begins not with the bubble, and not with the burst, but with the growth model that produced both: a system instituted in the rubble of the Second World War, executed brilliantly for forty years, but managed poorly once it was exhausted and should have been abandoned; and whose terminal phase the country is still living through today.
From industrial powerhouse, to bubble, to bust
For most of the second half of the twentieth century, Japan — like West-Germany — were presented as economic wonders. Defeated, occupied, and rebuilt under American security guarantees, they emerged from the 1950s as showcase economies of the Cold War’s free-market bloc.
By 1968 Japan had overtaken West Germany to become the world’s second-largest economy. By the late 1980s, serious people in serious institutions, who also had serious knowledge of the matter, were modelling the date at which Japanese GDP would surpass American GDP.
The growth model that produced this outcome deserves to be understood in detail, because its internal logic still defines Japan’s predicament today.
Reading beyond the Cold-War Propaganda
Reading beyond the Cold-War propaganda, the Japanese and German growth models were actually fundamentally anchored within a political order guaranteed by the Americans. Allied nations were – first happily, then begrudgingly, as Martin Daunton shows – permitted to run persistent trade surpluses; mainly through undervalued currencies, but also other forms of industrial policy that subsidized production at the expense of consumption.
At their core, these were export-led, high-investment, high-savings systems. But each of those descriptors conceals more than it reveals. This is where one of my favourite economists, Michael Pettis, comes in.
People tend to assume the Japanese and the Germans save a lot because of culture: wartime memory, national temperament, a Confucian or Protestant inheritance. This explanation is comforting because it requires nothing to be done about it. Pettis has spent two decades arguing it gets the causation precisely backwards. The Japanese household savings rate was not high because Japanese families chose to save. It was high because the system was designed to leave them no choice.
There is probably a compelling Marxist-inspired argument that policymaking and elite culture coalesce around material interests — that culture and economics shape each other in ways that make them impossible to fully separate. But I’ll leave that to the academics.
The mechanism was financial repression. Household deposit rates were held artificially low, which is effectively a tax on savers and a subsidy for borrowers.
That vast pool of suppressed savings was then channelled, through a tightly coordinated banking system, toward favoured industrial conglomerates — the keiretsu — at subsidised rates. The coordinating institution behind this was the Ministry of International Trade and Industry, MITI, whose officials steered private capital toward strategic sectors through what they euphemistically called administrative guidance. Wages were deliberately held below productivity growth. The yen was kept undervalued.
The cumulative effect was a continuous transfer of wealth from households to corporations: workers earned less than their productivity warranted and savers less than their deposits warranted.
This is not a critique from a free-market perspective, nor is it a normative judgement about what constitutes fair compensation for labour. It is a description of a coherent national growth strategy that worked extraordinarily well for several decades, raising the welfare of citizens and corporations alike.
However, this model only worked under certain geopolitical circumstances that are now disappearing, and whose hidden costs only became visible once the growth phase was exhausted.
Japan was the canonical case of this model. South Korea, Taiwan, and most consequentially China have each reproduced their own national variations. It is impossible to look at contemporary China without seeing Japan’s shadow. China is living through the earlier stages of a comparable exhaustion. Japan, thirty-five years ahead on the curve, shows what the late stages look like.
One important difference, worth keeping in mind: Japan was a subservient American client throughout this story. China is an intransigent challenger. That distinction matters for comparative history, as we shall see in the next section. Japan was willing to revalue its currency, but with catastrophic consequences, whether China is willing to do the same is uncertain.
The bubble
By the mid-1980s, the model had become a problem for Washington. Japanese exports were eviscerating American manufacturing and the bilateral trade deficit had become politically intolerable. Reagan’s Treasury Secretary, James Baker, convened the finance ministers of the G5 economies at the Plaza Hotel in New York in September 1985 and extracted a coordinated agreement to weaken the dollar against the yen and the deutschmark. The Plaza Accord did exactly what it promised: within two years, the yen had appreciated from roughly 240 to the dollar to 150.
This was the moment the contradictions baked into the post-war order became visible. The system Washington had built in which it tolerated Allied trade surpluses, underwriting the security guarantees that made export-led growth possible, produced exactly the imbalances that became politically intolerable once American factory towns began to bleed.
The Plaza Accord was less a coordinated rebalancing than a unilateral demand from the architect of the system to one of its clients. It worked because Japan was a client. The same contradictions are now playing out in Washington’s confrontation with China, except Beijing is not a subservient client, has no incentive (yet) to revalue its currency under American pressure, and cannot be summoned to a hotel in New York to sign an accord. If you’d like a piece exploring this parallel in more depth, leave a comment.
Though probably the right decision macroeconomically, the rebalancing was sudden and painful, and the Japanese economy had no time to adjust. Japanese exporters, suddenly facing prices forty percent higher in dollar terms, screamed for relief.
The Bank of Japan delivered it in the form of aggressive monetary easing. The policy rate was cut. Credit conditions were loosened. Cheap money met an already-overheated economy with a financial system flush with corporate savings and no productive home for them. The result was the most spectacular asset bubble in modern history.
