Bessent’s defence of the yen is a risky innovation

Treasury Secretary Scott Bessent’s decision to join Japan in supporting the yen was the first joint intervention of its kind for decades and took investors by surprise. There’s a respectable case for such cooperation: The US and Japan can both benefit, at least for a while. But the policy fails to tackle the underlying problem and could easily backfire — not least by drawing the Federal Reserve into exchange-rate policy at an especially awkward moment, according to the Tribune News Service.

In recent months, the yen has fallen to its weakest level against the dollar in 40 years. This is partly due to growing concern about inflation, which the currency’s depreciation (in a familiar vicious circle) has compounded. Supporting the yen eases the pressure on prices and helps stabilize currency markets. Acting alone, though, Japan would need to buy yen with dollars from its reserves. This would mean selling US Treasuries and pushing dollar interest rates higher.

Desirable as stabilizing the yen might be for the US and Japan alike, Bessent doesn’t want to make borrowing more expensive for Americans. He hopes to intervene without this collateral damage — and with the possibility, as he and the White House have noted, of a financial windfall.

Recently, the US bought yen using euros from the Treasury’s Exchange Stabilization Fund, reducing the risk of upward pressure on Treasury yields and downward pressure on the dollar. The manoeuvre’s novelty has a further benefit: the more investors are surprised, the more cautious they’ll be about shorting the yen. Initially, the intervention didn’t just arrest the currency’s decline; it also pushed it back up, turning at least a temporary profit.

An experienced macro trader, Bessent had similar success with last year’s plan to support Argentina’s peso. Trouble is, currency intervention is rarely more than a temporary patch. Sustaining such measures can quickly get complicated — and expensive, once investors turn skeptical. Worse, it can weaken confidence in broader economic policy, with potentially dire implications for long-term borrowing costs. The Treasury secretary surely needs no reminding of these hazards: in a previous career, he helped make a fortune shorting sterling, despite the UK’s best efforts to defend it.

Bessent is now preparing other tools for intervention. In particular, he wants to expand the Fed’s Foreign and International Monetary Authorities Repo Facility and use it to lend Japan more dollars to buy yen. In theory, the Fed should have no objection: on exchange-rate policy, it expects to follow the Treasury’s orders. Even so, tapping an expanded FIMA would affect the central bank’s holdings of government debt, threatening to further blur the line between monetary and fiscal policy. With investors seeking reassurance that the Fed and its new chairman, Kevin Warsh, will act independently of the White House on monetary policy, the timing is worrisome.

In any event, the only sure way to relieve pressure on the yen is for Japan to address concerns about inflation and government borrowing. That means curbing plans for further fiscal loosening or raising short-term interest rates. In the meantime, currency intervention with US support can help — with luck, without raising US bond yields, and even at a profit. But currency trading is no substitute for sure and steady policy. Ignore that lesson for too long, and the reckoning for all concerned could be brutal.