Japan's LDP Rocked And Roiled In An Election Earthquake

It surprised many that this meant swapping one 67-year-old conservative with another. Ishiba's man-of-the-people persona led LDP bigwigs to hope he might revive the party's image.

Instead, reality caught up with Ishiba – and fast. For years,
Boling notes, Ishiba
polled very favorably with the public.

He benefited from being seen as an outsider within the LDP because he was willing to criticize the party. That made him unpopular with many LDP lawmakers but popular with the public.

But“since becoming prime minister, he has made some missteps that have opened him to attack,” Boling notes. That Sunday's results mean Ishiba is“weakened” and that the“odds would be against him rebounding.”

If Ishiba does stay in, he'll be busy struggling to save his premiership. Odds are he'll be too preoccupied to address the economic headwinds racing Japan's way.

Chief among them is an economy fast losing altitude. This might come as quite a surprise to LDP elders who encouraged Kishida to stand down.

Back in mid-September, when these machinations were in motion, the party figured the economy was on sound footing.

At the time, the Nikkei index was testing all-time highs amid stable economic growth, 10 years of corporate governance reforms were gaining traction and hopes were high that wages gains would accelerate.

Earlier this year, labor unions scored the biggest wage bump in 33 years. That fueled optimism that the“virtuous cycle” Tokyo had craved for decades had arrived.

All this encouraged the BOJ to begin exiting 25 years of zero interest rates and quantitative easing. On July 31, BOJ Governor Kazuo Ueda's team hiked short-term rates to 0.25%, the highest since 2008. That sent the yen skyrocketing.

Since then, a clear deceleration in retail sales, exports, industrial production, machine tool orders and other sectors has Team Ueda hitting the pause button on additional tightening moves.

It also had Ishida's government pivoting to the kinds of short-term stimulus maneuvers he claimed his government would avoid. A long-time fiscal hawk, Ishiba also was a proponent of higher rates and a stronger yen. Not anymore.

Ishiba's reversal on these and other policies has sent the yen tumbling past the 150-to-the-dollar mark. It's also generating increased volatility in Japanese government bond yields.

For one thing, Ishiba's government having to rely on opposition parties to retain power makes it harder to champion fiscal consolidation and monetary liquidity normalization. For another, the clock is now ticking faster and faster for Japanese leaders to act on implementing economic reforms.

The LDP's stumble could not be worse timed for Asia's second-biggest economy. The export boost on which Tokyo was betting is in growing doubt as Chinese growth slows. China is slow-walking moves to address a property crisis that many compare to Japan's 1990s bad-loan debacle.

Stephen Innes, managing partner at SPI Asset Management, notes that Beijing is“trying to talk the talk, with more noise about stabilizing the property market.” Generally speaking, though, Innes says,“China's property mess isn't something that can be patched up with a few speeches and half-baked measures.”

Macquarie Bank economist Larry Hu adds that measures taken so far“may not be enough to turn the housing market around.”

Meanwhile, Germany's recession weighs on Europe's prospects. The US is showing signs of wear. The geopolitical environment is hardly ideal as Middle East tensions flare and Russia's Ukraine invasion drags on.

The rising odds that Trump might be re-elected on November 5 to supersize trade wars is a major source of global uncertainty.

Amid such uncertainty, investors have valid reasons to question Tokyo's ability to get the reform process back on track. In the 12 years since the LDP returned to power, few big-picture upgrades have been implemented.

In 2012, the Prime Minister Abe pledged to modernize labor markets, reduce bureaucracy, increase innovation and productivity, empower women and strengthen corporate governance. Abe succeeded with this last endeavor.

The Nikkei's surge to record highs is partly a result of steps to increase returns on equity, give shareholders a louder voice and diversify boardrooms. It's also the result of ultra-low interest rates.

Yet surging stocks have meant little to the average Japanese household. Wages have generally lagged the rate of inflation. Japan
ranks 30th among the 38 Organization for Economic Cooperation and Development (OECD) members in productivity.

What so-called Abenomics did, ultimately, was prove that“trickle-down economics” still doesn't work. And that sporadic stimulus packages don't alter economic trajectories nearly as much as structural changes. Now, the clock is already ticking as Japan's latest government inherits a uniquely lopsided economic trajectory.

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On the one hand, the inflation Tokyo had been craving for 25 years is here. And the BOJ is finally trying to normalize a super-aggressive interest-rate regime. On the other, that very rising-price dynamic is wrecking household and business confidence. It makes Japan the economic equivalent of the dog that caught the car. Consumers find themselves missing deflation, which many viewed as a stealth tax cut.

This balancing act proved too much for Kishida, who took power in early October 2021. Ostensibly, Kishida's dismal approval ratings reflected political funding scandals within his LDP. In reality, it was mostly an underperforming economy that ended his tenure.

Like his mentor Abe, Kishida did himself no favors by prioritizing foreign policy over reforms. Ishiba, a former defense minister, irked voters by appearing to do the same. An old-school China hawk who favors creating an“Asian NATO,” Ishiba seemed more interested in creating a bulwark against Beijing than tackling kitchen-table issues.

Now, with political winds shifting, Tokyo seems even more captive to events in Beijing and Washington.

Recently, Chinese leader Xi Jinping's government conceded that the globe's No 2 economy is in trouble.

Earlier this month, Beijing unveiled aggressive stimulus measures to support an economy grappling with a deepening
property crisis. The People's Bank of China announced its first simultaneous cut in key short-term rates and banks' reserve requirements since at least 2015.

Mainland stocks have tried to rally on the news. And
PBOC Governor Pan Gongsheng is hinting at further cuts in the amount of cash banks must hold as reserves.

The faster Beijing puts a floor under the economy, the more Japan's prospects will improve. China is by far Japan's
biggest trading partner. Having the top customer for your goods battling deflation is rarely a plus for economic confidence.

On top of that, the specter of Trump trade 2.0 is keeping many Tokyo officials up at night. Preparing for a Trump or Kamala Harris administration will be a major preoccupation for LDP officials. Yet not as great as figuring out whether the nation's dominant party can find a way forward. With, or without, Ishiba in the mix.

Follow William Pesek on X at @WilliamPesek

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