(Yicai) Aug. 6 -- The recent coordinated intervention by the United States and Japan to support the Japanese yen, which was driven by the two countries' respective interests, effectively broke market rules and weakened the financial credibility of both governments, the former deputy managing director of the International Monetary Fund told Yicai in an exclusive interview yesterday.

The short-term nature of the US Federal Reserve's Foreign and International Monetary Authorities Repo Facility, coupled with the fact that US bond yields rose rather than fell after the intervention, highlights the difficulty of sustaining such market operations, said Zhu Min, who is also former deputy governor of the People's Bank of China.

The depreciation of the yen is a long-term structural problem that is rooted in Japan's heavy debt burden, persistent trade deficits and capital outflows, and only domestic structural reforms can address those challenges, Zhu said. What is even more alarming is that the US dollar's global dominance has increasingly outstripped the strength of its underlying real economy and this intervention could further erode confidence in the greenback.

Undermined Independence

The coordinated intervention reflected different objectives on each side, Zhu said.

Japan sought to stabilize its economy and financial markets after the yen's sharp depreciation, while the US was concerned that Japan might sell large amounts of US Treasuries to support its currency, disrupting the US bond market. Washington also has an interest in preventing a prolonged deterioration of Japan's economy.

However, Zhu noted that the intervention was carried out outside the framework of the International Monetary Fund, breaking established market norms and damaging the credibility of both countries, particularly the perceived independence of the Bank of Japan.

Zhu said the coordinated action should not be considered as a new "Plaza Accord." The original Plaza Accord involved coordinated negotiations among five major economies to intervene in the yen exchange rate, had clearly defined objectives and was implemented over an extended period. By contrast, the latest intervention was a one-off operation with no explicit long-term policy target.

Short-Lived Intervention

Zhu said the intervention is unlikely to continue for two main reasons.

First, Japan relied on the Fed's FIMA repo facility, a mechanism introduced in 2020 that allows foreign central banks to obtain US dollar liquidity by temporarily pledging their holdings of US Treasury securities as collateral, so as to avoid hiking selling pressure on the US bond market.

According to available data, Japan pledged about USD60 billion through the facility, which is the maximum for a single day. Because the FIMA repo facility is short-term and liquidity must be repaid within seven days, it provides only temporary support and poses a significant challenge for Japan if intervention needs to continue, Zhu said.

Second, the US participated in the intervention primarily to stabilize US bond yields and protect its Treasury bond market. However, on July 31 the yield on the benchmark 10-year US Treasury rose to 4.7388 percent, its highest level since January 2025.

If the yen continues to strengthen, capital could flow back to Japan, reducing demand for US Treasuries and placing additional pressure on US financial markets.

As of the first quarter, the proportion of US public debt to its gross domestic product exceeded 100 percent. Rising interest costs mean that rolling over debt will require continued support from the market. Therefore, maintaining stable bond yields has become critical to both the US economy and financial system.

Following the intervention, long-term US Treasury bond yields climbed instead of declining, while government bond yields in France and Germany fell. Zhu said this divergence suggests investors are increasingly voting with their feet and questioning the resilience of the US bond market.

Yen Weakness

Debate over the Fed's next policy move remains intense, Zhu said. With inflation still elevated, expectations for interest rate cuts have diminished and, in some cases, even shifted toward the possibility of further rate increases.

As a result, the interest rate differential between the US and Japan has not fundamentally changed. Even if the Bank of Japan raises rates by 0.25 percentage point, the Fed could hike rates by a similar amount, leaving the yield gap largely intact.

In addition, US tech giants such as Tesla and Google have seen their cash flow positions deteriorate. Once major buyers of US Treasuries, they could shift from net buyers to issuers. At the same time, geopolitical uncertainty has reduced global demand for government debt.

The US needs foreign capital inflows to stabilize the yields of Treasury bonds and avoid fiscal stress. These dynamics mean that arbitrage between the US dollar and the yen are likely to persist, Zhu said.

Debt Dilemma

Japan, meanwhile, has pursued an ultra-loose monetary policy since around 2000, leaving it with the highest government debt-to-GDP ratio in the world. Because servicing that debt is costly, the country cannot tolerate high interest rates.

For years, Japan has relied on yield curve control to cap the yields of 10-year government bonds. But with interest payment costs now accounting for 9.6 percent of the national budget, the policy has become increasingly unsustainable, Zhu said.

At the same time, the Middle East war has pushed up oil and food prices. Japan, which depends heavily on imports of energy, food and digital services, has seen inflationary pressures intensify. While raising interest rates could help curb inflation, it would also increase the government's debt burden, leaving the Bank of Japan caught in a dilemma.

Trade Deficit

Japan has also shifted from a trading powerhouse to a trade deficit country. Since 2018, with the exception of a modest surplus during the pandemic in 2020, the country has consistently recorded trade deficits, reflecting a decline in the competitiveness of its real economy.

Prolonged low interest rates have also led to substantial capital outflows, with Japanese households investing heavily in international financial assets through securities firms. Over the past two years, those overseas investments have amounted to roughly 3 percent to 4 percent of the country’s GDP.

Markets expect the Bank of Japan to raise interest rates in September. However, Zhu argued that an increase to 1.25 percent from 1 percent would do little to solve Japan's underlying structural problems while immediately increasing fiscal pressure.

"The combination of persistent trade deficits, financial deficits and a huge public debt burden represents a structural challenge," Zhu said. "The yen is therefore likely to continue to depreciate."

Editor: Kim Taylor