Multipolarity The Podcast

3/ The problem for Bessent is that he is fighting economic gravity. And the singularity at the heart of that gravity well is the yen carry trade. This is a term often mentioned in the financial press, but what is it, and how does it work?

4/ For years Japan has maintained far lower interest rates than other Western economies. Even after recent rises, the Japanese 10-year yield sits at 2.85% while the US 10-year is at 4.68% -- a gap of nearly two percentage points.

5/ Traders borrow yen at the low interest rates, and use this cash to buy dollars, euros or other currencies so they can lend at higher rates and pocket the difference. Every trade involves selling yen, putting downward pressure on Japan's currency. The incentive is pure profit.

6/ One measure of that profit: since 2022 the yen-peso carry trade has generated roughly twice the returns of the S&P 500. No wonder official interventions keep failing to break the trade when selling yen makes is such a moneymaker!

7/ The only durable fix would be for the Bank of Japan to raise rates and close the differential. But Japan’s entire economy has become addicted to ultra-low rates after decades of them. What does this addiction mean in practice?

8/ Around 15% of Japanese firms are “zombie companies.” They earn less in profit than they pay in interest. They survive only through what Hyman Minsky called Ponzi borrowing -- taking on new debt simply to service old interest.

9/ So if the Bank of Japan raised rates sufficiently to close the gap, a large slice of the corporate sector would vanish. Unemployment would spike. Social and political stability would be put at risk.

10/ So why not simply let the yen fall? Two linked reasons make that perilous. First, the decline could be bottomless. As long as the interest-rate gap remains, the incentive to borrow yen and sell them is permanent. There may thus be no natural equilibrium price.

11/ Second, Japan is one of the most energy-insecure countries on earth. It imports nearly 100% of its oil, coal and natural gas. A weaker yen means much higher prices for energy imports. Indeed, the Strait of Hormuz blockage is helping trigger this exact issue.

12/ So far Tokyo has contained the inflationary hit by managing the currency -- with American help. Let the yen freefall and energy prices could spiral, wages would chase them, and Japan would risk an Argentine-style inflationary trap.

13/ Such a scenario would destroy what remains of Japanese manufacturing competitiveness -- already under pressure from China -- and force capital controls and other emergency measures as the economy structurally decays.

14/ The US government is visibly terrified of these outcomes, because they would have real and dramatic consequences for US living standards and the entire US dollar system. This fear is behind the desperate attempts to prop up the yen.