Could Japan Face Another Thirty Lost Years?

The Nikkei has reached 70,000. Core CPI has remained above 2% for 18 consecutive months, and wage growth is at its highest in more than three decades. Meanwhile, Japanese government bond yields continue to rise, the yen is near a 40-year low and trade has been in deficit for three consecutive months. Different markets in the same economy are moving in sharply different directions. That divergence brings Japan's previous thirty lost years back to mind.

A look back at Japan's thirty lost years: the Heisei slump, 1989-2019

In 1985, Japan, the United States and three other countries signed the Plaza Accord. The yen appreciated sharply from around 240 to around 120 per dollar, putting sustained pressure on exporters' profits and becoming the immediate trigger for the Heisei slump.

In response, the Bank of Japan lowered its discount rate from 5% to 2.5%. Large amounts of money flowed into equities and property. Land prices in central Tokyo quadrupled in five years, and the Nikkei tripled in four. In 1989, the central bank repeatedly tightened policy and markets suffered a hard landing. The Nikkei fell more than 60%, housing prices in major cities dropped sharply and nationwide land prices declined for 15 consecutive years, substantially eroding household wealth.

During the 1997 Asian financial crisis, trade collapsed and bad loans surfaced together. Sanyo Securities and Yamaichi Securities failed in succession, severely damaging the financial system.

Japan then entered a deflationary deadlock lasting two decades. Even though Abenomics later brought periods of recovery, it never fully broke the long-term cycle of low growth, low inflation and high debt.

The problem was not yen appreciation alone, but the aggressive policy choices made at the time.

Today: a similar crossroads

Japan now stands at another crossroads resembling the earlier one. If the yen appreciates, exporters' profits are squeezed and strong businesses may even face acquisitions at low prices by overseas investors. If it depreciates, carry-trade money continues to flow abroad, energy and raw-material import costs rise and households' real purchasing power declines.

If rates are raised hastily, every step higher multiplies the government's interest burden. The economy's largest source of risk is no longer private businesses, but a government with an exceptionally large stock of debt.

How can Japan find a way through?

The challenge is difficult, but the key is not simply whether the exchange rate rises or falls. It is whether the domestic positive cycle between wages and inflation can continue. If inflation remains high, wage growth falls behind and energy prices erode household income, that cycle will break and underlying risks will emerge together.

Three core indicators to watch

1. The September 17-18 Bank of Japan decision, with markets pricing a 75% probability of a hike.

2. The wage-inflation cycle: nominal wage growth, real wage growth and annual Shunto wage settlements.

3. Fiscal risk: interest rates paid on government debt, the debt-to-GDP ratio and the cost of newly issued bonds.

Japan has only recently emerged from its long period of deflation. We will continue watching whether it can navigate this crossroads successfully.