A crucial question now hangs over global markets as the US Department joins forces with Japan to face investors betting against the yen: who really holds the strongest bargaining chips - Washington or Tokyo?
At the same time, it appears that the dollar system under Trump's leadership has become toxic and threatens US's closest and most stable ally, as it was led into over-indebtedness to support it.
Trump presents the first joint US-Japan currency intervention since 2011 as a «message of friendship», a move that, as he argues, will strengthen economies internationally.
And indeed, violent fluctuations of the yen can prove extremely destabilizing.
Very few financial mechanisms function as a stronger accelerator of instability than the so-called «yen carry trade», a strategy that has led to the collapse of numerous hedge funds.
Two decades of near-zero interest rates turned Japan into the world's largest creditor nation.
Investors borrowed cheaply in yen in order to seek higher yields abroad, inflating valuations of bonds of Argentina, commodities of South Africa, real estate in India, the New Zealand dollar, derivatives in the stock markets of New York, even cryptocurrencies.
When the yen recovers sharply, these transactions are liquidated with lightning speed. Markets move in one direction when the yen moves in the other.
Japan is the largest foreign holder of American government bonds (US Treasuries), with a portfolio approaching 1.2 trillion US dollars.
This exposure works both ways.
It constitutes a huge responsibility for such a large part of the national wealth to be committed to a currency whose value is threatened by the policies of Trump - including his efforts to place the Federal Reserve under greater political control.
At the same time, however, Tokyo knows very well the influence deriving from its position as America's largest funder.
Something important is happening...
The team of Scott Bessent, the US Secretary of the Treasury, has about 1.2 trillion reasons to keep the volatility of the yen under control.
After more than 30 years of monetary interventions, the Japanese yen finds itself on the verge of a free fall.
Last week, the yen came dangerously close to breaking downward through a critical technical support level. A breakdown below this level would open the way for a generalized collapse, driving the currency to levels not recorded since 1990.
Japan is making every possible effort to prevent such a possibility, resorting to increasingly larger interventions in foreign exchange markets.
However, the problem is that, in order for the Bank of Japan (BoJ) to buy yen, it must liquidate assets to secure the required liquidity. And the assets that Japan liquidates are American government bonds (US Treasuries).
To be clear, these are not small amounts.
In just one day, the BoJ spent a record amount of 52 billion US dollars within a single day.
It is obvious that the United States does not wish to see the largest foreign holder of American government bonds proceed with mass sales.
For this reason, last week the US Treasury actively intervened in favor of the yen for the first time since the Asian Financial Crisis of 1998.
Mutually assured destruction
The timing could hardly be worse.
Traders call this possibility «mutually assured destruction»: a mass sale would severely hit Japanese exporters and simultaneously skyrocket interest rates globally.
It also remains completely uncertain to what extent the first joint US-Japan intervention in 15 years can prove effective.
One reason is that both the Japanese and the American sides seem to be acting more for impressions than with a real intention to direct the markets.
A characteristic example is the fact that the USA sold euros to buy yen, instead of using dollars.
And it is clear that, unless the Bank of Japan finds the courage to raise interest rates above the current 1%, those betting on the further weakening of the yen have every reason to question Tokyo's determination to strengthen the currency.
Japan's patience is running out...
It is one thing for the USA and Japan to characterize the yen as «substantially undervalued» and entirely another for central banks to undertake the necessary actions to support it, points out Louise Loo, lead economist for Asia at Oxford Economics.
Despite this, Sanae Takaichi's patience with Trump is running out.
Late last month, Trump imposed new tariffs, ranging from 10% to 12.5%, on 60 trading partners, among which is Japan, which is supposed to be a «friendly» country.
Tokyo was caught by surprise.
The government of Sanae Takaichi is working in good faith to compile the 550 billion US dollar package that Donald Trump demanded in exchange for tariff reductions.
Japan is coordinating with JPMorgan and other American banks for the structuring of the financing.
However, domestic banks appear hesitant, as their funding base is in yen, a fact that makes it expensive to raise large amounts in dollars to fund long-term infrastructure projects.
