The Yen Crisis: Why the Bank of Japan Cannot Raise Rates

I recently published a post summarizing the talk of a yen bank run. By placing figures like the 45 trillion yen in Bank of Japan (BOJ) unrealized losses on government bonds and the 15 trillion yen in losses for life insurers alongside the SVB crisis, I concluded that “the likelihood of a bank run is low; the real risk lies in the unwinding of the yen carry trade.” At the time, I thought that settled it.

However, a few days later, while reading through another document that delved into the overall Japanese economy, I hit a snag. I had treated the government bond losses and the weak yen as separate issues, but I began to think that they aren’t entirely distinct events. The hollowing out of Japanese manufacturing, the entrenchment of ultra-low interest rates, and the Takaichi cabinet’s plans to revise fiscal rules—they all converge on a single question: Why does the BOJ, after signaling rate hikes multiple times, remain unable to act? Following that thread, I realized that government bond losses and the carry trade are two sides of the same coin.

Why the Yen Lost Its Status as a Safe-Haven Asset

First, we need to understand how we got here. The yen wasn’t called a safe-haven asset for a long time because of high interest rates; it was the opposite. Even with almost zero interest, the world wanted to hold the yen. The reason is simple: in the 20th century, Japan was the world’s best at making and selling everything from steel and home appliances to semiconductors. As goods were sold, foreign currency flooded into Tokyo, while the yen circulating domestically remained relatively scarce. Just as the price of a scarce good rises, the value of the yen was naturally firm.

However, things started to unravel as the grammar of industry shifted from analog to digital. Organizations that reached the top through the craftsmanship of precision machining often freeze up when faced with a “speed war” that requires failing fast and rebuilding. With facilities, performance reviews, and supply chains all tuned to past winning formulas, changing direction wasn’t easy. There is one more decisive factor: Japanese companies, unable to bear labor costs during the long era of a strong yen, built production bases abroad, including in the U.S. As a result, Japanese conglomerates still generate surpluses in the global market, but that money rarely returns to the Japanese mainland because they produce and sell overseas. Given that the capital for those overseas factories came from draining previously stockpiled foreign reserves, a structure was completed where the doors for foreign currency inflow narrowed while the doors for outflow widened.

Why Raising Rates Shakes Both Government Bonds and the Carry Trade

Since external earnings weren’t what they used to be, the Japanese government stuck to ultra-low interest rates to keep the domestic economy warm. But here, a single policy began to branch into two conflicting directions. In a country that relies almost entirely on imports for raw materials and energy, low rates weaken the yen, causing import prices to spike. It is a contradiction where the fire lit to warm the house ends up burning the grocery basket. At the same time, the yen carry trade—where investors borrow yen at low interest to invest in high-yield U.S. or European assets—opened wide. Interest rates are not just simple borrowing costs; they act as a sluice gate determining whether a country’s money circulates internally or leaks outward.

Now, let’s assume the BOJ actually raises rates. In theory, the yen should strengthen, solving the problem. But here, two different ruptures occur simultaneously. One is bond prices. If rates rise, the prices of existing low-interest government bonds inevitably fall. The BOJ itself has over 45 trillion yen in unrealized losses on its government bond holdings as of fiscal 2025, and losses at commercial banks and life insurers are also piling up into the trillions. The other is the carry trade. The moment the yen strengthens, investors who borrowed money at low interest rates face both interest burdens and exchange rate losses, prompting them to rush to buy back yen to pay off their debts. In the process, they sell off their overseas assets—and the scary part is that this isn’t a one-time event. When the BOJ raised rates in August 2024, the Nikkei 225 plunged 12.4% in a single day, and the KOSPI dropped 8.77%. In December 2025, even just the Governor’s hint at a rate hike caused the Nikkei to fall 1.89% and rattled the New York Dow. It means the same pattern is repeating.

In short, the switch of a rate hike sends shockwaves in two directions: the bond market and the foreign exchange/stock market. It is a structure where the button pressed to silence one issue triggers another.

