Yves here. Satyajit Das describes the corner Japan has gotten itself into, and the likely reasons why Scott Bessent has attempted to ride in and attempt to rescue the yen, a move no one expects to work for more than a very short time.
By contrast, the G-5 Plaza Accord intervention, which was a too-late attempt to rescue the US auto industry and other US manufacturing by weakening the dollar, was narrowly too successful but failed to achieve its objective. The yen overshot on its increase, leading to the Louvre Accord to bring it back down. While the yen increase did lower Japanese exports to the US, it did not boost US exports to Japan. Japanese had and still has a strong preference for domestically made products, correctly seeing US wares as inferior.
Forgive Das his fiscal orthodoxy, which pretty much all finance professionals share. If you have had to spend much time thinking about debt coverage ratios and credit ratings, or worse, ever read an indenture, you will tend to see every government as being like a business, as in borrowing is legit only to help with short-term cash hiccups or to invest in growth. The notion that a currency issuer will not involuntarily go bankrupt but can generate too much inflation is alien.
So why is Bessent so concerned? The first possibility is he believes the bad orthodoxy. A second is that he is placating Trump, who was banging on about how they were too high, yet has pursue policies like tariffs, serious and seriously unproductive fiscal deficits, and an energy and food price goosing war with Iran, that would increase inflation and along with that, interest rates.?
By Satyajit Das, a former banker and author of numerous technical works on derivatives and several general titles: Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006 and 2010), Extreme Money: The Masters of the Universe and the Cult of Risk (2011) and A Banquet of Consequences (2016 and 2021). His latest book, The Everything Bubble: A Guide to the New Age of Financial Speculation and Phantom Wealth,> will be released in 2027. He has also written on ecotourism – In Search of the Pangolin (2006) (with Jade Novakovic) and Wild Quests: Journeys into Ecotourism and the Future for Animals (2024). This is a version of a piece published in the print edition of the New Indian Express
The joint intervention by the Bank of Japan (BoJ) and the US Federal Reserve (Fed) to support the floundering yen resembles two drowning people, neither of whom can swim, trying to keep each other afloat.
Since end 2020, the yen has fallen from 102 to the dollar to a low of 164, a decline of 60 percent to its lowest level in nearly four decades. After failed attempts to jawbone markets, checking rates to signal intent, the BoJ and Fed were forced to finally buy yen equivalent of around $87 billion. The official rhetoric was market stability. According to President Trump: “they have a weakening yen, and they wanted a little bit of help … Japan’s been very good to us, with the exception, of course, of Pearl Harbor.” The reality is different.
Japan faces rising inflation exacerbated by high energy prices, most of it imported, which is affected by a weaker yen. Reluctance to increase rates to counter inflation reflects a weak economy and high government borrowings. Another consideration is that a weak yen may result in foreign investors, who own around 32 percent of Japanese equities, divesting affecting share prices and selling the currency.
A weaker yen presents different problems for the US. Upward pressure on the dollar reduces export competitiveness. For Japanese investors, who are major global exporters of capital, higher BoJ rates favour domestic over overseas investments. With Japan the largest holder of US Treasury bonds (around $1.1 trillion), this could push up American rates and reduce demand for new issues.
It could undermine the carry trade where borrowed yen at low rates is used to fund higher yielding assets. Its total size, estimated at anywhere between $500 billion to over $4 trillion depending on what is included, poses a significant problem. Policymakers are wary of a repeat of the August 2024 unwind of the yen carry trade when Japan’s Nikkei 225 index fell 12.4 percent triggering declines in asset prices globally.
Intervention utilised a repo facility where the BOJ received dollars from the US Treasury using its bond holding as collateral to fund its yen purchases. This avoided liquidation of Treasuries which could pressure US rates The Fed also sold Euros not dollars to buy yen to lower selling pressure on the US currency.
