Dollar Diplomacy: US and Japan Join Forces to Support Yen

The joint intervention by Japan and the US in currency markets to prop up the yen has been successful, at least for now. On Thursday and Friday of last week, the Bank of Japan (BoJ) sold dollars to buy yen while the US Treasury sold euros, using a unique approach that avoided weakening the dollar. The BoJ spent an estimated $US53 billion on Thursday and another $US36 billion or so on Friday.

The weak yen has been driven by Japan's poor fiscal position, with new Prime Minister Sanae Takaichi planning expansive tax cuts and spending in an economy where government debt is already over 200% of GDP. The BoJ has tried to put a floor under the yen, but its attempts have been unsuccessful so far.

America's willingness to lend its firepower and credibility to the defence of the yen may seem puzzling at first glance, but there are several reasons behind it. One reason is that Japan holds about $US1.1 trillion of US Treasury securities, which would need to be sold if left to defend the yen by itself.

This could push up US bond yields and increase the administration's debt costs, which are already nearing $US40 trillion or 123% of GDP. By intervening in currency markets, the US is protecting its own interests and maintaining the dollar as a global reserve currency.