The Liberal Democratic Party (LDP) has every reason to feel that it does not receive the recognition due to it from an American president who is alienating his allies at rapid speed.
In the vortex of geopolitical developments
At the same time, Japan finds itself right at the center of Trump's high-risk geopolitical initiatives.
The country imports 95% of its oil from the Middle East, a fact that renders it particularly vulnerable both to the conflict currently pushing international energy prices higher and to any rise in US Treasury yields.
The White House ought to know that a new collapse similar to that of Long-Term Capital Management (LTCM) could prove catastrophic.
The bankruptcy of LTCM in 1998 was caused in part by the rapid rise in US Treasury yields and constituted one of the most severe financial crises prior to 2008.
A repetition of such an episode - which could be triggered by tariffs, inflation, or a conflict with China - might make even the Lehman Brothers crisis of 2008 look like a mild episode of financial crisis.
James Carville aptly captured the mood of the early 1990s when he joked that he would like to be reincarnated as the bond market because «you can intimidate everybody».
At that time, investors in the debt market reacted strongly even to minor shifts in fiscal discussions in Washington.
Today, with American public debt approaching unprecedented levels, inflation remaining high, and population growth slowing, Asia has valid reasons to worry about the fiscal condition of the United States.
The Republican Party of Trump has abandoned all pretense of fiscal discipline.
The political deadlock in Congress is even deeper than in 2011, when S&P stripped the USA of its top AAA credit rating, essentially confirming the warnings of then Premier of China Wen Jiabao regarding the need to protect massive Chinese dollar reserves.
During that period, American public debt was less than 12 trillion dollars, that is, less than half of today's level.
Beijing ultimately concluded that, in the event of a financial crisis, the United States had more to lose than China.
Similar calculations have been made by Japan in the past.
In 1997, then Prime Minister Ryutaro Hashimoto admitted before an audience in New York that Tokyo had «several times» considered proceeding with mass sales of American government bonds (dump Treasuries) in order to send a political message, even during intense auto trade negotiations.
The Ministry of Finance of Sanae Takaichi is also in a state of heightened vigilance.
A volume of Japanese state wealth, equivalent to the annual GDP of Switzerland, is invested in American public debt. At the same time, Trump's policy mix - inflationary tariffs, interventions in the independence of the Federal Reserve, weakening of the Internal Revenue Service (IRS), and pursuit of new tax cuts amounting to trillions of dollars - rests on the assumption that Asian central banks, from Tokyo to New Delhi, will continue willingly to fund Washington's ambitions.
This assumption appears increasingly uncertain.
Asia is watching and preparing to react
The irony is apparent. A quarter of a century ago, Washington was lecturing Asia on crony capitalism, lack of institutional transparency, and irresponsible governance.
Today, Asia watches with wonder as the United States undermines its own financial credibility with impressive speed.
Policymakers across the entire region are examining various scenarios for how Trump's tariffs and unpredictable economic policy implementation could overturn their economies. For now, the damage that Trump has caused to stock markets may be smaller than the blow he has inflicted on bond markets.
Under normal conditions, recession risks would favor the bond market, however, the inflation caused by tariffs has overturned this logic.
Markets worry that the Trump administration appears to demonstrate greater tolerance for a scenario of causing a recession or even extreme turbulence in the international economy than many deemed likely.
During the past year, turmoil in bond markets has repeatedly forced Trump's team to back down.
There is also the view that part of Scott Bessent's haste to stabilize the yen aims at preventing a similar move by China.
This dynamic brings back memories of the late 1990s, when global markets worried intensely that China would proceed with a devaluation of the yuan. Such a development would trigger a new race of competitive devaluations in international currency markets.
The currency war
Besides, if someone were President of China Xi Jinping and faced increasingly stronger trade headwinds, why not choose a more favorable exchange rate?
Especially when «beggar-thy-neighbor» policies applied by US ally Japan provide him with political cover as well.
Such a development could lead to a currency war of a scale that, likely, markets have never experienced before.
