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Will Japan bring down the world economy? | The Economist
7/10TL;DR
A rare US-Japan currency intervention has drawn attention to the weak yen, the vast yen-funded carry trade, and the risk that changes in Japan’s interest rates could ripple through US Treasuries, equities and global capital flows.
KEY POINTS
Rare joint intervention
The US Treasury joined Japan in supporting the yen for the first time in roughly three decades, with Treasury Secretary Scott Bessent reportedly buying between $5 billion and $10 billion worth of yen. The move stood out not only for its rarity but also because the purchases were made using euros rather than dollars. It followed months of pressure on the Japanese currency and signaled that yen weakness had become an issue of broader international concern.
Japan had already stepped in heavily
The joint action came after a much larger unilateral effort by Japan, which had already spent about $73 billion in May to defend the currency. Japanese officials had also repeatedly tried to steady markets with verbal warnings and policy signals. The latest intervention therefore marked an escalation of an existing campaign rather than a sudden shift.
Why the weak yen is now a political problem
A weak yen once benefited Japan by making exports more competitive, helping large multinational manufacturers. That calculation has changed. Yen weakness now raises import costs, adds pressure on households, contributes to inflation above 2%, and has become tied to domestic complaints about the cost of living and overtourism.
Interest rates are at the center
The underlying reason for the yen’s weakness is Japan’s long era of ultra-low interest rates. For years the country struggled with deflation, weak growth and near-zero price pressures, leading to exceptionally loose monetary policy. Investors could borrow cheaply in yen and shift money into higher-yielding assets abroad, weakening demand for the currency.
The policy regime is changing
That backdrop is no longer as stable as it once was. Japan’s inflation has stayed above 2% for around four years, and the Bank of Japan has already moved rates from -0.1% to about 1%. Markets now expect another increase, potentially toward 1.25% or 1.5% later this year, raising the question of whether higher Japanese yields will disrupt long-standing global investment strategies.
The global carry trade is exposed
The yen has long served as one of the world’s main funding currencies, sometimes described by traders as the world’s ATM. Cheap yen borrowing has financed purchases of US Treasuries, overseas equities, Asian assets and even US tech stocks. If higher Japanese rates make that borrowing model less attractive, investors may unwind positions across multiple markets at once.
Why Washington is watching closely
Japan is the largest foreign holder of US Treasuries, making its financial stability a direct concern for Washington. A disorderly unwind that pushed Japanese investors to sell Treasuries could lift US borrowing costs. The concern is not limited to government bonds: a broader retreat from yen-funded risk-taking could intensify selloffs in richly valued stock markets already seen as vulnerable.
Systemic risk is possible, but not inevitable
The main danger is not Japan alone but Japan acting as a catalyst in an already fragile system marked by high equity valuations and geopolitical fragmentation in capital flows. A sharp unwind of carry trades could accelerate a wider retreat from cross-border investing. Still, recent volatility has so far been a warning rather than a collapse, and governments retain tools including foreign-exchange reserves, asset sales and policy coordination to contain stress.
CONCLUSION
The yen has become more than a currency story: it sits at the intersection of Japan’s inflation shift, US financing conditions and the stability of global risk markets. Whether the adjustment is gradual or disorderly will determine how serious the threat becomes for the wider financial system.
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