Stocks went vertical. Land went more than vertical. By the end of 1989 the Nikkei had reached 38,957. The price-to-earnings ratio of the Japanese market exceeded 70. The total market capitalisation of Japanese equities surpassed that of the United States, in an economy half its size. The market was populated by companies that produced nothing — but had inflated land holdings on their balance sheets that traded at prices implying double digit appreciation of their assets.
Then, in 1990, the new BoJ governor Yasushi Mieno decided enough was enough. He raised rates, sharply and repeatedly. Consequently, the Nikkei peaked on the last trading day of 1989 and then began its freefall, which lasted for thirtieen years. By 2003 it had lost more than 80% of its value. Land prices in the major cities fell by similar magnitudes, and would not recover for decades. In some districts, they have still not recovered, more than thirty-five years on.
The balance-sheet recession
Imagine you are a Japanese industrial firm in 1992. Three years ago you borrowed heavily, at the urging of your main bank, with the implicit blessing of MITI, to expand capacity, buy land, and acquire other companies. Your collateral was a real estate portfolio that has now lost 60% of its value. Your share price has collapsed. You are technically insolvent, though the accounting standards of the time allow you to pretend otherwise. The only path back to solvency is to use every yen of operating cash flow to pay down debt.
Now imagine that every other major firm in Japan is doing the same thing. The consequence was barely any investment or hiring. Instead, companies were deleveraging.
Richard Koo, a former New York Fed economist who watched the unwinding from inside Nomura Research, coined the term that has defined Japan’s last three decades: the balance-sheet recession. In a normal recession, firms maximise profits but demand is weak. In a balance-sheet recession, firms have stopped maximising profits altogether. They are minimising debt instead.
In this regime, monetary policy becomes almost entirely impotent. You can cut interest rates to zero, but if the entire corporate sector is determined to deleverage, no one wants to borrow at any price.
Households followed suit. With lifetime employment guarantees fraying, with the salaryman contract that had underpinned post-war Japan visibly cracking, with property wealth evaporating, households did what households do under uncertainty: they cut spending and increased savings. The chronic demand suppression that had been a feature of the growth model became a fact of daily life.
The government was left as the only entity willing to borrow. And so it borrowed. Public debt, which had stood at around 60% of GDP in 1990 climbed steadily through the 1990s and 2000s. By 2010 it had passed 200% of GDP. Today it is north of 250%, by far the highest in the developed world. Each fiscal stimulus was an attempt to fill the demand hole left by private-sector deleveraging. Each one was pulled back too early, under pressure from a Ministry of Finance institutionally obsessed with deficits. None was sustained long enough to break the deflationary equilibrium.
This dynamic, private-sector deleveraging absorbed by public-sector borrowing, with monetary policy pushing on a string, is the engine room of everything that has happened in Japan since. It is the reason the Bank of Japan would spend the next twenty-five years inventing one unconventional monetary tool after another. And it is the reason none of them really worked.
The BoJ as laboratory
With the private sector determined to deleverage and households determined to save, only two actors were left: the government, which borrowed, and the central bank, which experimented.
The Bank of Japan became the world’s laboratory for unconventional monetary policy. Every tool the Federal Reserve and ECB would later deploy after 2008 was first piloted in Tokyo, against a more rigid deflationary problem. It pioneered the zero interest rate policy in 1999. In 2001, when that failed to revive inflation, it invented quantitative easing: large-scale bond purchases meant to increase lending. The reserves accumulated on bank balance sheets and largely sat there, because no one in the real economy wanted to borrow. In 2016 came negative interest rates, and later that year yield curve control, under which the BoJ committed to buying unlimited quantities of Japanese government bonds to pin the ten-year yield near zero. The central bank had, in effect, declared that the price of long-term Japanese debt would be whatever it said it would be.
Each step was taken inside the same dilemma. Raise rates and you crush a debt-saturated balance sheet. Keep them too low and you hollow out the currency. There was no good exit.
The lost decades
The 1997-98 period nearly broke the system. The Asian financial crisis hit a Japanese banking sector stumbling through the post-bubble decade with vast quantities of unrecognised bad debt. Hokkaido Takushoku collapsed in November 1997, the first city bank failure of the post-war era. Yamaichi Securities, founded in 1897, dissolved itself a week later. Long-Term Credit Bank and Nippon Credit Bank were nationalised in 1998. For a few months, the system genuinely teetered.
The three decades that followed were defined by stagnation. Prices barely moved. Wages barely moved. A generation came of age in an economy where the very idea of inflation was foreign. It was so foreign that, by 2016, executives at an ice cream company would bow on national television to apologise for raising the price of a popsicle by ten yen.
