The Japanese Crisis Breaks the Spell of the Carry Trade

The grave Japanese financial crisis has long since passed its preliminary stage, and is now coming into the light of day through the cracks left open by the embarrassment of state media and private investors. The nature and implications of the events that unfolded since the beginning of August have created a situation that cannot be resolved simply by scapegoating the government. In fact, it has rather hastened the fall of the Kishida government. This latest event should be seen in the wake of the search for a credible new approach to deal with the slowly worsening crisis. There are several key aspects that need to be highlighted to explain the situation from which this financial instability arose, often portrayed by the media as a passing storm, far less worrisome than a tsunami warning, no longer even worthy of second or third place in the evening news broadcast.

These factors, which are to be regarded as preconditions for the actual development observed in Japanese finance and economy, can be divided into two groups. The first dates back to July 2024. The second, more remote, has been in place since at least the first half of 2023.

As of July, Japan’s corporate and financial capital had lost confidence in the idea that the state sector would be able to buy back the full amount of its public debt from the market.

This undermined a crucial element of the accumulation process in terms of its connection to financial stability. Until then, the Japanese bourgeoisie had been able to rely on this fact in order to gain greater trust from private investors.

This development significantly undermined the “public secrecy” surrounding the operations of Japanese financial institutions. These operations had allowed them to stay afloat in the global market, revealing their critical flaw for the first time. They consisted of widespread and regular recourse to carry trade operations. This type of operation consists of borrowing sums of money in foreign countries where interest rates are lower and then investing it in other countries with higher interest rates. This way, higher returns of investment can be obtained, achieving extra profit. Japanese capitalists have historically been accustomed to this kind of behavior, aided mainly by the ironclad stability of the yen, which has long made it a safe haven for many investors.

For many years Japan had no significant inflation, which meant a prolonged absence of the primary factor that traditionally prompts central bankers to raise interest rates. The phenomenon of zero inflation was, in turn, the result of the weak growth in the Japanese economy and the yen. Japanese capitalists took advantage of the extremely low interest rate (sometimes even negative, at -0.1%) to become the main source of cheap capital for buyers interested in speculative investments, both in the G7 and elsewhere.

Coincidentally, Japan was also considered a “suitable alternative” for Western capitalists unwilling to invest in mainland China.

In the comparison between the second quarter of 2023 and the second quarter of 2024, Japan’s GDP fell 1.3%. This drop was due to weak consumer demand, which also caused a sharp drop in investments and household spending. Household spending, in particular, continued to decline in three of the four quarters examined. Around the world, bourgeois economists kept their eyes out for the second half of this year. They expected to see a disruptive effect on domestic demand growth, thanks to a weak currency and simultaneous improvement in wages. The real “main course” for workers was but a paltry increase after the conclusion of Shuntō, the spring wage negotiations.

The envisioned stability was based on two assumptions: the Kishida cabinet still in power and the Biden administration.

The reality, however, has been far more bitter. The grim outlook for the global economy—driven by low industry profit rates and the uncertainty caused by ongoing conflicts, which lead to sharp fluctuations in energy prices—has derailed plans for increased development and investment growth in the country. Japan, lacking access to cheap energy, has been forced to purchase liquid natural gas even from the Russian Federation. This situation, which threatens to push the Japanese economy into stagnation once again, reinforces the policy of low interest rates. It underscores a bourgeoisie trapped in the parasitic management of fictitious capital, which uses the carry trade as its main tool for making large profits without doing practically anything else but generating money from money itself.

Household spending had already contracted sharply on an annual basis by 6.3% in January, with a subsequent small annual contraction observed in May (1.8%). Overly optimistic estimates of real wage growth (+4.7%) had succeeded in persuading outside observers that household demand was set to increase in the short term, thanks to the “predictable” increase in workers’ purchasing power. What was truly “off the radar” of economic analysts was the need for an aging population —forced to rely on a declining public healthcare system and depend on private pension plans—to offset their widespread social insecurity by saving. The Kishida cabinet was faced with a persistent shortage of workers in the healthcare sector (doctors, nurses, caregivers to the elderly) and the relative weakness of the yen discouraging the arrival of immigrants, especially Vietnamese, who covered labor shortages in many sectors.

Meanwhile, spending on light, water and fuel increased 6.6% in May from a year earlier, and food prices rose 4.3%. On the flipside, the decline in spending on culture and entertainment plummeted to -9.6% year-on-year.

As if that were not enough, the projected wage growth is accompanied by a decline in productivity, which in turn leaves consumers in the least desirable position. In order to offset the needs of businesses to maintain their profit margins under continuing inflationary pressures, consumers now have to pay higher prices for the same services as before. Meanwhile, the import price index rose 6.9% annually in May. The weakness of the yen is the most exaggerated factor behind the rise in prices of imported goods and is at the same time the source of the high financial status and wealth of Japanese capitalists.

