The Japanese Money That Helped Finance America Is Coming Home

For three decades Japan supplied cheap capital to the world and became America’s largest foreign creditor. Then the yen approached ¥164 to the dollar, and an apparently Japanese currency crisis began to look uncomfortably like an American debt problem.

On the last Friday of July, traders at the Federal Reserve Bank of New York entered the foreign-exchange market and began buying Japanese yen, joining an intervention by Tokyo that was already attempting to halt a dangerous slide in the currency.

There was nothing particularly unusual about Japan trying to rescue the yen. Tokyo has intervened before, sometimes on a formidable scale. What was unusual was the presence of the United States and, more strikingly still, what Washington chose to sell.

It did not sell dollars. It sold euros.

The American transaction was small beside the vast daily turnover of the foreign-exchange markets and smaller still than Japan’s own intervention. Yet it marked an extraordinary moment. The United States had decided that the value of the Japanese currency mattered sufficiently to American interests for the Treasury to commit its own reserves to defending it.

The yen had been approaching ¥164 to the dollar. Intervention sent it sharply higher, towards ¥155, inflicting losses on traders positioned for further depreciation and demonstrating how much force two governments could bring to bear when they chose to enter the market together.

Then the effect began to wear off.

Within days the yen was falling again. By the following week it was once more hovering around ¥160, as though the enormous machinery of two governments had succeeded in interrupting the market without persuading it to change direction.

The episode lasted only hours, but the forces behind it have been accumulating for more than three decades.

Japan spent much of that period doing something the world came to depend upon without often noticing it. Alongside the Toyotas, machine tools, electronics and precision components for which its export economy became famous, Japan exported something less visible and ultimately more important to the financial system: money.

Japanese households saved heavily. Banks accumulated deposits. Pension funds and life insurers acquired immense pools of capital. With interest rates at home close to zero, and sometimes below it, those savings travelled overseas in search of returns that Japan itself could no longer provide.

They bought European bonds, Australian securities, emerging-market debt and American assets on a vast scale. Above all, Japan bought the debt of the United States government, eventually becoming America’s largest foreign Treasury creditor.

For years the arrangement suited both countries remarkably well. Japan had more savings than attractive returns at home; America had an apparently limitless capacity to create attractive assets for foreigners to buy.

Now the economic conditions that produced that bargain are changing, and the weakness of the yen is exposing how deeply Japan’s financial system has become entangled with America’s own.

The world’s cheapest money

At the centre of this system lies one of finance’s simplest ideas: borrow money where it is cheap and put it somewhere it earns more.

For years Japan offered almost perfect conditions for doing so. An investor who could borrow ¥1 billion in Tokyo at 1 per cent might sell those yen for dollars and buy an American bond yielding 5 per cent. Provided the exchange rate remained reasonably stable, the difference between the two interest rates became the return.

If the yen weakened while the trade was open, the arithmetic became more attractive still, because when the investor eventually had to repay the ¥1 billion loan, each dollar earned abroad would buy more of the depreciated Japanese currency.

This is the yen carry trade, although the phrase can create the misleading impression that there is a single enormous speculative position somewhere in the financial system waiting to be closed.

There isn’t.

Hedge funds borrowing yen to finance leveraged investments are one part of the story. Japanese insurers buying American bonds are another. Banks lending abroad, pension funds accumulating overseas securities, investment funds and corporations managing their currency exposure belong to related but distinct financial flows. Estimates purporting to place a single multitrillion-dollar figure on the carry trade often blur those categories together.

What can be measured is the extraordinary accumulation of Japanese wealth abroad.

By the end of 2025, Japanese residents owned nearly ¥1.81 quadrillion of foreign assets. After overseas claims on Japan were deducted, the country remained a net creditor to the rest of the world by ¥562 trillion — around $3.5 trillion at an exchange rate of ¥160 to the dollar.

This is one of the peculiarities of modern Japan. Its government is spectacularly indebted, while the country itself remains spectacularly wealthy.

For decades those two conditions coexisted without producing the crisis that might ordinarily have been expected. The Bank of Japan kept interest rates extraordinarily low, the government’s enormous debts remained manageable and private Japanese capital, unable to earn much at home, continued travelling abroad.

A significant portion crossed the Pacific.

America borrowed while Japan saved, and over time the relationship became one of the largely invisible foundations of the international financial system.

The yen starts to move

That arrangement depended upon economic conditions inside Japan that came to seem almost permanent. They were not.

Inflation returned, forcing the Bank of Japan into a slow retreat from the extraordinary monetary policies of the deflationary era. Interest rates began to rise, but only cautiously, because Japan cannot tighten monetary policy with the freedom available to a country carrying a smaller stock of government debt.

