OK, this is a little circuitous so I’ll take it one step at a time.
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Japan’s government debt-to-GDP ratio exceeds 250%—the highest in the developed world.
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The Bank of Japan (BOJ) buys most of Japan’s government debt to suppress yields. It’s called “fiscal dominance” using fiat yen created out of thin air. If they didn’t do this, the government’s cost of borrowing would skyrocket.
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Investors and financial institutions routinely sold yen to buy higher-yielding foreign assets (like US Treasuries). This massive capital outflow—and the popular “yen carry trade”—placed persistent selling pressure on the yen. Now the yen is at a record low and still falling.
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Japan owns a LOT of U.S. Treasury bonds. They could sell their Treasurys on the open market to get dollars. Then they could use the USDs to buy yen which would support the value of the yen.
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The U.S. Treasury market is in a very sensitive condition right now. Long bond yields are rising for several reasons. (See my last Control Panel.)
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Treasury Secretary Scott Bessent doesn’t want Japan to sell their Treasurys because that would provide supply without more demand. Prices would fall. Yields would rise. Higher yields would force the huge U.S. deficit to pay higher interest rates over here.
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Treasury (Bessent) has asked the Federal Reserve (Warsh) to use an obscure program used temporarily during the 2000 Covid crisis to lend USDs to Japan using Japan’s Treasurys as collateral so the Japanese wouldn’t have to sell the Treasurys to get the USDs (which they would spend on yen).
This is pretty convoluted and in a gray area of Fed operation.
Should the Fed protect the long Treasury from Japanese Treasury sales?
On the one hand, our government (Treasury) would benefit from lower interest rates.
On the other hand, I don’t really see the point. The problem is Japan’s super-high deficits and fiscal dominance. A one-time deal won’t fix that problem.
Also, where would the USDs for Japan come from? The U.S. also has a huge deficit. The Fed would have to print fiat USDs to lend to Japan. That would increase the Fed’s already bloated book of assets which Fed Chair Warsh says he wants to decrease. It would put a load of fiat USDs into the international currency market which would depress the value of the USD.
Since the problem is systemic in Japan, how long would this go on? Forever?
This would be inflationary for U.S. citizens because there would be more fiat dollars in the international market.
I agree with Fed Chair Warsh. The market should transparently set the price of the Treasury, the yen and the USD without a back-door bailout by the Fed.
The benefit would be short term (preventing a temporary spike in Treasury yields). The harm would be long-term (acting as a permanent pawn shop for Japan while causing more inflation in the U.S.).
My vote would be no.
But it’s not clear what the Fed will decide to do.
Wendy
