In the current global economic landscape, Japan finds itself grappling with significant challenges, particularly regarding its currency, the yen. Satyajit Das provides insights into Japan’s precarious situation and examines the efforts of Scott Bessent to stabilize the failing yen—an endeavor many believe will yield only temporary relief.
Historical Context
Historically, the G-5 Plaza Accord intervention aimed to support the US manufacturing sector by weakening the dollar. While it made a notable impact, it ultimately fell short of its intended goals. The yen’s value surged excessively, necessitating the Louvre Accord to correct its trajectory. This fluctuation affected Japanese exports to the US without meaningfully increasing American exports to Japan, as Japanese consumers have consistently favored domestically produced goods, viewing US products as inferior.
Das’s Perspective
Das’s perspective is shaped by conventional fiscal norms that most finance professionals subscribe to. Those acquainted with debt ratios and credit assessments often perceive governments through the lens of business operations—viewing borrowing as acceptable only in emergencies or for growth investments. The concept of a currency issuer not facing insolvency but rather dealing with inflation is foreign to many.
Concerns about the Yen
Why is Bessent troubled? One possibility is that he subscribes to traditional economic beliefs. Alternatively, he may be trying to appease political pressures, particularly from Trump, who has criticized Japan’s economic practices, despite his administration’s own inflation-inducing policies, such as tariffs and conflict-related energy price increases.
By Satyajit Das, former banker and author of several influential works, including: 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 upcoming book, The Everything Bubble: A Guide to the New Age of Financial Speculation and Phantom Wealth, will be published in 2027. This piece also appeared in the print edition of the New Indian Express.
Recent Developments
The recent joint intervention by the Bank of Japan (BoJ) and the US Federal Reserve to bolster the struggling yen is akin to two drowning individuals attempting to save one another. Since late 2020, the yen has plummeted from 102 to 164 against the dollar, marking a 60% decline and hitting its lowest point in nearly four decades. After numerous failed tactics to manage market perceptions, the BoJ and Fed were compelled to purchase yen worth approximately $87 billion. The official narrative championed market stability, but the underlying realities were starkly different.
The Inflation Dilemma
Japan faces escalating inflation, intensified by soaring energy costs—largely imported—that are further compounded by a weakening yen. The unwillingness to raise interest rates stems from a delicate economic environment and substantial government debt. Furthermore, a diminished yen could lead to divestment by foreign investors, who hold about 32% of Japanese stocks, ultimately impacting share prices and currency stability.
Consequences for the US
For the US, a weak yen can create various complications, exerting upward pressure on the dollar and diminishing export competitiveness. Since Japanese investors are significant global capital exporters, an increase in BoJ rates could shift their focus back to domestic over international investment. Notably, with Japan holding around $1.1 trillion in US Treasury bonds, this scenario could inflate American interest rates and dampen demand for new issuances.
Moreover, the weakened yen places the carry trade—a strategy where low-interest yen is borrowed to purchase higher-yielding assets—at risk. Current estimates of this strategy’s size range from $500 billion to over $4 trillion, posing considerable risk to the market. Policymakers are wary of a repeat of the August 2024 unwind of the yen carry trade, which caused a 12.4% decline in Japan’s Nikkei 225 index, triggering global asset price drops.
Mechanics of Intervention
The recent intervention utilized a repo facility where the BoJ received dollars from the US Treasury, leveraging its bond holdings as collateral for yen purchases. This strategy avoided a Treasury liquidation that could pressure US rates. Furthermore, the Fed opted to sell Euros instead of dollars for yen to mitigate selling pressure on the American currency.
Limited Effectiveness of Currency Intervention
Historically, currency interventions like these have often proven ineffective, with impacts typically being fleeting. While the Plaza Accord of September 1985 successfully weakened the dollar, subsequent interventions have yielded less favorable outcomes. The BoJ has also intervened on various occasions, with inconsistent results. By late August, the yen had begun to weaken once more.
