Japan Cheap Money Era is Ending, and Washington has Noticed
For decades, Japan was one of the world's cheapest places to borrow money. Interest rates were near zero, encouraging investors to borrow yen and put that money into higher-return investments worldwide. That very system helped make Japan an important source of cheap money for global markets.
However, that system is changing. The Bank of Japan has raised interest rates, bond yields have climbed, and the yen remains weak against the dollar. These changes create a difficult situation for Japan because investors worldwide have relied on Japan for cheap money, and those effects could extend well beyond the country. Investors worldwide eventually found a way to take advantage of that system. They borrowed yen cheaply and invested money elsewhere for a higher return. This became known as the yen carry trade.
If Japanese interest rates rose or the yen strengthened significantly, the economics of the trade could change very quickly. Investors could find themselves selling the assets that they bought and converting the money back into yen to repay their loans. However, investors didn't have to worry about that until August 2024.
The Bank of Japan raised interest rates, which strengthened the yen and made the yen carry trade less attractive. Investors began unwinding their positions, selling assets to reduce their exposure to the borrowed money they had to repay. The result was a sharp global market sell-off. The Japanese Nikkei index fell about 12.4% in a single day, the largest one-day decline since the bubble burst mentioned earlier. Luckily, the market recovered quickly, but it showed how Japan's monetary policy could affect markets far beyond Japan.
The situation in 2026 is different from the sudden shock in 2024. However, the underlying issue remains the same. Japan is gradually moving away from the ultra-low interest rates that defined the economy for decades. The Bank of Japan's policy rate is now at 1.25%, the highest since 1995. At the same time, Japan's 10-year government bond yield has risen above 3%, the highest since the mid-1990s. Those numbers may not sound dramatic compared to U.S. interest rates, but for Japan, they represent a major change. This is where Japan's problem becomes very relevant to the United States. Japanese investors hold a large amount of foreign assets, including U.S. securities. For years, the gap between low Japanese interest rates and higher returns elsewhere encouraged money to flow out of Japan.
Japan is not necessarily heading toward another 2024 market collapse, but it's a big concern what happens if this transition continues. Japan is dealing with a combination of a weak currency, rising borrowing costs, and large government debt. Japan's shift away from cheap money is no longer just a Japanese issue. Because its financial system is so connected to global markets, what happens next could affect investors far beyond Japan.
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