When two of the world's largest economies intervene jointly in markets for the first time in over a decade, they are essentially telling investors that beneath the surface of the global financial system pressures are accumulating, and not simply that there is a problem with an exchange rate.
The real question is when the strongest bond vigilantes - that is, the central banks themselves - will begin actively selling American government bonds.
Japan and China constitute Washington's largest funders, followed by the UK, Luxembourg, the Cayman Islands, Belgium, Canada, France, Ireland, Switzerland, Taiwan, and Hong Kong.
If markets perceive that any of these countries is selling American bonds - or even simply suspending its purchases - global credit markets could plunge into chaos.
If Trump perceives this danger, so far he has not shown it to Asian central bankers who, in practice, hold control of the American economy in their hands.
As 2026 unfolds, the initiative of moves may rest more in the hands of Japan than Trump's team believes.
The multi-trillion question
The multi-trillion dollar question - as assets worth trillions are valued based on the exchange rate of the yen and the yields of Japanese government bonds - is this: Was this intervention enough to de-escalate tension in the markets?
The answer seems to be a categorical «no».
Japan held one of its worst government bond auctions in recent decades. Without getting into technical details - as bond auctions are extremely complex - the following occurred:
• Weak demand: The bid-to-cover ratio (which reflects how many bids were submitted relative to the number of available bonds) stood at 2.56, significantly lower than the usual average of 3.3, recording one of the worst performances of the last decade. This indicates that investors showed limited interest in these specific bonds.
• Large «tail»: The difference between the price investors expected to pay and the final price at which the bonds were issued was the second largest since 2000. Simply put, the government was forced to accept a lower price (and consequently a higher borrowing cost) than what it expected, in order to complete the issuance.
• Surge in yields: Due to weak demand, the yield (that is, the interest rate) of these specific bonds rose to approximately 2.87%, approaching its recent highs.
Bond prices and their yields move inversely; consequently, weak demand means a fall in prices and, by extension, a rise in yields.
The yield of the particularly important 10-year Japanese government bond is now following an almost vertical upward trajectory. The final stage of Japan's huge public debt «bubble» appears to be approaching.
The major debt crisis is at the doorstep
Japan constitutes the most characteristic example of excessive borrowing and extreme central bank interventions. The United States first reached a Debt-to-GDP ratio equal to 100% in 2015.
Japan had already reached that level by 2001.
The USA first introduced Zero Interest Rate Policy (ZIRP) and Quantitative Easing (QE) in 2008, in order to address their debt problems.
Japan had implemented the same policies as early as 1999 and 2001, respectively.
Since then, the central bank of Japan, the Bank of Japan (BoJ), has essentially nationalized the entire financial system of the country. Today, the BoJ:
1. Owns more than 50% of Japanese public debt.
2. Is the largest shareholder in Japanese listed companies globally.
3. Is listed among the ten largest shareholders in more than 90% of the companies participating in the Nikkei 225 index.
4. Possesses a balance sheet larger than the Gross Domestic Product (GDP) of Japan itself.
All these interventions allowed Japan to accumulate a level of public debt that exceeds anything historically recorded.
The Debt-to-GDP ratio amounts to 215%.
Interest payments to service the debt constitute the second largest category of expenditure in the state budget - after social security spending - absorbing about 24% of the country's federal fiscal expenditure.
Simply put, however alarming the situation of the United States may appear from the perspective of public debt and monetary interventions, the situation in Japan is of manifold intensity.
And, based on today's data, Japan stands a serious chance of being the first country to enter a public debt crisis.
In financial markets, nothing comes for free.
Not even for central banks.
When a central bank constantly intervenes in the bond market, it usually ends up sacrificing the value of the national currency, following the well-known strategy of «inflating the debt away».
Since the Bank of Japan intensified its interventions in the government bond market in 2012, the Japanese yen has lost more than 50% of its value.
And, at the moment of writing these lines, the yen sits right on top of a critical technical support level. If it breaks downward through this level, it is very likely to enter a free fall phase.
The results will be catastrophic for the global economy.
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