Japan's Liberal Democratic Party has been shaken and shaken by the election earthquake

As political miscalculations continue, it's hard to look past Shigeru Ishiba's decision to hold a snap election on Sunday, just 30 days after his surprise ascension to Japan's prime ministership.

Ishiba's Liberal Democratic Party has lost its majority for only the third time since 1955. But this latest insult to a party that has long taken the priorities of Japan's 125 million people for granted may be its most consequential yet.

Ishiba's blunder, and the political turmoil it causes, comes amid a dizzying array of headwinds heading toward the nation.

They include slowing growth at home, a decline in China, North Korea's provocations, and the growing odds that Americans will return Donald Trump and his trade wars to the White House.

This comes as Japanese inflation outpaces wages and the Bank of Japan considers whether to continue raising interest rates. This comes as investors evaluate whether the Nikkei 225 stock index's rise to record levels is sustainable in light of political instability in Tokyo.

At the very least, Ishiba appears more willing than ever to serve as Japan's leader for a short period in the wake of the LDP's disastrous results in Sunday's election.

“Japan is now entering a period of political uncertainty about whether a new coalition government is possible,” says David Bowling, an analyst at the Eurasia Group. “Political uncertainty will remain high in the near term,” adds Takeshi Yamaguchi, economist at Morgan Stanley MUFG.

Certainly, the upside for the LDP is that the opposition parties did not join forces to win a majority or form a ruling coalition. However, the best scenario for the LDP and its coalition partner Komeito is to find additional seats through a third party.

However, damage had been done, particularly to Ishiba and his ability to retain the prime ministership or claim a mandate to lead.

Although his predecessor, Fumio Kishida, was in power for three years, and his mentor, Shinzo Abe, for nearly eight years, most Japanese prime ministers get 12 months to make their mark – and most do not.

It comes down to leaders spending too much time holding down their jobs, and no time doing theirs. It seems certain that this cycle, which has been particularly prevalent since the mid-1990s, will come to Ishiba. Even before voters rejected him on Sunday, Ishiba had suffered one of the steepest declines in popularity ever seen by political observers.

In late September, when he shocked the political establishment by overtaking the front-runners for prime minister, Ishiba enjoyed support ratings exceeding 50%. But after four weeks of political shifts and administrative chaos, his numbers fell into the twenties.

This is far from what Kishida expected when he stepped down last month. Having agreed in his 20s amid scandal and weak economic conditions, Kishida chose to allow his party to enter the competition on Sunday with a new face.

To the surprise of many, this meant swapping one 67-year-old governor for another. Ishiba's persona as a man of the people led senior LDP figures to hope that he could revive the party's image.

Instead, reality collided with Ishiba – and fast. Bowling points out that for many years Ishiba enjoyed the public's approval.

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

But “since becoming prime minister, he has made some mistakes that have left him vulnerable to attack,” Bowling points out. Sunday's results mean that Ishiba is “weaker” and that “the odds are against him bouncing back.”

If Ishiba remains in office, he will be busy fighting to save his premiership. He will likely be too busy to address the economic headwinds coming Japan's way.

The most important of which is the economy, which is rapidly losing ground. This may come as a big surprise to LDP elders who encouraged Kishida to step down.

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

At the time, the Nikkei was testing all-time highs amid stable economic growth, 10-year corporate governance reforms were gaining momentum and hopes were high for accelerating wage gains.

Earlier this year, trade unions recorded their largest wage increase in 33 years. This has fueled optimism that the “virtuous cycle” that Tokyo has been yearning for for decades has arrived.

All of this has encouraged the Bank of Japan to begin exiting zero interest rates and 25 years of quantitative easing. On July 31, Bank of Japan Governor Kazuo Ueda's team raised short-term interest rates to 0.25%, the highest level since 2008. This sent the value of the yen sky-high.

Since then, an apparent slowdown in retail sales, exports, industrial production, machine tool orders and other sectors has led the Ueda team to hit the pause button to take additional tightening steps.

It also prompted the Ishida government to focus on the kind of short-term stimulus maneuvers that he claimed his government would avoid. Ishiba, a longtime financial hawk, has been an advocate of higher interest rates and a stronger yen. Not anymore.

Ishiba's retreat from these and other policies led to the yen's value falling beyond the level of 150 against the dollar. It also generates increased volatility in Japanese government bond yields.

On the one hand, the Ishiba government having to rely on opposition parties to retain power makes it more difficult to support fiscal consolidation and monetary liquidity normalization. On the other hand, the clock is now ticking faster and faster for Japanese leaders to work on implementing economic reforms.

The LDP's stumble could not come at a worse time for Asia's second-largest economy. The export boost that Tokyo was betting on is increasingly in doubt as Chinese growth slows. China is moving slowly to address the real estate crisis, which many compare to Japan's bad-loan crisis in the 1990s.

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.” But overall, “China's real estate mess is not something that can be fixed with a few rhetoric and ill-considered actions,” says Innes.

Larry Ho, an economist at Macquarie Bank, adds that the measures taken so far “may not be enough to change the housing market.”

On the other hand, Germany's recession weighs on Europe's prospects. The United States is showing signs of erosion. The geopolitical environment is not ideal with tensions flaring in the Middle East and the Russian invasion of Ukraine continuing.

The growing prospect of Trump being re-elected on November 5 to curb trade wars is a major source of global uncertainty.

Amid this uncertainty, investors have good reasons to doubt Tokyo's ability to get the reform process back on track. In the twelve years since the LDP returned to power, few significant improvements have been made.

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

The Nikkei's rise to record levels is due in part to steps to increase returns on equity, give shareholders a greater voice and diversify boards of directors. It is also a result of very low interest rates.

However, rising inventories did not mean much for the average Japanese household. Wages have generally lagged behind the rate of inflation. Japan ranks 30th among the 38 members of the Organization for Economic Co-operation and Development (OECD) in productivity.

What so-called Abenomics did, in the end, was prove that trickle-down economics still doesn't work. The scattered stimulus packages do not change economic paths as much as they change structural changes. Now, the clock is already ticking, as Japan's last government inherited a uniquely unbalanced economic trajectory.

On the one hand, the inflation that Tokyo has been craving for 25 years is here. The Bank of Japan is finally trying to normalize its overly aggressive interest rate regime. On the other hand, this high price dynamic is destroying household and business confidence. It makes Japan's economic equivalent of the dog that caught the car. Consumers find themselves missing out on deflation, which many saw as a hidden tax cut.

This balance has proven to be too much for Kishida, who took power in early October 2021. On the surface, Kishida's dismal approval ratings reflect political financing scandals within the LDP. In fact, it was mostly poor economic performance that ended his term.

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

Now, with the political winds shifting, Tokyo appears more captivated by events in Beijing and Washington.

Recently, the government of Chinese leader Xi Jinping admitted that the world's second largest economy is facing a problem.

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

Mainland stocks tried to rise on this news. The Governor of the People's Bank of China, Pan Gongsheng, hints at further reductions in the amount of cash that banks must hold in reserves.

The sooner Beijing sets a floor for the economy, the better Japan's prospects. China is Japan's largest trading partner ever. Having the first customer for your goods fighting deflation is rarely a positive for economic confidence.

Moreover, the specter of Trump Trade 2.0 is keeping many officials in Tokyo awake at night. Preparing for a Trump or Kamala Harris administration will be the primary concern for LDP officials. However, it is not as important as knowing whether the country's dominant party is able to find a way forward. With or without Ishiba in the mix.

Follow William Pesek on X at @WilliamPesek

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