But ultimately, these actions were “defensive.” They simply helped halt the weakness in the yen. To truly drive the dollar-yen rate lower and persuade Japanese institutional investors to refrain from expatriating capital, the Ministry of Finance will need to be more offensive.
The question is whether it is capable of doing this, but the partnership with Washington could be a signal that Japan is ready to do whatever it takes to shift the narrative.
In the last four years, the tumbling yen has generated long-desired inflation in Japan and flattered corporate profits, supporting a massive bull run in the country’s equities. This is great, right? Why, then, should Japan be concerned about a weak yen?
Weak currencies may sound attractive because they make a country’s exports more competitive, but over time, they can create inefficiencies, such as enabling uncompetitive corporate behaviour and distorting trade balances.
There are also implications for capital flows. If a currency is expected to depreciate, why should capital not flow out in anticipation of losses on domestic asset holdings?
Moreover, when a currency weakens too much, it risks plunging an economy into a danger zone marked by disorderly bond moves, weak consumption and plummeting capital investment. Given the yen’s sharp depreciation against the dollar since 2022, Japan faces this risk.
Of course, Japan’s interventions in the foreign exchange market also come with potential hazards. Government efforts to support the currency could trigger an avalanche of unwinding and repatriation, given the large overhang of yen carry trades.
But for Tokyo, the status quo is unsustainable, so this risk may be one worth taking.
What about the rationale on the U.S. side? Treasury Secretary Scott Bessent indicated that the joint intervention was driven largely by financial stability concerns. He noted that the relentless rise in the dollar against the yen was reminiscent of the 1997-98 period, when the rise in this cross rate helped trigger the Asian Currency Crisis.
But I suspect another motive: the desire to strengthen America’s manufacturing competitiveness. Reshoring a critical mass of U.S. manufacturing to boost U.S. jobs and ensure national security is clearly an overriding objective of the Trump administration. To achieve this end, the dollar will need to be weaker.
But the challenge is to engineer a weaker dollar without undermining the world’s holdings of U.S. dollar assets – both bonds and equities.
One way to do this is to engineer several small “Mar-a-Lago Accords” that chip away at the value of the dollar without imparting a general expectation of future dollar weakness.
By stringing together a series of “mini-lurches” that surprise the market, the U.S. could deflate the value of the dollar over time without creating expectations of further depreciation. If that’s the case, surprises like the one earlier this month could become more common over the next two years.
FXY•