Combined central and local government long-term debt is projected at roughly ¥1,344 trillion in the current fiscal year, close to twice the country’s annual economic output. Higher interest rates do not immediately reprice every bond the government has issued, but over time they increase the cost of refinancing that enormous stock of obligations.

The Bank of Japan consequently finds itself attempting several difficult things at once: restraining inflation, normalising monetary policy after decades of exceptional intervention, preventing government bond yields from becoming destabilising and stopping the yen from falling far enough to make imported inflation worse.

Then another problem arrived from several thousand miles away.

The war with Iran and the disruption of Middle Eastern energy supplies struck Japan at one of the most vulnerable points in its economic structure. Japan possesses little oil of its own and has historically imported the overwhelming majority of its crude from the Middle East, leaving an advanced industrial economy unusually exposed to events around the Persian Gulf and the Strait of Hormuz.

Because oil is largely priced in dollars, a Japanese refinery confronting an energy shock has to worry about two prices simultaneously: the dollar price of the barrel and the number of yen required to buy each dollar.

During the latest crisis, both moved against Japan.

As energy became more expensive and the Japanese currency weakened, the same barrel demanded more dollars while every dollar demanded more yen. The consequences travelled well beyond refineries and petrol stations, feeding through electricity, transport, chemicals, manufacturing and ultimately household prices.

The energy shock did not cause the yen’s structural weakness, which long predates the war. It aggravated it at precisely the moment when the Bank of Japan’s room for manoeuvre was already constrained.

By late July, the pressure was visible on trading screens around the world. A dollar was buying almost ¥164.

Tokyo decided that the decline had gone far enough.

Japan’s trillion-dollar weapon

Japan possesses formidable resources with which to defend its currency.

The basic operation is uncomplicated. The authorities enter the foreign-exchange market, sell foreign currency and buy yen. Concentrated on sufficient scale, that demand can overwhelm traders betting on further depreciation and force the exchange rate sharply in the opposite direction.

The complication lies in where the money comes from.

Foreign-exchange reserves are sometimes imagined as enormous stores of dollars sitting untouched in central-bank vaults. In practice, reserves are invested in deposits and securities, because governments no more wish to leave hundreds of billions of dollars idle than private investors do.

Japan’s reserves are vast, and among the assets Japan owns are obligations of the United States government.

Japan remains the largest identified foreign holder of US Treasury securities, with holdings exceeding $1 trillion.

That does not mean that every Japanese currency intervention requires Tokyo to sell Treasury bonds. Japan possesses other reserve assets, including deposits, and the financing of individual interventions can be more complicated. Nor should Japan’s official reserves be confused with the vastly larger foreign holdings accumulated by its banks, insurers, pension funds, companies and households.

But sustained pressure changes the calculation.

If Tokyo has repeatedly to mobilise foreign reserves to prevent the yen from collapsing, the composition of those reserves becomes increasingly important. And if Japanese interest rates continue rising, a separate question begins to confront private investors: why accept substantial currency risk to earn a higher return in America if returns available at home are becoming more attractive?

The first mechanism involves the Japanese state defending the yen. The second involves Japanese investors deciding where they want their money.

They are not the same thing, but both can lead in an uncomfortable direction for Washington: towards less Japanese money in American securities.

There is also a third danger, created by the carry trade itself.

This is the uncomfortable feature of the present situation. A collapsing yen is dangerous because it intensifies imported inflation and can force Tokyo into increasingly expensive interventions, but a violently rising yen carries dangers of its own because it can trigger the liquidation of positions accumulated during years of cheap Japanese money.

Japan and the United States therefore do not necessarily require a strong yen.

They require an orderly one.

America’s problem

For Washington, the issue arrives at an awkward moment.

The United States is financing large budget deficits while continuously refinancing the immense stock of debt accumulated in previous years. The Treasury market has consequently become not merely another financial market but one of the central pieces of infrastructure upon which the American state depends.

Its yields determine far more than Washington’s interest bill. They influence American mortgages, corporate borrowing costs, asset valuations and the price of credit throughout much of the world.

At a time when long-term Treasury yields are already elevated, Washington has little reason to welcome the prospect of one of its most important creditors becoming a persistent seller.

The vulnerability is sufficiently well understood that the Federal Reserve has constructed an obscure piece of financial plumbing partly to contain it.

The Foreign and International Monetary Authorities Repo Facility, usually known as FIMA, allows approved foreign central banks and monetary authorities to obtain dollars temporarily by placing their Treasury securities with the Federal Reserve rather than selling those securities into the open market.

Its existence reveals something important about the modern dollar system.

Foreign countries help finance the United States by accumulating American debt, but in periods of stress those same creditors may need dollars quickly. If they obtain them by dumping Treasuries, their solution can become America’s problem. The Federal Reserve therefore provides a mechanism through which the creditors can obtain liquidity without destabilising the market in the securities they own.

