Avoiding Charges of Disorderly Conduct

America is drunk with debt, and the cost of the tab is under the influence of monetary and fiscal policies around the world. With few exceptions, our government saddles future generations with bills from current spending. It has been easy to do since the world’s primary reserve currency is the U.S. dollar, offering global markets a deep, liquid, and secure place to store savings. But the price of borrowing has changed dramatically in the past few years, rising well beyond rates available leading up to the Covid-19 pandemic. When borrowing costs for the U.S. Treasury rises, it crowds out other lending, pressuring things like mortgages and corporate borrowing rates higher. It also increases the interest expense of the nation, one of the largest outlays in the America’s budget.

Japan has been making its way into headlines about America’s interest rate situation recently because of its influence on rates here at home.  Those in Japan have been relatively low compared to America for decades, allowing speculative investors to borrow money there and invest it here in something called a carry trade. These borrowed funds have helped keep rates lower in America and support higher stock prices by creating demand from those seeking higher returns. This, however, does not happen in a vacuum. To invest the borrowed yen in America, those borrowed yen must be sold and exchanged for dollars. This selling puts downward pressure on the yen’s value which looks like inflation to Japan. For years the Japanese economy experienced deflation and could absorb this selling pressure. More recently, the Bank of Japan (their central bank) has been raising interest rates after a period of negative rates and is largely expected to do so again next week.

This new regime of higher rates in Japan matters because if the situation isn’t managed delicately, it could get chaotic in global markets, like a bar fight. Buyers of U.S. investments who borrowed yen may have to pay back their loans at higher values. This is where the potential for chaos exists, fighting to get out of their dollar denominated assets (stocks and bonds) quickly to settle debts in Japan before the yen appreciates too much.

Treasury Secretary Scott Bessant has been trying to keep the bar open a bit later, attempting to create an orderly unwind of the carry trade instead of it happening violently. America joined Japan in a “yentervention.” That is, U.S. Treasury purchased yen at the beginning of August. This strengthened the yen but only marginally. Secretary Bessent also met with the Bank of Japan Governor Kazuo Ueda and Japanese Finance Minister Satsuki Katayama in Ashville, North Carolina at the start of this September. It is reported here by Reuters that Bessent and Katayama agreed to coordinate in order to achieve “orderly” yen moves.

It was kind of like telling the bartender that the tab is still open but that there is now a limit to how much more support the party will receive. Secretary Bessent may also be changing the structure of America’s debt by borrowing short-term to purchase back longer-term debt having higher interest rates, likely hoping to minimize the impact of future selling on longer-term rates in America which impact borrowing costs for consumers and businesses here.

It takes a lot to close a saloon like this. The hope is that these actions will allow last call to happen in an orderly way instead of unleashing chaos in global markets caused by mass selling ahead of an appreciation in yen value. It may buy time and help with market order, but it cannot fight the math. Most likely at some point, our government will have to pay much higher prices to investors buying the next round of borrowing.