Currency intervention rarely works, and it effects are generally temporary. While the September 1985 Plaza Accord designed to weaken the dollar was effective, subsequent attempts have proved less successful. The BoJ have intervened on several occasions with indifferent results. By late-August, the yen had resumed it weakening path.
The episode highlights deep structural problems of both economies.
In the case of Japan, these can be traced back to the ‘bubble’ economy, which resulted from the Plaza Accord. To offset the effects of a stronger yen, policymakers expanded liquidity setting off unsustainable increases in real estate and equity prices. At the end of 1989, the Nikkei closed at 38,915.87, constituting 42 percent of the total global equity market (just below the current proportion of the S&P500 relative to the global share market capitalisation). Extravagant property values were evidenced by the fact that the 3.4km² grounds of the Imperial Palace in Tokyo were worth more than the 424,000 km² land value of California.
After the BoJ raised interest rate to 6 percent, equity and urban land prices fell around 80 percent. The share market only regained its 1989 level in February 2024. Property prices remain below those bubble levels. The falls resulted in catastrophic bad debts requiring bailouts of major banks. Reluctance to restructure or foreclose on bad loans as it would recognise losses created zombie firms (some 15-20 percent of all Japanese businesses) whose earnings barely cover debt interest. The lack of investment retards growth.
As Japan became mired in its ‘lost decades’, policymakers responded with repeated fiscal stimulus, low and then negative interest rates, multiple rounds of quantitative easing, and liquidity infusions. The measures designed to offset the country’s ‘balance-sheet recession’ did not restart economic activity which averages an anaemic 1 percent, create inflation to boost asset values or reduce the real debt levels. It created chronic budget deficits, the highest government debt in the OECD (250 percent of GDP) and an over-burdened central bank whose government bond holding peaked at 54 per cent in 2023.
When inflation increased due to post-pandemic supply chain problems and global wars, policymakers could not increase rates. The BoJ’s policy rate is 1.0 percent after five increases over two years and remains negative in real terms. Higher rates, which may support the currency, would increase the government’s interest cost, and worsen deficits requiring additional borrowings to service debt. Government’s borrowing costs are a quarter of spending and projected to reach 30 percent of outlays in three years. But without higher rates, the yen will continue to weaken.
The US faces similar challenges with continuous budget deficits (6 percent currently) and rising debt from large serial crises, increased defence spending, and demographic pressures. Like Japan, it has become addicted to expansionary fiscal settings, low rates and loose monetary policy to sustain growth. The US faces additional constraints because of high levels of private debt alongside unsustainable government borrowing, a large trade deficit, and low domestic savings. Deindustrialisation means that many of these problems, like the trade imbalance, are difficult to correct.
America is increasingly dependent on leveraged speculation, in the form of basis trades, to fund the government. Japan is domestically financed (90 percent of Japanese government bonds are held by local investors). In contrast, the US is reliant on foreign capital, with overseas investors holding roughly 30 percent of government debt as well as significant amounts of corporate equities and bonds. Like Japan, it can’t afford rates to rise or reduced foreign demand for its securities.
The US government must refinance around a third of its debt every year as it funds increasingly with short-dated Treasury bills to minimise borrowing costs. It annual gross financing needs are around 45 percent of GDP and rising.
The only solution is a return to fundamentally sound fiscal and monetary disciplines alongside international co-ordination. Neither government seems willing to take decisive action for ideological reasons as well the overwhelming financial and economic costs.
Instead, the focus is on short-term measures. Alongside intervention in currencies, US Treasury Secretary’s plans to increase purchases of long dated Treasury bonds to manage its costs of borrowing provides evidence of the desperation. President Trump’s suggested that he could use the military to reduce bond rates. It ignores the fact that market manipulation cannot be for sustained periods of time.
Japan and America foreshadow the approaching economic end game. Without policy changes and steely political resolve to address the core issues, a crisis appears inevitable. It will take the form of an unprecedented financial crash and the failure of the currency system, which will, in turn trigger a collapse of economic activity, societal and political breakdown. Given the importance of the two economies, the effects will be global.
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