The recent joint intervention by the Bank of Japan (BoJ) and the US Federal Reserve (Fed) to support the floundering yen resembled two drowning people, neither of whom can swim, trying to keep each other afloat.
The yen has slid since the end of 2020 from 102 to the US dollar to a recent 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 Donald 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 Harbour”. 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 divestment from foreign investors, who own around 32 percent of Japanese equities, affecting shares and 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 investments. With Japan as the largest holder of US Treasury bonds (around $1.1 trillion), this would 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. 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.
The intervention used 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 sold euros, not dollars, to buy yen to lower selling pressure on the US currency.
Currency intervention rarely works, and its effects are temporary. While the September 1985 Plaza Accord designed to weaken the dollar was effective, subsequent attempts have proved less successful. The BoJ has intervened on several occasions with indifferent results. By mid- August, the yen had begun weakening.
The episode highlights deep structural problems of both economies.
For 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. Extravagant property values were evidenced by the fact that the 3.4km² grounds of the Imperial Palace in Tokyo were worth more than 424,000 km² of land in 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 as it would recognise loan losses created zombie firms (some 15-20 percent of all businesses) whose earnings barely cover debt interest.
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 did not restart economic activity which averages an anaemic 1 percent, create inflation to boost asset values and reduce the real debt levels. It created chronic budget deficits, the highest government debt in the Organisation for Economic Co-operation and Development—250 percent of GDP—and an over-burdened central bank whose government bond holding peaked at 54 percent 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 would support the currency, would increase the government’s interest cost, and worsen deficits requiring additional borrowings to service debt. The 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 at present) 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 leverage 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 reduce foreign demand for its securities.
The US government must re-finance around a third of its debt every year as it funds increasingly with short-dated Treasury bills to minimise borrowing costs. Its 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.
Japan and America foreshadow the approaching economic endgame. 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.
Satyajit Das | Former banker and author of The Everything Bubble (2027)
(Views are personal)