Ishiba “Gives Away The Store” to Trump

Pact Permits Trump To Impose New Tariffs if Japan Declines Any Of His Investment Schemes

Note: see explanation below in the text

So desperate was now-former Prime Minister Shigeru Ishiba to lower Donald Trump’s 25% tariffs on Japanese products to 15%, especially on automotive products, that he signed on to an incredible surrender regarding Tokyo’s promise for the government to invest $550 billion in the US over the coming three years.

Not only does Trump get to choose the projects and the US get the lion’s share of any profits, but if Japan dares to reject any of Trump’s schemes as nonviable, Ishiba has given Trump permission to impose even higher tariffs. The jointly-signed Memorandum of Understanding (MOU) says that, “In the case where Japan elects not to fund [a project Trump has named—rk], the United States may also impose tariff rate or rates on Japanese imports into the United States at the rate determined by the President [emphasis added].” Some in Japan excuse this by saying that Trump could raise tariffs anyway in violation of any written agreement, as he has already done repeatedly. True enough, but by permitting Trump to do so, Tokyo has eliminated its ability even to protest, let alone negotiate.

Even if Trump doesn’t raise tariffs again, the economic harm to Japan’s population could far outweigh any gain to the big exporters from lowering tariffs to 15%. It seems that Ishiba has sacrificed Japan in the hope of helping Toyota and Mazda.

Neither the EU nor Korea accepted anything like this in their investment discussions with Trump, and certainly no permission to raise tariffs if goals were not met. Europe, for example, just said what it expected private firms to invest.

There’s a big fly in the ointment. While the overall deal does not have to be approved by the Diet, the financing mechanism does have to be approved (details below). Since the ruling LDP no longer has a majority in the Diet, this could become contentious.

Stop the Presses: Trump Told The Truth!

Astonishingly, Trump has spoken more truthfully than Tokyo. All along, Trump insisted that he would choose the projects, and the US would get 90% of the profits. Assurances by Japan’s chief negotiator, Ryosei Akazawa, that each country would benefit in proportion to its share of the investment were false. And yet, Akazawa now says the details of the MOU are more or less the same as was agreed to in July.

Japan’s negotiator Ryosei Akazawa wearing MAGA hat in the Oval Office in April

I wonder whether the provision about raising tariffs was something Trump added at the last minute. I don’t recall anyone mentioning this before. Moreover, Akazawa last week cancelled a planned meeting in Washington to consult with Tokyo on a new US demand.

It should be noted that giving Trump $550 billion to invest in what he pleases and with what companies he pleases increases his leverage over American corporations, making them even more fearful of displeasing him. So, this deal harms the US, not just Japan.

Caveats

The MOU has not been published yet, but Japan’s Cabinet Office provided reporters with printed versions in Japanese and English. It is full of ambiguities and omissions that make different interpretations almost inevitable. So, it is not hard to imagine Tokyo asserting that the MOU says X while Trump insists it means Y, accuses Japan of violating the terms, and then raises tariff rates.

While the MOU states that it is “an administrative understanding...and does not create legally binding rights and obligations,” Trump will certainly regard Japan’s concessions as binding.

$550 Billion Equals Japan’s Total Tax Revenue Per Year

The MOU says Japan will invest $550 billion through the rest of Trump’s term, an average of $183 billion per year. That’s enormous. $550 billion is more than Japan’s entire national tax revenue of ¥75 trillion ($511 billion) in fiscal 2024. $183 billion per year is more than Japan’s $143 billion in exports to the US. It’s 2.4 times the foreign direct investment of Japanese companies into the US in 2024.

While the MOU does not state where the $550 billion will come from, a Nikkei article saying the pact makes Japan “subject to Trump’s whims” cites unnamed Japanese officials as saying that two government agencies, JBIC (Japan Bank for International Cooperation) and NEXI (Nippon Exports and Investment Insurance), will provide investment money, loans, and loan guarantees. JBIC is the primary agency for such a mission. It is now being asked to invest each year for the next three years more than ten times the ¥2 trillion ($14 billion) it invested in 2024. Where will JBIC get the funds? This could become a political problem (see below).

Trump Chooses the Projects

The MOU says that “The President of the United States of America selects Investments that have been recommended by the Investment Committee [headed by the Secretary of Commerce].” There is a Consulting Committee in which Japanese officials will participate, but it has no power.

When Trump tells Japan to invest in this or that project, Japan has 45 business days to provide the funds in dollars into a special account or else risk a hike in tariff rates.

The MOU says that the projects include, but are not limited to, semiconductors, pharmaceuticals, metals, critical minerals, shipbuilding, energy (including pipelines), and artificial intelligence/quantum computing.

Japan can even be forced to invest in projects with commercial viability or face higher tariffs. For example, Trump has been pressing Japan and Korea to invest in a $44 billion Alaskan pipeline oil project and buy some of the resulting oil. No Japanese companies want to invest for the same reason that American companies have abandoned it: the proposed project is a money-loser. Why would Ishiba agree to this?

