In March 2022, while the yen was
trading around 115 to the US dollar, I wrote that the "yen will burn to a
crisp over the coming years." Four+ years (and numerous interventions)
later, it takes 159.2 yen to buy one dollar, the weakest it’s been in 40
years, which is amplifying Japan’s rampant inflationary pressures. If
the oil prices continue to rise, which seems likely, and if the yen
continues to fall, which also seems likely, Japan could find itself in a
disastrous double jeopardy.
» The predictable disintegration of Japan's fiscal and economic position is now all but inevitable. Japanese Government Bonds will collapse. The unraveling could resemble what Germany had experienced 100 years ago. «
Namely, Japan has to import about 3 million barrels of crude oil per day which, at current prices, is well in excess of $250 million/day, settled in US dollars. The higher the oil price goes, the greater Japan's demand for US dollars, and the greater the downward pressure on the yen. The lower the yen, and the higher the prices of oil and other imported goods, the more inflation Japan imports via its US dollar oil purchases.
US Sovereign Liquidity Strain: Facing weak demand that pushed 30-year yields to a 16-year high of 5.33%, the US Treasury doubled its liquidity buybacks of 10-, 20-, and 30-year bonds from $2 billion to over $4 billion per operation. By issuing short-term debt to repurchase long-term debt, the Treasury temporarily suppressed yields by 9–10 basis points.
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Aggressive Japanese Capital Flight: Japan, the largest foreign holder of US debt, liquidated $26.4 billion in Treasuries in June alone (bringing holdings to $1.117 trillion) to raise funds to defend the falling yen.
Failing Currency Interventions: Despite joint US-Japan interventions pulling the yen back from 40-year lows near 164, the currency quickly erased over half those gains to trade above 159, pressuring the Bank of Japan to prepare further sales.
Systemic Risk: The alignment of Japan selling US debt to protect its currency alongside the US acting as the buyer of last resort for its own bonds indicates deep structural friction in global debt markets, deferring broader volatility across equities, real estate, and fixed income.
Raising rates is not an option
Ordinarily, when they wish to strengthen their currency, central bankers raise interest rates. That would make Japanese financial assets more attractive to global investors, which would boost the demand for and purchases of yen. But the Bank of Japan (BOJ) can hardly afford to do that, given that it would bankrupt the Japanese government, which is leading the developed world in terms of debt-to-GDP, which currently stands at around 240%.
» As inflation accelerates, the Nikkei could continue to soar.
However, the nominal gains in stocks will be more than offset by their
losses in yen, still leaving investors with close to total losses in
real terms. «
Nikkei (weekly candles), July 2022 to August 2026.
Raising interest rates would also crash Japan’s financial markets and with it, Japan’s pension funds. When the BOJ raised the interest rates by only 0.25% on 31 July 2024, the Nikkei collapsed by -12.4%—its worst one-day crash since the Kobe earthquake in 1987. Currently, Japan’s debt to GDP stands at around 240%.
Sustainable market manipulation?
The answer, probably, is yes, but not this week. Given that raising interest rates is unpalatable, Japan had the option of selling its $1.1+ hoard of US Treasuries and using the proceeds to buy and prop up the yen. In fact, Japan’s Finance Minister Satsuki Katayama was anxious enough about her government's fiscal position that on July 10 she explicitly encouraged Japanese households and pension funds "to increase their investments in Japanese financial assets."
But selling US investments to buy Japanese assets would put further pressure on US interest rates, putting a squeeze on the US Government which is already in a massive fiscal bind. In fact, the US Government can be so sensitive about foreign governments selling their Treasury debt that they can regard it as an act of war. Accordingly, Ms. Katayama quickly backpedaled from her cunning plan. Instead, the US and Japan together coordinated an intervention to support the yen and relieve Japan’s inflationary pressure.
» The
reason why even real assets turn worthless is that inflation
indiscriminately annihilates the purchasing power in an economy. «
The Economics of Inflation. Basis for all curves: January 1922 = 100.
In late July, the US coordinated market operations with Japan to support the yen, which have been somewhat successful: they knocked the yen back up from its 40-year low of 164 yen to the dollar to below 156. Since then, however, the yen fell back to just under 160 yen/USD, where it is trading today.
Even when governments do it, currency rate manipulations ultimately fail: they buy a temporary respite from the accelerating collapse, but they cannot reverse the decline as they leave the structural causes of the financial imbalances intact. In the end, I believe that the yen will indeed burn to a crisp (as will the euro and the British pound) and that Japan will ultimately drag the United States with it.
We'll know it when it happens
Unfortunately, predicting the timing of all these events is out of the question. Note, my original article about Japan being the harbinger of bad things to come is over 16 years old, and its predictions are yet to unfold in full. US/Japanese joint yen rescue operation may not be over yet. Further efforts to boost the yen could be successful, especially if they trigger large-scale short covering in the markets.
Namely, global investors and traders have accumulated the largest short position on record against the yen. Panicked short-covering could give another boost to the yen in the near term, but in the end, the predictable disintegration of Japan's fiscal and economic position is now all but inevitable.
What happens next
Reiterating my earlier prediction with relation to this crisis, we can make three predictions about Japan’s economy:► We'll see a period of stagflation (inflation+recession), the inflation part could ultimately morph into hyperinflation;
► Interest rates will continue to rise, and the price of Japanese Government Bonds will collapse. I believe that the unraveling could resemble what Germany had experienced 100 years ago;
► The Nikkei could continue to rally (for now)—as currency and debt turn worthless, equities tend to go vertical as we saw in many cases through history, including Venezuela, Zimbabwe, Argentina, Israel, and the Weimar Republic too.
Thus, as Japan's inflation accelerates, the Nikkei could continue to soar. However, the nominal gains in stocks will be more than offset by their losses in yen, still leaving investors with close to total losses in real terms. The reason why even real assets turn worthless is that inflation indiscriminately annihilates the purchasing power in an economy. When everyone’s purchasing power converges on zero, we really get the great reset: owning nothing minus being happy.
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