The Yen Is Japan's Problem. Until It Isn't.

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A weak currency sounds like a domestic problem.

For Japan, it is anything but.

The yen has fallen to levels not seen in decades, forcing Tokyo to intervene repeatedly in currency markets. But this time there is something unusual: the United States is getting involved.

That matters because the yen isn't simply Japan's currency. It is one of the world's most important funding currencies, sitting underneath trillions of dollars of investments in US bonds, Asian equities, European assets and emerging markets.

For years, investors have borrowed cheaply in yen and invested that money elsewhere, exploiting the enormous gap between Japanese interest rates and those available in the rest of the world. As long as the yen stayed weak and predictable, the trade worked beautifully.

But when the yen moves sharply, the same trade can unwind with extraordinary speed.

That is why the question confronting Japan is no longer simply, "How do we strengthen the yen?"

It is a much more difficult question:

How do you fix a currency without destabilizing the global financial system that has quietly been built around it?

To understand today's yen crisis, it helps to go back to a very different Japan.

In the 1980s, Japan was one of the world's great economic success stories. The Nikkei rose more than 450% over the decade. Banks lent aggressively, property prices surged, and investors became convinced that Japanese growth had no obvious ceiling.

Then the Bank of Japan raised interest rates dramatically in 1989, taking them from roughly 2.5% to 6%.

The boom collapsed.

What followed was not simply a normal recession. Japan entered a prolonged period of stagnation and deflation that would shape its monetary policy for decades. Interest rates eventually fell toward zero as policymakers repeatedly tried to revive demand.

The extraordinary part is how long that emergency became normal.

While the US, Europe and eventually emerging markets offered investors increasingly attractive returns, Japan remained an economy where money was exceptionally cheap.

That created one of the most important financial trades of the modern era.

Imagine being able to borrow money at extremely low interest rates in Japan and invest it somewhere offering substantially higher returns.

If you are a global investor, the logic is difficult to resist.

Borrow yen.

Sell the yen.

Buy US Treasuries, Korean stocks, European assets, emerging-market bonds or almost anything else offering a higher return.

The trade became known as the yen carry trade, and its scale is enormous. Estimates cited in the podcast put offshore investments funded through yen borrowing at more than $4 trillion.

That number explains why the yen's weakness matters far beyond Tokyo.

Every time an investor sells yen to buy another asset, downward pressure is placed on the Japanese currency. And as long as Japan's interest rates remain dramatically below those elsewhere, investors have an economic reason to keep repeating the trade.

This creates a peculiar feedback loop.

The weaker the yen becomes, the more attention it attracts from policymakers.

But unless the underlying interest-rate differential changes, investors have an incentive to come back and sell it again.

It would be easy to blame currency traders for the yen's weakness.

The reality is more complicated.

Japan has one of the highest government debt burdens among developed economies, with national debt exceeding 200% of GDP. It is also heavily dependent on imported energy, meaning geopolitical disruptions and higher commodity prices can quickly increase the country's import bill.

Then there are Japan's own institutional investors.

Japanese pension funds and life insurers are among the world's largest pools of capital. They have enormous overseas portfolios and long-term liabilities to meet. If domestic assets offer relatively unattractive returns, they have a powerful reason to continue investing abroad.

That creates another structural source of yen selling.

The result is that Japan isn't fighting one group of speculators.

It is fighting an entire financial architecture that has developed around low domestic interest rates.

And that is much harder to reverse.

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There is a conventional economic argument for a weaker currency.

It makes a country's exports cheaper and can attract foreign tourists. For Japan, the effect is visible in places like Tokyo and Kyoto, where international visitors increasingly find the country remarkably affordable.

But what benefits exporters can hurt consumers.

Japan imports enormous quantities of energy and other goods. When the yen weakens, those imports become more expensive in local currency. Household costs rise. Small businesses face higher input prices. The resulting squeeze becomes a political problem.

And voters don't care about the theoretical benefits of a competitive currency when their grocery and energy bills are rising.

That political pressure is becoming increasingly important.

Japan's government has already been responding to the cost-of-living burden, but fiscal support can only go so far. Eventually, the currency itself becomes part of the political conversation.

A weak yen may help parts of the economy.

It also becomes painfully visible in everyday life.

This is where the story becomes much bigger.

Japan is one of the world's largest holders of US Treasury securities. If Tokyo needs to support the yen, one mechanism available to it is selling some of its dollar-denominated foreign-exchange reserves and using those dollars to buy yen.

That can mean selling US Treasuries.

And that creates a fascinating connection.

Japan selling assets to defend its currency can push Treasury prices lower and yields higher. Higher US Treasury yields, in turn, increase borrowing costs across the American economy, from government financing to mortgages and corporate debt.

Suddenly, a Japanese currency problem can become an American borrowing-cost problem.

The carry trade creates another transmission mechanism.

When the yen suddenly strengthens, investors who borrowed in yen and invested elsewhere can find their positions moving against them. They may be forced to unwind those trades, selling stocks, bonds and other assets to repay yen-denominated liabilities.

We saw a version of this dynamic in August 2024, when a sharp yen move contributed to turmoil across global markets.

This is why the yen matters.

It isn't simply a currency.

It is part of the plumbing of global capital.

Japan has substantial firepower.

It holds more than $1 trillion in foreign-exchange reserves and has already demonstrated its willingness to intervene aggressively in currency markets. When Tokyo sells dollars and buys yen, the immediate effect can be dramatic. The dollar-yen exchange rate can move several percentage points in a matter of hours.

But intervention has a fundamental limitation.

It can change the price.

It cannot permanently change the reason investors wanted to sell the yen in the first place.

If US interest rates remain substantially higher than Japanese rates, the carry trade remains attractive. If Japanese investors continue seeking higher returns abroad, capital will continue flowing outward. And if markets believe the Bank of Japan is reluctant to raise rates quickly because of the risk of destabilizing the domestic economy, investors have little reason to abandon the trade permanently.

That is why the most effective intervention is ultimately not the one that creates the biggest one-day rally.

It is the one that changes expectations.

For Japan to truly stabilize the yen, investors need to believe that the interest-rate gap is narrowing and that the country is willing and able to support a stronger currency over time.

Currency markets have a habit of exposing problems that remain invisible elsewhere.

For years, the world's investors treated the yen as cheap funding. Japan's extraordinarily low interest rates effectively became part of the global financial system, allowing trillions of dollars to flow into higher-yielding assets around the world.

That system worked because everyone believed the underlying assumptions would remain intact.

Now those assumptions are being tested.

Japan wants a stronger yen without triggering economic instability. The United States wants financial markets to remain orderly without absorbing the consequences of Japanese policy. Investors want the attractive returns generated by the carry trade without being caught on the wrong side of a sudden currency reversal.

Those objectives do not perfectly align.

And that is what makes the yen so important.

The biggest risk isn't that Japan fails to strengthen its currency.

It is that everyone discovers, at the same time, just how much of the global financial system was quietly built on the assumption that the yen would remain weak.

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Peeyush and Mohit

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