Because currency exchanges are not centrally and directly monitored by the authorities, the extent of the practice of carry trading actually remains unknown. Its influence is therefore more easily detected in the light of day through closer observation of the market in which those who borrowed capital operate, rather than the country in which the loan was made. Without too much surprise, such a market is the US, namely the technology stocks at the center of the NASDAQ. Investors driving these stocks are accustomed to buying and selling with cheap money that, very often, comes from Japan. Although this habit has been established throughout the zero-rate era, it has re-emerged more blatantly and directly in the current era of “chip fever” running ever higher on Wall Street. At such times, however, such investors can no longer trust Japanese institutions not to raise interest rates.

The trigger for the crisis was, in fact, the poor reception of economic data by some US Big Tech companies on the first Friday in August, including a disturbing forecast on job cuts. When, at the same time, the US and Japanese stock markets reopened on Monday, August 5th, their performance continued to bear the brunt of the crisis, with Japan’s Nikkei 225 stock market index plummeting to its lowest level since 1987 with a loss of -5.8% in the Friday, August 2, session and -12.4% on Monday, August 5th.

For a quick comparison, let’s also look at US indices. The S&P 500 fell 3% in the same two days, while the NASDAQ Composite lost nearly 5%, the Dow Jones Industrial Average lost at least 1,000 points, down 2.6%. On the other hand, the VIX index, which measures volatility expectations for the coming month, literally exploded. Other technology focused stock market indices, such as Australia’s ASX 200, South Korea’s KOSPI and Taiwan’s Latex, closed Monday at -3.7%, -9% and 8.4%.

This trend makes sense when considering the main event. The Bank of Japan (BoJ) made the decision to make the yen more expensive by raising rates once again. To better understand where carry trading fits into the equation of this financial crisis, let us consider the practice not as a contract between individual capitalists, but as an interbank transaction between two participants. We have a Japanese bank offering a yen loan, another foreign bank, and finally a third party, usually another bank or a financial company. The Japanese bank would offer a convenient loan to the foreign bank in a cross-border transaction that, as mentioned earlier, is a transaction about currency trading, thus subject to greater opacity than a purely financial transaction. In addition to allowing aggressive leverage on profits, this practice is also often used to protect investors from large losses, such as those all but rare in the industry called fintech, where risks and gains are often spectacularly high, both in the same transaction.

Japanese investors also rely heavily on foreign reserves without paying attention to the potential even catastrophic consequences that lurk in every BoJ policy change. The change in strategy was set in motion by the latter just when the phenomenon currently under our attention had already become unmanageable, just like a snowball. Public funds, such as the Government Pension Investment Fund, have been allocated about half of their value ($1.6 trillion in total) in foreign stocks and bonds. This fund has a presence in the U.S. stock market, but could be expelled from it if the BoJ decides to make one or more interest rate hikes. The net international investments of Japanese investors amount to 487 trillion yen ($3.4 trillion). It should be added that the BoJ has put all its eggs in the same basket of foreign investments of a financial nature. The search for a cheap way to sell Japan as a market for venture capital has come at the cost of lifting the lid on what is at the heart of Japanese capitalism and its central bank. In the absence of more meaningful observations, the entire Japanese state can be seen as a giant carry trade powerhouse that also benefits client economies. A key indicator of this conclusion comes from an indirect parameter, Japanese banks overseas lending, which can be monitored through data provided by the Bank for International Settlements. As of March, it exceeded the $1 trillion mark, a sharp increase of 21% over 2021.

On the trade union repercussions of the crisis, Rengo, that is, the country’s largest trade union confederation, faces a rather complicated situation after its disastrous handling of the wage negotiations. Now the Rengo has to defend the “triumph” of having obtained a 5% increase in average wages paid by big industry, since Nippon Steel ltd, Toyota and others have agreed to meet part of the workers’ demands and decided to raise wages, in the case of Nippon Steel ltd going even beyond what the union demanded. The issue lies at the heart of how the economy operates according to Kishida’s model, one step away from a money laundering scheme, where wages were raised from a weak yen as the basis for negotiations. The rate increase was already in sight, with all parties involved in the negotiations obviously aware and in cahoots with each other against the workers. This outcome is difficult for Japan’s top unions to use the moment to let smaller unions take the lead and fail miserably in their attempt to persuade medium-sized companies (i.e., those where they historically have the most presence), to raise wages with current rates, inflation, and the value of the yen at the time, and then suffer a predictable loss in purchasing power, which would once again strengthen the Rengo and make it easier for the bourgeois class to work in intensifying exploitation.