Japan’s Wobbling Yen Could Trigger A Global Financial Crisis

The wobbling Japanese yen could trigger a global financial crisis, but effectively dealing with it is surprisingly straightforward.

The yen recently reached a 40-year low against the dollar. The fear is that a further fall in the currency’s value will precipitate a crisis of confidence that will not only set off a serious bout of inflation inside Japan—the very definition of monetary inflation is reducing the value of a currency—but also adversely impact financial markets around the world.

That’s why the U.S. and Japan just undertook a very rare joint intervention in currency markets to prop up the yen. In other words, both countries used dollars to buy the yen.

The intervention has had success. However, most experts believe the relief will be short-lived because of adverse fundamentals in Japan: a too-low short-term interest rate, which is 1% vs. around 3.5% in the U.S.; a national debt that is proportionately twice that of the U.S.; rising energy prices; and a declining and aging population.

The immediate worry for U.S. Treasury Secretary Scott Bessent is that in an effort to save the yen from collapse, Japan will start liquidating its $1.1 trillion portfolio of Treasury bonds and bills, not to mention its holdings of German and British bonds. Such sales would put pressure on interest rates. After all, financing our immense budget deficits and refinancing some $7 trillion of our existing debt that’s coming up for renewal are already worrying the markets. This anxiety, for instance, is why the interest rate on our 30-year Treasury bond has reached its highest level in almost 20 years.

Bessent wants the Federal Reserve to beef up a facility it created in 2020 to deal with a dollar shortage caused by the pandemic and use it now to help the yen. He could also employ a Depression-era facility called the Exchange Stabilization Fund. The idea is that through these devices Japan could borrow dollars using its Treasury holdings as collateral. No sales necessary.

This help is nice, but there are better, more immediate ways to deal with the crisis. Japan should boost its utterly unrealistic short-term interest rate. More important, it should stop making a big, basic mistake when it uses its dollars to buy yen in the foreign exchange markets: After it buys the yen, Japan then effectively reintroduces those yen back into its economy. It’s similar to taking a bucket of water from one end of a pool and pouring it into the other end. In other words, the supply of yen remains unchanged. No wonder Japan’s previous interventions to buck up the yen have failed.

Another important thing that both the U.S. and Japan should do—but won’t—is to announce that they want a stable rate between the dollar and the yen. They might even give a range of, say, 150 to 155 yen to the dollar and make clear that the two countries would massively intervene in the exchange markets to keep it there. Japan would, if necessary, reduce the supply of yen to keep it in that range. These steps would quash the immediate crisis.

Longer-term, Japan needs to enact major cuts in its tax rates to set off an impressive economic boom. In the U.S., the combined Social Security and Medicare tax rate is 12.4%. In Japan, it’s over 30%. Japan’s sales taxes and individual and corporate taxes are higher than they are here.