Japan Takes All The Risk, Gets Only A Small Reward, Perhaps a Loss

When Akazawa first raised the notion of investment instead of tariffs in his Oval Office meeting with Trump, he was talking about the amount that Japan’s private companies were intending to invest in the US. Companies from Toyota to Panasonic to Bridgestone own and control them and thus receive the resulting profits. Instead, in this deal, Japan is simply handing cash to Trump and taking all the risk despite little reward.

Although this is called an investment rather than a loan, Japan suffers the downside of both worlds. Normally, the upside for lenders is that, unless the borrower goes bankrupt, they will get all their money back. The downside is that its upside gain is limited to the interest rate, no matter how high the profits. Conversely, an investor’s upside is that there is no ceiling on its gain: think Amazon.com. The downside is the investor could lose much or all of its investment: think Kodak. In this deal, there is no guarantee that Japan will get all its money back, or even any. And, even if the project does well, Japan will gain little profit because the US will get the lion’s share. Tokyo would be better off putting $550 billion into US Treasury bonds.

In this deal, Japan and the US share on a 50/50 basis (net of US taxes) the profits of the project until they reach a so-called “Deemed Allocation Amount.” What is the latter? It has two components.

The first component is interest on the investment, as in a loan. The rate is the rate on a “six-month SOFR”—now around 4%—plus a spread to be determined by the length of the project and risk premium. If the total were 6%, then Japan would get 3%.

The second component is repaying the loan. Although the MOU does not say so, I presume this includes whatever interest JBIC has to pay on the bonds it issues. This is one of those cases where the MOU is open to contending interpretations. If constructing the project takes ten years, then Japan supposedly gets back 10% of its investment each year, but only if the project generates enough operating profit to afford the repayment.

Here’s the catch. The money to pay back Japan comes from the project’s so-called “free cash flow.” The latter is the revenue from operations minus all expenses, including investment expenses. Often, in a new complex project, the required investment can exceed the revenue for several years. Think of the years needed to build the Alaska pipeline. In that case, there may not be enough money either to pay the interest or repay the initial loan for years, perhaps never. So, Japan could lose a lot.

On the other hand, suppose the project earns a 20% annual return on investment above and beyond the interest. 90% of the excess profits go to the US, just 10% to Japan.

So, if the project is a loser, Japan loses; if it’s a winner, the US wins.

Why Did Ishiba Acquiesce?

Ishiba contended that reducing the tariffs to “only” 15% was so vital that it was worth signing almost anything. I think that calculation is wrong in sheer economic terms, not to mention the precedent it sets for Trumpian blackmailing of Japan.

Nikkei cites a Japanese official as saying, “It will take time, but we basically see no chance for the loans to go bad and become unrecoverable.” If he really sees no chance, perhaps it’s time for new eyeglasses.

There’s another possibility. When I recently asked influential Europeans why the EU had surrendered to Trump rather than carrying out its threat of retaliation against the tariffs, I was told, “Trump threatened us on security matters.” I have yet to have a chance to ask Japanese sources whether Tokyo received similar threats.

Will The Diet Approve the Funding Scheme?

Ishiba has tried to avoid making a legally binding pact because it would be subject to Diet approval. That’s one reason the MOU says it is not legally binding. However, the Diet has to approve the JBIC budget. Moreover, to the extent that JBIC issues bonds internationally, these are guaranteed by the government, which affects the national budget and deficit. Given the minority status of the LDP/Komeito coalition, the incoming Prime Minister needs support from at least one opposition party. I suspect such parties would not want to be blamed for giving Trump an excuse to raise tariffs. However, I also suspect that any party willing to comply would want to extract a high price, either affecting the terms of the MOU or some other issue, e.g., taxes. This could become contentious, and the public will become aware of how much Ishiba gave away.

What This Means For the US-Japan Trade Deficit And the Dollar?

While Trump wants to reduce, or even eliminate, the US trade deficit, this deal and similar ones with the EU and Korea will cause the deficit to explode. Here’s why.

Building these projects will require enormous amounts of supplies. Suppose the US buys all the supplies from Japan. The trade deficit with Japan would almost quadruple from $63 billion in 2024 to $246 billion ($63 plus $183). See chart at the top of the post.

Suppose the US bought everything domestically, with none coming from Japan or any other foreign supplier. That would push the dollar much higher. That’s because, to supply the $550 billion, Japan has to sell yen and buy dollars, thereby creating a marked increase in demand for the dollar. The resulting rise in the dollar means the US would buy more imports (because they’d now be much cheaper) and export less (because their price to foreign buyers would rise).

Some might think an increase in Japan’s trade surplus is a good thing. However, this mainly benefits the large exporters, and if achieved through a cheaper yen, it means higher prices and a lower standard of living for Japanese households.

Whatever route brings about the explosion of the US trade deficit, Trump will, no doubt, accuse foreign countries of cheating via currency manipulation. In reality, the fault, dear Donald, lies not in cheating by others but in your own harebrained schemes.

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