Structural Issues in Japan
These events underscore the deep-rooted structural issues afflicting both economies. For Japan, challenges can be traced back to the aftermath of the ‘bubble’ economy that emerged post-Plaza Accord. In an effort to counteract the stronger yen, policymakers expanded liquidity, leading to unsustainable surges in real estate and equity prices. By the end of 1989, the Nikkei closed at a staggering 38,915.87, accounting for 42% of the global equity market—a proportion only recently rivalled by the S&P 500. The exorbitant value of the Imperial Palace grounds in Tokyo, exceeding the worth of all of California’s land area, illustrated this real estate bubble.
When the BoJ raised its interest rate to 6%, equity and land prices dropped by approximately 80%. The stock market only regained its 1989 level in February 2024, and property prices still linger below those peak values. This decline led to substantial bad debts, necessitating bailouts for major banks. The reluctance to restructure or write off bad loans gave rise to ‘zombie’ companies, which account for about 15-20% of businesses in Japan, where their earnings barely cover debt interest. This lack of investment hampers economic growth.
Economic Stimulus and Challenges
As Japan became entrenched in its ‘lost decades’, policymakers attempted to stimulate the economy through repeated fiscal measures, low and subsequently negative interest rates, and multiple rounds of quantitative easing. However, these strategies have failed to rejuvenate economic activity—averaging only about 1% growth—combat inflation to positively influence asset values, or mitigate real debt levels. This situation has resulted in chronic budget deficits and the highest government debt in the OECD—at a staggering 250% of GDP. The BoJ’s holdings peaked at 54% in 2023, burdening the central bank.
The recent rise in inflation—due to global supply chain disruptions and geopolitical conflicts—has further complicated the landscape. The BoJ’s current policy rate sits at 1.0%, following five increases over two years, yet remains negative in real terms. Raising rates could support the yen, but simultaneously inflate government interest expenses, exacerbating deficits and necessitating more borrowing to service existing debt. Current projections suggest that the government’s borrowing costs may reach 30% of total spending in three years. Without a rate increase, the yen’s depreciation is likely to persist.
Challenges Faced by the US
Similarly, the US grapples with continuous budget deficits—currently at 6%—and rising debt resulting from ongoing crises, increased defense spending, and demographic pressures. Like Japan, it has developed a dependency on expansionary fiscal policies, low-interest rates, and lax monetary measures to sustain growth. The US also faces unique challenges, including high levels of private debt intertwined with unsustainable government borrowing, a significant trade deficit, and low domestic saving rates. The deindustrialization of the economy renders some of its issues—including trade imbalances—difficult to address.
America’s economy increasingly relies on leveraged speculation to fund government operations, while Japan’s debt is predominantly domestically financed, with 90% of its government bonds held by local investors. In contrast, the US depends on foreign capital, with international buyers owning roughly 30% of government debt, alongside significant stakes in corporate equities and bonds. Like Japan, it cannot afford rising interest rates or diminished foreign demand for its securities.
The US government must refinance about a third of its debt annually, predominantly using short-term Treasury bills to curb borrowing costs. Its annual gross financing needs represent around 45% of GDP and are on the rise.
A Path Forward
The only viable solution lies in a return to fiscally and monetarily sound policies and enhanced international coordination. However, both governments seem hesitant to take decisive actions due to ideological constraints and significant financial and economic repercussions.
Instead, the focus remains on short-term fixes. The intervention, along with US Treasury Secretary’s emphasis on increasing long-term Treasury bond purchases to manage borrowing costs, indicates desperation. President Trump has even suggested using military influence to lower bond rates, disregarding the reality that market manipulation is typically unsustainable.
The Inevitable Crisis
Both Japan and the US serve as harbingers of an approaching economic crisis. Unless there is a significant policy shift and strong political resolve to tackle essential issues, an inevitable crisis will unfold. This may manifest as an unprecedented financial downturn, leading to a collapse of currency systems and consequently triggering a sharp decline in economic activity and a potential societal and political breakdown. Given the global significance of these two economies, such an event would have far-reaching consequences.
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