The Federal Reserve's interest rate hike policy swept the world like a financial storm, and was originally intended to attract capital to the United States and strengthen the global position of the dollar. However, this strategy has not only hit the domestic market of the United States, but also brought challenges to countries around the world.
Especially in Asian countries, the appreciation of the US dollar has triggered capital outflows, and the global tendency of capital to pursue profits has further consolidated the financial hegemony of the US dollar. Asian countries have reacted differently to the aggressive monetary policy of the United States: China has cut interest rates to maintain liquidity in the market and avoid being held hostage by the dollar system, while Japan has chosen a very different strategy.
The Fed's interest rate hike had a profound impact on the Japanese market, with the yen briefly falling below 160 against the dollar, forcing the Bank of Japan to take emergency rescue action and inject $90 billion in reserves to stabilize the exchange rate. While the move temporarily stabilized the yen, it also quickly depleted Japan's dollar reserves. To raise the required funds, Japan has used reverse repurchase agreement instruments to enter into deals with other financial institutions to fill the funding gap. However, this action also reduced Japan's dollar reserves by $60 billion.
In this intervention, the Bank of Japan opted for cash intervention to maintain exchange rate stability and avoid selling US Treasury bonds. However, while this strategy works in the short term, in the long term, Japan may have to sell up to $200 billion of US debt to ensure that the yen does not depreciate sustainably.
Interest rates in Japan have remained low compared to other countries, and economic conditions have been stagnant for many years, making it difficult to raise interest rates as a countermeasure. If interest rates rise, domestic debt will become unsustainable, and Japan's financial system could also suffer a more severe shock.
Therefore, the Bank of Japan should not act rashly while stabilizing the monetary system. Rising interest rates will weigh on the domestic economy, while non-intervention in the exchange rate could exacerbate the yen's depreciation. Japan can only carefully balance market intervention with the sell-off of US bonds to ensure the stability of its domestic financial markets and monetary system.
At the same time, the pressure of high US government debt is gradually emerging. Since 2000, the US government's fiscal deficit has increased year by year, especially during the George W. Bush administration, the national debt climbed from $5.67 trillion to $10.6 trillion.
After the 2008 financial crisis, the United States adopted large-scale fiscal stimulus measures to save the market, raising the national debt to $19.9 trillion. Since then, the Trump administration has further exceeded the $1.8 trillion deficit, while the national debt has exceeded $35 trillion under Biden.
The U.S. government appears to be more than willing to cope with the huge debt burden. The debt crisis and the stress on the financial system have become more prominent, and the United States' reliance on foreign debt to maintain fiscal balance is no longer sustainable. In order to reduce debt pressure, the U.S. interest rate hike strategy appears to be imminent. But this poses a great risk for countries that rely on the dollar system.
Whether Japan will sell off US bonds has become a suspense that has not yet been clarified. If Japan decides to sell $200 billion in U.S. bonds, it will inevitably have an impact on the U.S. bond market and the U.S. dollar exchange rate, and may even trigger a U.S. fiscal crisis. The price of the U.S. Treasury market could collapse and the U.S. dollar exchange rate will fall, creating a ripple effect that will cause turmoil in global financial markets. Conversely, if Japan does not act, it may be difficult to avoid falling into this financial turmoil.
Although the yen remains stable for the time being, Japan's economic fundamentals are not solid. Over the past 11 years, Japan's GDP has shrunk from $6.27 trillion to $4.21 trillion, and the size of the economy has fallen by 33%. Japan's weakening position in the global trading system and economic stagnation make it impossible for the central bank to sustain its intervention strategy for a long time, and it may eventually face a larger financial crisis.
The currency war between the United States and Japan has created uncertainty in global financial markets. The Fed's interest rate hike strategy is aimed at the Japanese market in order to harvest financial benefits, and the Bank of Japan has had to use reserves and reverse repo facilities to stabilize the yen.
But this strategy is not a long-term solution, as Japan's weak economic fundamentals and heavy debt burden make it impossible to absorb the high size of the US debt on its own. The sell-off of U.S. bonds will allow Japan to reduce the pressure on the dollar in the short term, but it could trigger a fiscal crisis in the United States and global economic turmoil, and the impact is difficult to estimate.
In this currency war, the United States still has the upper hand, relying on the global dominance of the dollar to influence the economic decisions of countries. For Japan, selling US bonds is one strategy, but it is not a sustainable solution.
Japan may need to be more cautious in its monetary policy, actively seeking partners and diversifying its financial assets to more effectively cope with the impact of rising US dollar rates. This complex financial game will affect the global market for a long time, and the future development is worth paying close attention to.