The Hidden Japanese Century: Cheap Money and Global Financial Risk
In 2015, Clyde Prestowitz's book Japan Restored envisioned a Japanese century emerging from geopolitical upheavals, such as an Israeli attack on Iran. While conflict now grips the Middle East, the revolutionary change predicted by the former US national security official has not materialized. However, in one crucial aspect, this already is a Japanese century—thanks to the yen's role as easy money for global finance.
The Yen Carry Trade: A Publicly Subsidized Pipeline
The Bank of Japan's loose monetary policy has transformed the yen into the world's cheapest and most reliable funding currency. By suppressing yields on public debt to sustain Japan's domestic economy, the BoJ effectively created a publicly subsidized funding pipeline for bankers. Financial institutions can profit by borrowing cheaply in yen and investing in higher-return assets, such as US equities. The yen carry trade surged after the pandemic, with speculators betting $435 billion in the two years to 2024 out of an estimated $1.7 trillion worth of yen supplied. Profits for global investors are reckoned to run into tens of billions of dollars.
Persistent Fears and Global Vulnerabilities
Japan's first interest rate hike since 2007 occurred in March 2024, but this shift barely dented the carry trade's popularity. There is a persistent fear that the BoJ may decide to catch the market unaware and aggressively raise rates. Such a move would risk a global financial shock for two primary reasons. First, the profit made from the spread between Japanese and US assets would shrink. Second, a stronger yen would mean borrowers need more dollars to repay yen-denominated debts. Add to this that hedge funds involved are heavily leveraged, and it is little wonder that even a hint of policy change unsettles markets.
Japan's Strength as Its Weakness
Japan's economic strategy has created an external dependency—in the form of the carry trade—to manage internal crises rooted in its own success. Following Japan's rise, its Western partners convinced Tokyo to substantially revalue the yen in 1985. The authorities overcompensated for the yen's strength with loose credit, leading to soaring asset prices. At its peak, the land under the emperor's palace in Tokyo, less than a square mile, was estimated to be worth about the same as all the land in California. The bubble burst in 1992, ushering in a long slump that forced increasingly radical policies.
Political Commitments and Economic Constraints
This trend is unlikely to change under Japan's new prime minister, Sanae Takaichi, a reflationist rightly committed to fiscal expansion. Tokyo has spent more than three decades stabilizing a private sector unwilling to borrow. This stability made the yen the cheapest cash in global finance, but stability is not synonymous with growth. The work of economist Luiz Carlos Bresser-Pereira helps explain why, arguing that a country's success depends on managing five macroeconomic prices: profit, the exchange rate, interest, wages, and inflation.
Applying this framework to the world's fifth-largest economy reveals its constraints. While Japan has recently seen real wage growth, wages historically have been either flat or falling, with no transformation in its wage-setting regime. Without a reliably competitive exchange rate and a viable profit rate, Japan's firms cannot confidently access demand. Without demand, reform stagnates. Japan has fixed some of its problems, but its century has arrived—as a financial condition, not a productive one.
