Has Japan finally escaped the Lost Decades

**SPEAKER_1** (0:00)
Hello, folks, you're tuned in to Finshots Daily. If you're new here, welcome. If you're returning, welcome back. In today's episode, we tell a tale of two metrics. Why weakening currency and rising bond yields mark a significant break for the Japanese economy.
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For more than three decades, the Japanese economy has operated under conditions that differed from almost every other developed nation. After its property and stock market bubble burst in the early 1990s, the country entered what economists call the lost decades. As the name suggests, economic growth slowed down, consumers stopped spending, companies held on to cash instead of investing, and prices either barely moved or kept falling. This persistent deflation became Japan's defining economic problem. Over the years, to break this cycle, the Bank of Japan tried almost every monetary policy available.
It cut interest rates to zero, introduced negative interest rates, bought trillions of yen worth of government bonds, and even controlled long-term bond yields through a policy known as yield curve control. The idea here was to keep borrowing costs low enough to encourage businesses and customers to spend and invest, while also convincing people that prices would eventually start rising again. Yet inflation remained stubbornly low. But over the last few years, something appears to have changed. Inflation has stayed above the Bank of Japan's target for an extended period, wages are finally rising after years of stagnation, and investors are demanding higher returns to lend money to the Japanese government. As a result, Japan's 10-year government bond yield has climbed to around 3%, the highest level in decades. Now, this might sound fairly ordinary for most countries, but for Japan, it represents a profound shift in an economy that had almost forgotten what meaningful positive interest rates look like. However, Japan isn't the only country experiencing this. Bond yields are rising across major economies. India's 10-year government bond yield, for instance, is around 7%.
While yields in the US, France, and Germany have also climbed to multi-year highs. At first, these may look like separate stories. However, they're all connected by a broader shift in the global economy. Let's explain. After years of relatively stable prices, economies have to contend with higher inflation. This means investors now want greater compensation for the possibility that the value of their money will decline.
In the last few years, governments have borrowed more due to the pandemic, higher defense spending, and infrastructure investments. Naturally, when governments issue more bonds, investors can demand higher returns before agreeing to absorb the extra supply.
So one reason is inflation. But another important change is also taking place. Central banks are also no longer buying government bonds. And when a central bank steps back as a major buyer, private investors must absorb more of the government's debt. However, unlike a central bank, private investors have little reason to accept very low returns. They can simply demand a higher yield. This matters because government bonds don't exist in isolation. Bond yields are the default risk-free rate of return, which affects the return investors expect across the financial system. If a relatively safe government bond starts offering a much better return, riskier assets have to offer enough additional upside to justify that risk. And this, folks, creates a difficult feedback loop for governments. When investors demand higher yields, governments have to pay more to borrow. Higher interest payments can then put additional pressure on government finances, potentially requiring even more borrowing. At the same time, higher bond yields make government debt more attractive relative to riskier assets. So, why invest in risky emerging markets for a modest additional return when a government bond offers a decent yield with almost no risk? This is particularly relevant for countries such as India, where global investors constantly compare returns across markets. If US, European or Japanese government bonds become more attractive, investors may demand a larger premium before putting money into Indian equities or bonds. That can influence foreign capital flows, the rupee and domestic borrowing costs too. That said, let's get back to Japan. As mentioned earlier, Japan was an odd one out in the global financial system, while other countries occasionally raised interest rates, the Bank of Japan kept borrowing costs close to zero because its bigger problem was deflation. Japanese investors therefore had little incentive to keep their money at home when government bonds offered almost no return. Instead, they looked abroad for better opportunities. That helped create one of the most important trades in global finance, the yen carry trade. The idea was simple. Investors could borrow money in yen at extremely low rates and use that money to buy assets offering higher returns elsewhere. As long as Japan's interest rate stayed low and investments abroad generated higher returns, investors could pocket that difference. But the economics of that trade is beginning to change, and the story starts with the yen itself.