Japan is the largest foreign Treasury holder of them all.

July 31

That was the financial landscape when Washington entered the currency market at the end of July.

Japan conducted the larger intervention, but the New York Fed, acting for the Treasury, also bought yen. Instead of selling dollars, however, the United States used euros from its foreign-exchange reserves.

The choice allowed Washington to support the Japanese currency without producing the politically awkward spectacle of the American government deliberately selling dollars in order to weaken its own currency.

European officials were reportedly not consulted beforehand, an unusual departure from the carefully choreographed interventions traditionally associated with the major Western economies.

There is a geopolitical story in that episode. An American administration confronted with a Japanese problem used European currency reserves to address it and apparently informed Europe afterwards. It suggests a more transactional approach to monetary cooperation than the familiar rituals of G7 coordination.

But the more consequential story was unfolding elsewhere.

The United States had concluded that instability in the Japanese currency mattered sufficiently to American interests for Washington itself to enter the market.

A relatively small American purchase could reduce the immediate burden on Japan, while the intervention as a whole signalled that Washington did not intend to remain passive if the yen’s decline became disorderly.

Seen in the context of Japan’s enormous holdings of American securities, this was not simply assistance to an ally.

America had something of its own to protect.

A narrow corridor

Neither government has an especially attractive destination from here.

Washington and Tokyo cannot simply force the yen dramatically higher and declare the problem solved, because a sudden appreciation could trigger precisely the carry-trade unwind they have reasons to fear.

An investor who has spent years earning several percentage points by borrowing cheaply in Japan gains little if the currency in which the loan must be repaid suddenly appreciates by 10 per cent. Losses appear, positions are reduced and foreign assets are sold to obtain the yen required for repayment.

The resulting purchases of yen push the currency higher, increasing the losses of investors who have not yet closed their positions and giving them an incentive to follow.

Assets apparently unrelated to Japan can then fall because somewhere else in the financial system an investor needs yen.

This is why the desired outcome for Tokyo and Washington is not necessarily a dramatically stronger Japanese currency. It is a controlled adjustment in which the yen stops falling without rising fast enough to set off a disorderly liquidation of the financial structures built around decades of cheap Japanese money.

For the United States there is an additional consideration: it would prefer Japanese capital to remain, as much as possible, where a great deal of it already is.

In America.

The market comes back

For several hours on July 31, the governments won.

The yen rose dramatically as traders retreated from positions that had appeared safe only hours earlier. The intervention demonstrated that the world’s most powerful financial authorities could still overwhelm the currency market when they concentrated sufficient resources against it.

What they could not do was alter the economy underneath the exchange rate.

Within days the yen began weakening again and soon returned towards ¥160 to the dollar.

American interest rates were still above Japanese rates. Japan’s immense public debt had not disappeared. Its dependence on imported energy had not changed. The Middle Eastern disruption continued, while Japanese investors still possessed extraordinary quantities of assets overseas and the incentives that had sent much of that capital abroad remained embedded across the global financial system.

Intervention could alter the price of the yen.

It could not, by itself, alter the arithmetic.

There is no reason to assume that Japan is about to liquidate its American holdings, and a wholesale reversal of Japanese capital is neither inevitable nor necessarily imminent. Japan remains immensely wealthy, its financial institutions are deeply integrated into international markets, and the normalisation of monetary policy after three decades of exceptional conditions could take years.

But the direction of pressure is changing.

For much of the past generation, the natural movement of Japanese capital was outward. Japanese savings searched for returns overseas, cheap yen helped finance investments abroad, and American borrowers could reasonably assume that one of the deepest pools of capital in the world would continue looking beyond Japan for yield.

There are now reasons for some of that money to look homeward.

The Iran war has accelerated the process without creating it. The falling yen has exposed the tension without being its sole cause. The deeper change is taking place within Japan itself, where the long era in which money could be assumed to cost almost nothing is drawing to an end.

An extraordinary amount of the modern financial system was built during that era.

On July 31, for a few hours, the architecture became visible.

Japan entered the market to defend the yen, and America joined it, selling euros to buy the currency of its largest foreign creditor. The intervention pushed the yen sharply higher, but within days the market was moving back in the other direction.

For three decades, Japan supplied capital and America absorbed it. The arrangement became so familiar, and lasted so long, that it acquired the appearance of permanence.

It was never permanent.

If Japanese capital begins, even gradually, to find its way home, the question will extend far beyond the price of the yen.

It will reach the market upon which the American government itself depends, and ultimately to a question Washington has seldom had to ask about its relationship with Japan: if one of the world’s greatest creditors becomes less willing to export its savings, who finances the world’s greatest debtor?