At the end of July, something extraordinary happened on the foreign exchange markets. It was an event that revealed the fiscal dilemma into which the US government, under the leadership of President Trump and Treasury Secretary Scott Bessent, has now manoeuvred itself.
It all began with massive sales of US government bonds by the Bank of Japan. The yen had come under pressure, and this was a measure taken to prop up the value of its own currency. This sell-off drove up US bond yields. The yield on 30-year Treasuries climbed at one point to 5.24 per cent, its highest level since 2007. To deter the Bank of Japan from further sales of US government bonds, Scott Bessent intervened and ordered the sale of euros against the yen in a concerted effort to prop up the yen and prevent US yields from rising even further. At the same time, Japan was granted easier access to a Federal Reserve liquidity facility through which dollars can be obtained in exchange for US government bonds. This was intended to prevent the defence of the yen from exerting additional selling pressure on the Treasury market.
It might be tempting to see this as a sign of strategic sophistication. On closer inspection, however, it was less a sign of strength than an attempt to contain the vulnerability of the US bond market. The world’s largest and most liquid government bond market should, in theory, be able to absorb such a development without difficulty. Instead, it has quite clearly become vulnerable.
The cause of the US dollar’s increasingly apparent weakness lies in the Trump administration’s fiscal policy, which has spiralled out of control. Under Trump, the deficit has consistently stood at 6 per cent of GDP, and inflation is not being effectively tackled because the Fed is under political pressure: whilst a more restrictive monetary policy could dampen price pressures, it would at the same time further increase the US government’s already high borrowing costs. As a result, public finances – and with them the perceived sustainability of US government debt – are coming under increasing pressure, creating a dilemma that cannot be resolved by a single political manoeuvre. The higher long-term yields rise, the more expensive it becomes to finance US debt. The harder Washington tries to keep interest rates low, the greater the risk that investors will demand higher risk premiums.
At the same time, there is a growing risk that international creditors – from Japan to China to the UAE – will quietly but surely withdraw from US government bonds. Washington can no longer take it for granted that foreign central banks and investors will finance every additional US deficit on the same terms as before.
Yet instead of facing up to this reality, the US government is merely engaged in political damage control. It is benefiting from the current strength of the stock market driven by the AI boom, but must retain the loyalty of foreign creditors through discreet currency swap lines to prevent panic selling.
In public, Trump presents himself as a president who can bend financial markets to his will. Behind the scenes, however, Bessent manages these dependencies, using increasingly sophisticated financial manoeuvres to contain the structural damage, because the illusion of economic strength must be maintained at least until the mid-term elections in November.
That is the real irony: over decades, Washington has gained fiscal freedom because the US dollar is the world’s most important reserve currency and US government bonds are regarded as the safest and most liquid asset. The flip side of the coin went unnoticed for a long time: at the end of the day, the US is dependent on the rest of the world to finance its debts.
Perhaps that is why the real significance of the yen intervention at the end of July lay not in Tokyo, but in Washington. The US helped an ally to defend its own currency so that this ally would not be forced to sell US government bonds.
This is not yet an indication of a sea change in the financial markets. But it shows that Washington can no longer treat its creditors as passive financiers. This time, Japan has gone along with the American solution. Next time, things could look different – in Tokyo, Beijing or Abu Dhabi. The US’s financial power is based not only on the size of its economy, but also on the fact that others are willing to finance America’s growing public debt. Washington cannot take that willingness for granted – and it cannot compel it.
Editor’s note on AI: I use AI tools for translation, English-language editing and, where useful, structural feedback. The arguments, analysis, sources and conclusions are my own, and I take full responsibility for the published text.
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