A society in which prices cannot rise is one in which wages cannot rise either, and one in which households can never quite escape the savings imperative the original growth model imposed on them. The deflationary trap was, in the Pettis reading, the long shadow of demand suppression. It was the predictable consequence of a system that had spent forty years engineering household consumption out of the economy. By the mid-2000s, Japan had become a macroeconomic puzzle the rest of the developed world treated with anthropological curiosity. Then 2008 happened, and the same puzzle began to appear in Europe and North America. The Lost Decades stopped looking like a peculiarly Japanese pathology and started looking like the prototype.
Abenomics: the great attempt
By 2012, Japan had been in the deflationary trap for two decades. One man decided he was going to break it.
In December 2012, Shinzo Abe returned to the prime ministership promising to do whatever it took to drag Japan out of deflation. His programme, quickly branded “Abenomics,” rested on three arrows: flood the financial system with money, boost demand through government spending, and reform the underlying structure of the economy.
The first arrow worked, briefly. The Bank of Japan under its new governor Haruhiko Kuroda doubled the money supply, the yen weakened, exports became cheaper abroad, and the stock market surged. Then the Ministry of Finance pushed through a sales tax increase in 2014 that sent consumers back into their shells. A second hike in 2019 killed the next recovery too. The structural reforms mostly never happened.
Michael Pettis’s reading, which I find persuasive, is that Abenomics was never really designed to break the trap. Look at what it actually did: it weakened the currency, raising the cost of imported goods for ordinary households, and pushed interest rates so low that anyone with savings in a Japanese bank was quietly losing money each year. It transferred wealth from Japanese households to Japanese corporations, the same trick the original post-war growth model had pulled, just executed through monetary policy instead of regulated interest rates. The Japanese consumer, once again, was the silent subsidiser. The deflation was never broken. But Abenomics did leave one durable legacy: a financial system so thoroughly rewired around cheap money that unwinding it would itself become a crisis.
The slow erosion
While policymakers were absorbed in the monetary plumbing, two slower forces were eroding the country’s foundations. Both had been visible for decades. Neither received the structural response its magnitude warranted.
The first is demographic. Japan’s working-age population peaked in 1995. The median age is now 50, the oldest of any major economy. Each year, Japan loses roughly 800,000 people on net. The equivalent of erasing a city the size of Frankfurt or Marseille annually.
The fertility rate sits at 1.3, well below the 2.1 needed to sustain the population. The ratio of workers to retirees has fallen from 6:1 in 1990 to roughly 2:1 today, trending toward 1.3:1 by 2050. In an economy already carrying public debt above 250% of GDP, the room to absorb this through more borrowing is increasingly constrained. Immigration, which might offset some of it, remains politically taboo.
The second is industrial. Japan’s automotive sector has been the spine of its export economy since the 1970s. Toyota, Honda, Nissan, Mazda, and Subaru anchor a vast supplier ecosystem around Aichi prefecture, and the complex is also a financial one: Toyota Motor Credit alone carries well over a hundred billion dollars in outstanding debt, and the broader auto-finance sector is multiples of that.
This structure is now being outflanked. Every Japanese major bet on hybrid technology and stayed committed to internal combustion through the 2010s, assuming the transition to electric vehicles would be slow and led by the West. They were wrong on every count. Chinese automakers, led by BYD, pivoted aggressively to electric drivetrains. By 2023, Chinese vehicle exports surpassed Japanese exports for the first time in history. Toyota and Honda have begun closing plants in China and writing down assets. Nissan is in genuine financial difficulty. The threat is not merely to the carmakers themselves but to the supplier networks behind them and the auto-finance complex sitting on hundreds of billions of dollars of debt collateralised by a business model that may not survive the decade.
Both trends were knowable. But each had been treated as a slow erosion to be managed with marginal adjustments rather than a structural threat requiring a different growth model. That posture could only work as long as the global environment remained stable enough to absorb the slow loss of competitiveness. As long as the dollar-yen rate remained orderly, as long as JGB yields stayed pinned at zero, as long as the carry trades kept flowing outward without disruption, the erosion could be ignored.
In March 2026, it stopped being stable.
In Part 2, I look at how the Hormuz shock, Sanae Takaichi’s fiscal programme, and a yen under siege have combined to put Japan into a trilemma it cannot escape — and why what happens to the yen now matters for everyone holding dollars, euros, or US tech stocks.
Will Japan cause a global debt crisis? (Part 2 of 2)
This is Part two of a two-part series. Part one traced how Japan’s post-war growth model produced the bubble of the 1980s, the lost decades that followed, and the slow erosions — demographic and industrial — that the country has been managing rather than confronting for thirty years. If you’d like the historical foundation, read part one. If not, here i…
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When a company goes broke but is still viable it is normal that the lenders get a part of the company. That is what should have happened in Japan after the Plaza Agreements - with maybe some government subsidies to lubricate the process.
But here we have the weak point of capitalism: it is no problem when the poor people have to give up some of their wealth, but when for the welfare of the country it is needed that the rich people make some sacrifice it is often a major problem.
Yet capitalism cannot work well when property relations are not clear - as happens when there are zombie companies.
It greatly benefited from being a privileged territory within a planetary economic central planning regimes geographic divisions of labor