Why Japan’s Currency Crisis Could Signal a Global Debt Reckoning
Japan’s currency and debt stress could raise U.S. mortgage rates and force investors to sell assets across global markets, potentially setting off a wider financial crisis.
Brian Daitzman is the Editor of The Intellectualist. Subscribe to his Substack.
Japan’s currency problem is not yet a sovereign-debt crisis. But on July 31, the United States joined Japan in buying yen, the first coordinated American-Japanese effort to support the currency in nearly 30 years.
The Federal Reserve Bank of New York reportedly sold euros and bought yen on behalf of the Treasury after the currency had fallen to its weakest level against the dollar since 1986. The yen had traded above 163 to the dollar before strengthening sharply following the intervention.
Japan’s finance minister said the operation was intended to counter excessive volatility and disorderly movements. The more consequential question is what Japan might otherwise have to do if the currency keeps falling.
The Bank of Japan could raise interest rates more aggressively. Japanese banks, insurers and pension funds could redirect money toward assets at home. Investors who borrowed cheaply in yen to buy stocks and bonds elsewhere could be forced to unwind those positions.
Each route offers a way for pressure that begins in Japan to move abroad.
What Is the Yen Carry Trade, and Why Does It Matter?
The yen carry trade is a strategy in which investors borrow money at low interest rates in Japan and use it to buy investments that may earn more elsewhere.
The potential profit comes from the difference between the low cost of the loan and the higher return on the investment.
The strategy works only while three things remain true:
Borrowing in Japan stays inexpensive.
The investments continue to earn money.
The yen does not rise sharply against currencies such as the dollar.
If the yen rises, investors must spend more dollars or other currencies to obtain the yen needed to repay their loans. A trade that once made money can quickly produce losses.
Investors may then reverse the strategy by selling stocks, bonds or other investments, converting the money back into yen and repaying their loans.
If many investors do this at once, the selling can push prices lower, create further losses and force still more selling.
That is why the yen carry trade matters beyond Japan. A sharp rise in the yen can spread financial stress through markets around the world, including markets with little direct connection to Japan.
Japan is caught in a difficult policy trap. Its interest rates have remained well below those in the United States, encouraging investors to seek higher returns in foreign assets, many denominated in dollars. Those flows can weaken the yen. A weaker currency, in turn, raises the local cost of imported oil, food and industrial materials, intensifying pressure on households, businesses and the central bank.
Higher Japanese rates could support the yen. But they would also reduce the market value of older bonds, increase the cost of refinancing government debt over time and make Japanese investments more attractive relative to foreign ones.
Currency intervention can postpone that choice. It cannot eliminate it.
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