It is never a good idea for a Politically-Exposed Person to give gratuitous advice to monetary policymakers — least of all to those who belong to another nation. A PEP is someone who holds a position of significant influence within a government.
The treasury secretary of the United States of America, Scott Bessent, appeared to have crossed a line recently when he tried to nudge the Bank of Japan to raise interest rates, arguing that its monetary mavens had fallen behind the curve by failing to quell inflation in the world’s fourth-largest economy where it is cresting at 3.3%.
To be fair, Bessent said that this was his personal view, while asserting that the BoJ needed to get its “inflation problem under control”. However, in a supercharged geopolitical environment, any comment emanating from someone within the inner coterie of President Donald Trump is reckoned to be laden with intent and will hardly be construed as innocuous, big brotherly advice.
The BoJ has one of the lowest policy rates among advanced nations — currently at 0.5% — which means borrowing rates are very low even though inflation has been well above the bank’s 2% target since end-March 2022. The BoJ governor, Kazuo Ueda, has, however, debunked the notion that Japan is at risk of falling behind the curve, while holding out the possibility of raising the policy rate later this year without actually committing to any deadline.
Monetary policymakers dislike being hustled into precipitate action on interest rates. Bessent’s subtle message to Japan’s central bank to raise rates comes at a time when President Trump is ratcheting up pressure on the Federal Reserve chairman, Jerome Powell, to slash rates. Curiously, the inflation rate in the US at 2.7% is also way above the Fed’s desired level of 2%. Monetary policymakers do not normally cut rates when inflation runs considerably above the desired level. Clearly, the US prod to Japan to raise rates doesn’t square with the logic behind Trump’s insistence on a Fed rate cut. When it comes to two advanced economies, sauce for the goose ought to work very well for the gander as well, thank you very much!
This begs a question: why does the Trump administration want Japan to raise its rates while badgering Powell to cut the Federal fund rate from its current range of 4.25-4.50%? In his Jackson Hole speech over the weekend, Powell conceded that GDP growth in the US had slowed in the first half of this year to 1.2% from 2.5% in 2024 — reflecting a slowdown in consumer spending and possibly justifying calls for a Fed rate cut. At the same time, he said the revision in US tariff rates had started to push up prices which could rouse inflation expectations. On the balance of risks, however, the Fed chairman appeared to soften his policy stance while saying that the “policy rate is now 100 basis points closer to neutral than a year ago” — a comment that the markets are reading as a sign of an imminent rate cut. Powell also pointed to the emergence of a new normal — characterised by low growth, low inflation, and a very flat Phillips curve — which suggests very little likelihood that any Fed rate cut will stimulate growth in the economy.
The truth is that Trump’s weaponisation of tariffs to reset the principles that undergird global trade is unlikely to achieve the stated objective of flattening the yawning trade deficits that the US has with its principal trading partners. Trump’s obsessive desire to call the shots in almost every sphere — ostensibly to Make America Great Again — could soon spill over into a situation where he might start to arm-twist nations like Japan to abandon monetary policy orthodoxy.
Others like India are under pressure to push domestic tax reforms or open up their markets to American goods at the risk of considerable harm to their local businesses. The sudden announcement by Prime Minister Narendra Modi at his Red Fort speech of a goods and services tax rate rejig where close to 90% of all goods and services will fall into two slabs of 5% and 18% is of a piece. For quite a long time, the government has held its ground amid a clamour from industry for a rate revision. The fact that it is prepared to revise the rates — which is expected to lead to a decline in GST collections, at least initially — raises suspicions that US trade negotiators are turning the screws as they do not want a concertina of taxes to make American products uncompetitive in India. After all, the US does not have a federal consumption tax like GST.
But the bigger game at play is in Japan with whom the US ran up a goods trade deficit of $69.4 billion in 2024. This is down by 2.8% — or by $2 billion — from 2023. But it obviously rankles which is why Trump struck what he termed as the “largest trade deal in history” with Japan. Under the terms of the deal, the US will levy a 15% reciprocal tariff on imports from Japan, substantially lower than the 25% that it had earlier threatened to impose.
More importantly, Japan has been forced to commit to an investment of $550 billion in the US in areas like energy, semiconductors, mining of critical minerals, pharmaceuticals and shipbuilding. The Japanese investment is expected to revive American industry, which hopes to retain and redeploy 90% of the profits from the investment. Trump has not spelt out the details as yet but the intent is clearly to stop repatriation of funds to Tokyo.
Japan is already the top foreign investor in the US. In 2024, it had made foreign direct investment worth $860.6 billion in the US. Japan’s commitment to invest
another $550 billion — on top of what has already been made — will substantially increase its FDI trove in the US. But that is not all: Japan is also the biggest foreign investor in US treasury securities at close to $1.15 trillion, which means it is
also underwriting a large chunk of US debt.
Although details are sketchy, the Trump administration is cock-a-hoop over the fact that it has driven a hard bargain in its trade agreements with Japan and the European Union by getting them to commit investments in the US. The EU has agreed to invest $600 billion. The trouble is that several Japanese commentators are already quibbling over the actual equity investment that will be made. No one seems to think that this will amount to more than 1%-2% of the figure. They reckon that most of the investment will be in the form of loans and loan guarantees.
There is a reason why the Japanese are keen to push loans rather than FDI in the form of equity investments. The policy interest rate spread between Japan and the US works out to 3.75% at the bottom end of the Fed fund rate of 4.25%. This raises the juicy prospect for the so-called yen carry trade where Japanese investors can borrow cheap loans in Tokyo and parcel them out in dollars in the US.
The Bank for International Settlements estimates that yen-denominated cross-border lending — a substantial amount going to the US economy — works out to around 40 trillion yen or $270 billion. Hyun-Song Shin, economic advisor and head of research at the BIS, believes that this trove is dwarfed by the humongous amount of cash that comes into play as nifty players turn to forex swap contracts. This gravy train works out to $14 trillion where investors borrow in yen and sell all of it on the spot market to acquire dollars. This entails a big risk in the form of a ‘naked yen obligation’ that they will need to fulfil by repurchasing yen on the spot market when the contract comes up for settlement.
All of this works phenomenally well when the yen depreciates against the dollar — as it has at present with the exchange rate settling at 147.85 yen to one US dollar from levels of 107.72 in March 2020 when the Covid pandemic broke out.
A BIS working paper titled “Global portfolio investments and FX derivatives”, which Hyun-Song Shin has co-authored, highlights the fact that forex swaps and related forex derivatives serve as “both a barometer ... and... conduit for international fund flows”. The report goes on to add that as a result of the increasing reliance on forex derivatives, “meaningful spillovers could also arise from policies abroad impacting financial conditions in the US”.
Trump and his White House advisers are clever; which is why they have started to mount pressure on the BoJ to raise interest rates so that it narrows the interest rate spread between the US and Japan, thereby capping the arbitrage opportunities that make the yen carry trade lucrative. It will be interesting to see how this tussle between
the two heavyweights plays out in the months ahead. The Indian sideshow must wait for the big stakes battle between the Goliaths on the global stage.
Saumitra Dasgupta is a senior journalist who writes on economic issues