The Hidden Risk in the US-Japan Yen Rescue

The Notepad and the Intervention [00:00]

• The U.S. Treasury is paying more to borrow money than in decades.
• A photograph of Treasury Secretary Scott Bessent's notepad revealed a "TO DO" item: "BUY JAPANESE YEN" for $5 to $10 billion.
• President Trump framed the intervention as an act of "pure international goodwill" towards Japan.

  "BUY YEN. 5 to 10 billion. MILK. EGGS. Take the autumn suits out of storage."

The Unprecedented Move [01:35]

• Joint currency intervention is typically a "boring" event, but this instance is notable because the U.S. Treasury rarely intervenes.
• The last time the U.S. Treasury stepped into the market to support the yen was in 1998.
• The decision is linked to a former Soros hedge fund manager, now running the Treasury, making a large bet on falling U.S. interest rates.

  "The last time it stepped into the market to prop up the yen was 1998. So when it happens again after 28 years, it's worth asking why."

The Weak Yen and the Carry Trade [03:31]

• The yen has been sliding towards a 40-year low against the dollar due to a large gap in interest rates.
• The Federal Reserve raised U.S. interest rates, while the Bank of Japan kept its rates near zero.
• This rate differential incentivizes the "carry trade": borrowing cheap yen, selling it for dollars, and investing in higher-yielding assets.

  "So, you have one country where borrowing money is nearly free, and another where parking cash in government bonds pays you around 4%."

The Forward Premium Puzzle and Global Exposure [05:22]

• Textbook theory suggests a low-interest-rate currency should rise to offset yield gains, but the yen has fallen for years.
• This phenomenon, known as the "forward premium puzzle," is seen as compensation for the risk of holding a depreciating currency.
• The global carry trade, estimated at over $4 trillion, is largely funded by borrowing cheap yen, making the yen the world's "funding currency."

  "The carry trade works right up until the point where it doesn't, and when it stops working, it stops for everyone, on the same afternoon."

The Katsu Curry Index and Market Distortion [07:41]

• A weak yen makes imports expensive for Japan, despite benefiting exporters.
• The "Katsu Curry Index" was created to illustrate the yen's undervaluation, showing a dollar should buy 62 yen but was trading at 159.
• This suggests the yen was undervalued by about 60% by this measure.

  "By the curry standard, the yen was undervalued by something like 60 percent, which is wonderful news if you are an American tourist eating your way through Kyoto, and rather less wonderful if you are a Japanese restaurant trying to pay for imported frying oil."

US Treasury's Shifting Stance [09:40]

• The U.S. Treasury's official stance has long been that it does not meddle in currency markets and intervention is ineffective.
• The Treasury even publishes a report monitoring countries whose currency practices "merit close attention," with Japan on the most recent list.
• In July, the same month Japan was monitored, the U.S. Treasury intervened to help move the yen.

  "So, in the same month the US Treasury was formally monitoring Japan over its currency, it was also in the market helping Japan move that same currency."

Selling Euros, Not Dollars [11:31]

• The intervention involved selling euros, not dollars, a detail not explicitly noted on Bessent's notepad but executed by the Federal Reserve Bank of New York.
• This move surprised and angered European Central Bank officials, as they were not informed.
• The U.S. Treasury may have dumped French government bonds to acquire euros, further escalating tensions with European authorities.

  "When the Federal Reserve Bank of New York executed the trade on July 31st on behalf of the Treasury, placing the orders through Goldman Sachs and Morgan Stanley. They didn't sell American dollars to buy yen, they sold euros, which came as quite a surprise to the European Central Bank, mostly because no one had bothered to tell them."

Bessent's Hedge Fund Background and Bet [14:56]

• Scott Bessent previously worked at Soros Fund Management, involved in trades that bet against central banks.
• His reputation was built on shorting currencies, including the yen under Abenomics.
• His current actions are seen as defending a currency against the same type of traders he once was.

  "Besant is a man whose entire reputation was built on betting against central banks that were trying to hold their currencies at artificial levels."

Protecting US Borrowing Costs [16:43]

• The intervention was primarily to protect American borrowing costs, not just to help Japan.
• Japan is the largest foreign holder of U.S. government debt; if Japan had to sell treasuries to defend the yen, U.S. borrowing costs would rise.
• Bessent has been issuing short-term bills instead of long-term bonds, betting that interest rates will fall.

  "Because despite all the rhetoric about friendship, this was never really about being good to Tokyo, it was about protecting American borrowing costs."

The Shrinking Treasury Convenience Yield [20:08]

• The U.S. Treasury's borrowing costs are rising because the "Treasury Convenience Yield" has vanished.
• This yield was a premium the world accepted for holding safe, liquid U.S. debt; now, due to massive supply, U.S. bonds are no longer as scarce or special.
• Japan selling its $1 trillion in treasuries would significantly increase U.S. borrowing costs.

  "For decades, the world was willing to accept a lower return to hold US government debt. Purely because it was the safest, most liquid asset on the planet."

Japan's Dilemma and Intervention's Limits [23:06]

• Japan faces a dilemma: raising interest rates would strengthen the yen but is politically unpopular and historically risky.
• Intervention is a temporary measure that doesn't change the underlying trend of a weak yen driven by interest rate differentials.
• The $88 billion intervention strengthened the yen temporarily, but it quickly reversed.

  "Intervention doesn't change the trend. It buys you a few days, a week maybe, until the underlying gap between the US and Japanese interest rates reasserts itself and the yen resumes its slide."

"Cakeism" and Contradictory Goals [25:26]

• The administration's approach is described as "cakeism" – pursuing contradictory goals simultaneously.
• The U.S. wants a weaker dollar, low inflation, low borrowing costs, and for Japan to buy its bonds while also strengthening the yen.
• U.S. trade policy also contributes to yen weakness, creating a situation where the U.S. is spending reserves to prop up a currency its own policies are sinking.

  "The belief that America can chase a pile of contradictory goals all at once, and never pay for it."

The Bond Market's Verdict [27:38]

• The U.S. Treasury recently had to pay a 5.22% yield on a $25 billion 30-year bond auction, the highest since 2001.
• A $42 billion sale of 10-year notes fetched the highest yield since 2007.
• The market is charging the U.S. more to borrow than it has in a generation, indicating a loss of confidence.

  "The market is charging the United States more to borrow than it has in a generation."

Bessent's Vision or Day Trading? [29:12]

• One possibility is that Bessent is a visionary who foresees falling inflation and a return of confidence in U.S. debt.
• The alternative is that he is a day trader making a risky bet on falling long-term rates with the nation's balance sheet.
• The bond market's reaction suggests the latter may be more likely, as borrowing costs continue to rise.

  "The second is that he's a day trader who's taken an enormous directional bet with the balance sheet of the United States, betting on a fall in long-term rates that no one really controls."