NEW YORK — In October 2016, Japan tried a new riff on an old economic strategy to mask the severity of mushrooming government debt: prodding the central bank to write Tokyo a blank check.
It was the first time since World War II that the Bank of Japan’s bond purchases would be “directly linked to the government’s issuance of debt,” observed analyst Mark Fleming-Williams at Stratfor. In many ways, he added, “this could be the biggest economic development Japan has seen since the 1985 Plaza Accord.”
Nearly nine years on, it’s an even bigger development. US President Donald Trump wants the Federal Reserve to issue a blank check to a White House that’s rapidly making runaway debt issuance great again.
Japan, the third-largest economy, dabbling in de facto debt-monetization is one thing. The globe’s biggest economy by far and protector of the reserve currency, angling for “fiscal dominance”, is quite another.
The reference here is to a practice common in developing nations where monetary policies serve the political whims of the national leader of the moment. Trump’s threats to fire Fed Chair Jerome Powell and Governor Lisa Cook, revamp how district Fed banks are run and load the Fed Board with #MAGA economists suggest the US is veering in the same direction.
“What we hear is, we need lower interest rates because interest payments are exploding,” former Fed economist Eric Leeper told Bloomberg. Now at the University of Virginia, Leeper says this ploy is effectively “admitting that fiscal policy is not going to take care of itself, and so they’re trying to find some other way out. This is fiscal dominance.”
George Saravelos, global research head at Deutsche Bank AG, noted that “the Fed is now subject to intensifying fiscal dominance risks. What is a bigger surprise to us is that the market is not more concerned.”
Last month, Powell tiptoed up to the issue, telling reporters that it “wouldn’t be good” to set policy to accommodate the government’s fiscal needs. He stressed that “no advanced-economy central bank does that.”
With the national debt well above US$37 trillion and Trump’s recent mega-spending tax cut bill adding trillions more, Washington’s debt-servicing challenge is growing. The US has also passed the precarious point where spending on government debt interest is now more than it spends on national defense.
The answer, of course, is less debt. Throughout the rest of Trump’s term, which ends in 2029, S&P predicts budget shortfalls of around 6% of the gross domestic product. That’s well above historical standards and two times the 3% target laid out by Treasury Secretary Scott Bessent. That would push Washington’s debt ratio to a peacetime record of greater than 100% of GDP.
Yet, tell that to Trump’s inner circle, which clearly seems to have learned the wrong lessons from Japan by betting on the Fed to take the problem off its hands.
In Japan’s case, we need to go back to the 1920s and 1930s, back to the days of Korekiyo Takahashi, who’s often called the John Maynard Keynes of Japan. The economist served as finance minister, Bank of Japan governor and, eventually, prime minister.
Takahashi is best remembered for a hyper-aggressive mix of monetary easing and aggressive fiscal expansion, along with efforts that modern economists would call debt monetization. Central banks buying ginormous blocks of debt directly from the government is as radical as any Group of Seven nation can get.
Many would say Takahashi ran the 20th century’s most audacious experiment in so-called “Modern Monetary Theory.” All the debating over so-called MMT ignores that Takahashi effectively pioneered it. MMT holds that a country issuing debt in its own currency can borrow aggressively with little financial fallout or risk of default.
Ben Bernanke, the former Fed chair, once told an audience that “Takahashi brilliantly rescued Japan from the Great Depression through reflationary policies.” In 2013, then-Prime Minister Abe said the “example of my forerunner Takahashi has emboldened me” in the battle against deflation.
That same year, Abe empowered his new BOK Governor Haruhiko Kuroda to grow the BOJ’s balance sheet to a size bigger than Japan’s US$4.2 trillion economy. The Kuroda era pushed the BOJ so deeply into government debt and the stock market that it remains effectively trapped.
And far from shrinking Japan’s debt as a percentage of GDP, the BOJ’s largess has enabled the government to borrow more and more, leading to today’s 260% debt-to-GDP ratio.
Even today, Japan can’t escape the last dozen years of zero-to-negative yields. As Robin Brooks, economist at the Brookings Institution, observed, “government bond markets — given high debt levels also many other places, not just Japan – are heavily manipulated with the goal of preserving the fiscal status quo. It’s thus important not to see these yields as a market price. They aren’t.”
It’s not like hoarding half the government bond market and dominating the stock market is saving the day. Brooks explained that “de facto central bank yield caps create bad incentives for politicians and make needed debt reduction less likely. Things will get worse before they get better, meaning indebtedness will rise.”
Two-plus decades of being the key economic engine via zero rates in Japan deadened the nation’s annual spirits. Corporate CEOs have been disincentivized to innovate, restructure and take risks. Government officials sat back and let the BOJ’s 24/7 ATM service take the lead. In the interim, Japanese government bonds have only grown in popularity, leaving everyone exposed.
If JGB yields jumped to 2%, banks, companies, local governments, pension and insurance funds, universities, endowments, the giant postal system and retirees get hurt. It’s created a “mutually assured destruction” dynamic that dissuades virtually anyone from selling debt.
As JGB yields continue to rise, Tokyo will face increasing difficulty in servicing the developed world’s largest debt burden, which is roughly 260% of its gross domestic product.
This unenviable challenge now falls to BOJ Governor Kazuo Ueda. Yet politics will be a bigger variable for Ueda than many investors seem to realize. The BOJ, it’s worth remembering, is less independent than, say, the Fed or European Central Bank. The powerful MOF has a seat in the room when BOJ officials make interest rate decisions.
Trump wants even greater control over the Fed, an arrangement something closer to the People’s Bank of China. Yet as Japan showed the world in the 1930s, monetizing debt only treats the symptoms of the problem, not the underlying cause.
Takahashi’s policies ended up getting him killed. Around 1934, he figured it was time to trim runaway spending. His moves to cut the defense budget irked military officers so much that they assassinated Takahashi in 1936.
Today, 89 years later, the odds of “Takahashinomics” making a comeback are increasing at an alarming rate. In modern-day Tokyo, Ueda is under great pressure to give up on the BOJ’s rate normalization process.
Ueda’s job is a near-impossible one. Though QE has been the law of the land since 2001, it’s been stuck in a very high gear since 2013. That’s when Ueda’s predecessor Kuroda began employing something approximating the “helicopter money” that Nobel laureate Milton Friedman wrote of as far back as the late 1960s.
Trump is angling for helicopter Fed money, and then some. This, of course, is not the role the Fed wants to play. Last month, Atlanta Fed President Raphael Bostic warned that monetary policy could become less effective if investors worry about fiscal risk.
“You could see interest rates move to some extent independent of things that we do,” he said. “That would be really something that we’d have to think hard about.”
To be sure, the so-called “bond vigilantes” could have the final say over Trump’s campaign to bring the Fed to heel.
As Pierpaolo Benigno, a monetary economist at the University of Bern, said, “this scenario – debt monetization and tax cuts coupled with substantial dollar depreciation – would inevitably fuel inflationary pressures, and adverse effects on economic activity cannot be ruled out.”
Earlier this month, S&P Global Ratings warned that Washington’s sovereign credit rating could “come under pressure if political developments weigh on the strength of American institutions and the effectiveness of long-term policymaking or independence of the Federal Reserve.”
This is no longer a question of if, but a matter of when, adding to global economic risks in 2026.
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