In trying to prop up the yen, the US wants to have its cake and eat it too

In a highly unusual move, the US Treasury joined Japanese financial authorities in a joint foreign exchange intervention to strengthen the yen on July 31. The US action was notable as its first intervention in support of the yen since June 1998, and Treasury Secretary Scott Bessent gave it a geopolitical gloss, stating, "The Trump Administration delivers for America's trusted partners." The likely rationales behind the intervention demonstrate not so much the Trump administration's ability to deliver as its pursuit of conflicting goals in multiple areas. The United States has vast economic and financial power, but not the power to have its cake and eat it too.

The yen had depreciated by around 4.6 percent against the dollar since the Japanese government's prior solo intervention last spring, hardly a massive or sudden move. But Japan spent an estimated $87 billion of its foreign exchange reserves to buy yen over the last two days of July. Treasury joined in at the end, adding a relatively small amount of financial support but a substantial signal of US political support.

Unlike in Treasury's intervention for Argentina last year, the United States does have a significant economic stake in Japan's fortunes, but intervention support will accomplish little. Advanced economies generally have intervened in the foreign exchange market only rarely in recent decades. As the floating exchange rate system evolved, policymakers came to realize that exchange rate trends depend primarily on monetary and fiscal policies, as well as long-run trade developments, making foreign exchange interventions at best a short-term corrective to disorderly exchange rate movements. A more activist role toward exchange rates, which the US Treasury is now embracing, relies on the illusion that inherent policy tradeoffs don't apply. This misguided belief leads to inconsistent policies likely to raise economic volatility.

Trade policy confusion

The first policy contradiction involving the recent yen intervention relates to trade. Despite being a "trusted partner," Japan has been hit by multiple US tariffs (most recently tariffs imposed under Section 301 of the Trade Act of 1974) and investigations. Under its so-called "trade deal" with the Trump administration, it agreed to invest $550 billion in US projects selected by the administration. Other things being equal, these factors would weaken the yen (Japanese exporters must find new buyers, while more investment into America requires a bigger Japanese trade surplus). Japan's yen intervention, supported by the US Treasury, cannot long mask the fact that the hostile American trade actions against Japan are one driver of a weaker yen.

Bessent has noted that currencies throughout Asia are weak and expressed fears that a weak yen could catalyze broader currency weakness regionally. Not coincidentally, those countries are also targets of US protectionist policies and threats.

To be sure, there are other fundamental sources of yen weakness. Prime Minister Sanae Takaichi's expansive fiscal plans, driven in part by higher defense spending that the Trump administration favors, worry markets: The Japanese debt-to-GDP ratio is massive already, and yen nominal interest rates have turned positive. Nonetheless, Japanese real interest rates remain far below US levels, giving additional fuel to yen weakness. Bessent has called on Japan to raise interest rates, and Bank of Japan (BOJ) officials are signaling that they may well do so in September. But the Japanese authorities face a dilemma between raising interest rates—to strengthen the yen and dampen inflation pressures—and worsening fiscal sustainability. At best, intervention can paper over these conflicting forces for a short time.

Strong dollar or weak dollar?

Secretary Bessent says he advocates a "strong dollar" and promotes the US role as the premier international currency, including through his enthusiasm for global dollar-based stablecoins. But a stronger yen means a weaker dollar—indeed, Bessent's concerns about currency weakness throughout Asia suggest that a weaker dollar is desired. One reason the Treasury sold euros rather than dollars for yen on July 31 may have been to signal a yen-strengthening rather than a dollar-weakening operation, but this detail doesn't alter the fact that the fundamental and, in fact, stated goal of the intervention is a more competitive (i.e., weaker) dollar.[1]

What's more, one motive for the US yen intervention stemmed directly from the dollar's global reserve currency role. The Treasury market has become increasingly fragile as the US public debt has grown. Further large-scale sales of Treasury securities by a holder as big as Japan could stress the market and raise borrowing rates. But the Treasury's participation in yen purchases allows Japan to buy fewer yen and thereby liquidate fewer of its reserve holdings of Treasuries. The contradiction between America's ongoing fiscal deficit, which is gradually eroding the Treasury's funding advantage, and the dollar's reserve currency role cannot ultimately be resolved by asking foreign holders of dollar reserves to limit their use or by helping them to do so through US currency interventions. The solution requires greater US fiscal prudence and upgrades to Treasury market infrastructure to facilitate trade even when large shocks occur.

Pressure on the Fed

The Federal Reserve recognized the potential clash between the dollar's global reserve role and the Treasury market's limited intermediation capacity when it set up the Foreign and International Monetary Authorities (FIMA) repurchase facility in the crisis conditions around the outbreak of the COVID-19 pandemic in March 2020. The facility takes Treasuries from foreign official holders in return for dollar cash under a repurchase agreement, obviating their need to sell their Treasuries into a possibly illiquid market.

In announcing the recent yen intervention, Bessent "encouraged" the Federal Reserve to "upsize" FIMA. That request misreads the purpose of the facility. FIMA was designed specifically for temporary emergency Fed acquisitions of Treasuries, aimed at supporting Treasury market functioning and global dollar funding markets. It was not designed to stabilize Treasury borrowing rates by accommodating foreign authorities' exchange rate management operations, absent immediate financial stability threats. Blurring the line between these two roles would move the US monetary regime a step closer to fiscal dominance.

Here lies another unpleasant tradeoff for US policy. If the Treasury sees more routine use of FIMA as an adjunct to its financial diplomacy around the world, that could come at the expense of Fed credibility and likely would be resisted by the Fed's Federal Open Market Committee. Whether the Fed even put its own balance sheet behind the July 31 intervention along with the Treasury's, as has been the case in most past US foreign exchange interventions, has not been disclosed.

Cakeism is bad policy

The US-Japan joint foreign exchange intervention of June 17, 1998, had a more compelling systemic rationale than its more recent echo. At the time, Japan faced a financial crisis, in common with many other countries in Asia. Reluctant to trigger a much deeper crisis for Asian economies, China had refrained from devaluing the yuan, but the yen's depreciation was making it harder for the country to maintain its own exports. The Treasury and the Fed intervened only after Japan promised more determined action to strengthen its financial sector and to stoke domestic demand.

Even so, the intervention had little enduring impact on the yen, and Japan's efforts proved insufficient to turn its economy around before new shocks hit it. But at least the effort was made to pair intervention with more fundamental action by Japan's government to address the underlying causes of yen depreciation.

In contrast, last month's US intervention to buy yen is a short-term response to more fundamental policy dilemmas on both sides of the Pacific that policymakers prefer not to address. It won't work over the longer term. Foreign exchange intervention is not a free lunch. It is not even a free cake.

Note

1. Treasury sold euros without consulting euro area authorities in advance, much to the latter's annoyance. The gesture of disregard was small in monetary terms but conveyed a strong negative signal about prospects for US cooperation in managing the international financial commons. Markets have taken note.