Open this photo in gallery:
U.S. Treasury Secretary Scott Bessent co-ordinated with the Bank of Japan last week to stem the yen’s decline, a highly unusual move that could affect us all, John Rapley writes.Kylie Cooper/Reuters
John Rapley is a contributing columnist for The Globe and Mail. He is an author and academic whose books include Why Empires Fall and Twilight of the Money Gods.
In a U.S. administration staffed with loyalist journeymen, Treasury Secretary Scott Bessent has stood out for mastery of his brief. A consummate Wall Streeter, he has managed the markets with aplomb, ensuring their steady rise despite serving a President who by now might have, given his fickleness and outlandish experimentation, brought everything crashing down.
That doesn’t mean Mr. Bessent is above doing Trumpian things, insofar as they break with traditional norms. Last week, for instance, he co-ordinated with the Bank of Japan to stem the decline of the yen, a highly unusual move. This could affect us all.
As Japan has emerged from decades of stagflation and the government has begun spending big to stimulate the economy, both Japanese bonds and the yen have been falling in value. Driving the yen’s weakness has been the return of inflation, which has been worsened by the rise in oil prices since the start of Donald Trump’s war in Iran. The Bank of Japan, which pioneered the use of ultra-loose monetary policy years ago to try to revive a moribund economy, still keeps short-term rates well below those of other G7 central banks – less than half the level of Canada and Europe and barely a quarter that of the U.S. and Britain.
Opinion: A broken economy. Few jobs. Rising costs. Are you surprised youth are rebelling?
Decoder: Did Canada just join the AI boom?
With investors still able to borrow cheaply in Japan, they have been fuelling a carry trade: Borrowing in yen and then converting their money into other currencies so as to buy the bonds of countries with higher returns. That movement, coupled with worries that the Bank of Japan may let inflation get out of control – at only 1.7 per cent, it has nonetheless begun rising at an average monthly rate of 0.1 per cent – has caused investors to dump yen to put their money elsewhere.
A weakening currency is always a concern for a central bank, because it raises import costs. As the exchange rate drops, an importer must pay ever more local currency for the same volume of imports, and so will charge a higher price to local consumers to make up the loss. That can worsen inflation. So when a currency loses a lot of value – and the yen had fallen 10 per cent over the past year, making most imports that much more expensive – a central bank will sometimes intervene to prop it up.
Typically, it does this by dipping into its foreign exchange reserves and converting some of the foreign currency into its own money, thereby driving up its value. The Bank of Japan has been intervening this way for years, selling dollars to buy yen. Alas, it has had little effect. Currency interventions rarely work, because traders know that central banks have only so much money in their foreign accounts and are happy to take it off their hands at discounted rates.
Open this photo in gallery:
An electronic board showing the U.S. dollar and Japanese yen exchange rate in Tokyo on Monday.Eugene Hoshiko/The Associated Press
However, last Friday’s intervention was different, with the yen leaping in value. The reason it did so is that the U.S. Treasury joined in, turning to a little-used facility at the Federal Reserve to convert euros into yen. That peculiar twist − dipping into its euro reserves rather than using dollars − may offer a clue as to why the Treasury decided to help Japan.
Interest rates are rising across all developed markets, and the U.S. leads the way, with the rate on a 10-year Treasury bond up nearly half a percentage point since the start of the year. Given the massive and ever-rising scale of U.S. debt, each percentage-point increase drives the U.S. budget deficit up by nearly US$400-billion.
Needless to say, this is becoming a problem for the Treasury. If Japan starts selling off its U.S. bonds to support the yen, the drop in demand for U.S. Treasury instruments will lower their price, which in turn will further raise their yield – their interest rates. Mr. Bessent wants to keep rates down through the backdoor, so selling euros enables him to help the Bank of Japan strengthen the yen without having to cash in any dollars.
It’s a risky move, though, and nobody knows that better than him. That’s because he made his fortune betting against currencies as a trader at George Soros’s fund. “You can’t beat the market” was the mantra of currency traders like him. The Secretary is trying to do just that.
The sheer scale of the U.S. Treasury, as the issuer of the world’s principal reserve currency, may make this time different. Then again, it may not. As the week wore on, the yen resumed sliding. With Japan’s interest rates rising fast as demand for its bonds falls below supply – interest rates have shot up nearly 1.5 percentage points over the past year – it may be just a matter of time before everyone starts selling their foreign bonds to buy Japan.
And if that happens, interest rates here and everywhere else could keep going up.