Government Bond Losses Aren’t a Bank Run, But They Change When Met with Takaichi’s Fiscal Policy

As I noted in my last post, it is hard to agree with the scenario that these bond losses will immediately lead to bank failures. The Japanese Financial Services Agency drew a line by stating that these losses are fundamentally different from the U.S. SVB crisis, and the basis is quite persuasive. While SVB had a highly concentrated structure dependent on startup and VC deposits, Japanese regional banks are centered on household deposits, making a sudden bank run unlikely. Furthermore, in accounting terms, government bonds classified as Held-to-Maturity (HTM) are not required to immediately reflect market losses on financial statements. Some mega-banks have even been assessed as having government bond valuation losses of less than 10% of their projected profits.

The problem is that these losses aren’t stagnant; they are continuing to grow. Recently, news broke that the yield on Japan’s 30-year government bond approached 3% for the first time in 30 years, and it doesn’t seem to be merely due to market volatility. The draft of the basic policy for economic and fiscal management released by the Takaichi cabinet last month omitted phrases related to fiscal soundness, and it included a plan to continue expansionary fiscal policy of 10 trillion yen per year from fiscal 2027 onwards. They also aimed to change the primary balance surplus target from an annual basis to a multi-year indicator and to abolish the practice of compiling supplementary budgets. Although follow-up interviews mentioned that fiscal consolidation would be pursued in parallel, it seems the market reacted first to the signal of increased spending. In a country that must continue to print more government bonds, if the central bank begins raising rates, the interest burden on those bonds further constrains the budget. Even if the risk of bond losses turning into an SVB-style bank run is low, the picture is definitely leaning toward the chronic stress of the bond market as it overlaps with fiscal expansion.

There is one more thing that people often overlook: even though the government says it will inject money, the Japanese public and companies are tightening their purse strings even more. There is a deep-seated perception that a massive earthquake occurs every 40 years, so even when the government waters the dry fields, individuals choose to hoard cash in their own jars. The fact that foot traffic in bustling areas like Osaka or Ginza has decreased noticeably compared to the past suggests this as well. If money doesn’t circulate even when fiscal policy is loosened, the effect of expansionary policy will diminish, leaving only the burden of government debt.

The Problem of Failing to Find Growth Engines Even When Money Is Poured In

There is another point that bothers me here. Where exactly is the Takaichi cabinet planning to spend this money while even touching fiscal rules? For instance, they declared they would invest 2.9 trillion yen into the next-generation semiconductor national project, Rapidus, to achieve 2nm mass production by 2027. Yet, even within the Ministry of Economy, Trade and Industry, the department deciding on the support, word has leaked that they see the success probability at only 20-30%. It’s a picture of a company with zero track record trying to play a chicken game with low-price offensives in a market held by TSMC, Samsung, and SK Hynix. Since performance and yield are more critical than price in semiconductors, skepticism is significant. The ‘Physical AI’ national project pushed by Noetra is similar. They plan to invest 1 trillion yen over the next five years, but the participating companies—SoftBank, NEC, Honda, and Sony—are either communication/entertainment companies or firms that recently abandoned electric vehicle development, leading to criticism that the combination is far from the actual physical AI technology.

Then there is the Line Yahoo incident. Not long after cutting off technical cooperation with Naver and taking over Line citing security leaks, news emerged that they are considering a plan to entrust sensitive data related to national defense and economic security to a U.S. private cloud. They say it’s due to limitations in their own data processing capabilities and security technology, but the situation looks like an effort to regain data sovereignty that has ironically led to greater dependence on another country’s cloud. I bring this up because the cleanest solution to the dilemma Japan currently faces is to grow the real economy itself through new growth engines. But if the national projects meant to drive that growth are in this state, it is hard to be optimistic that pouring in money will refill the coffers.

Why the Bank of Japan Cannot Move

Coming this far, it is easier to understand why the market reacted with indifference even though the BOJ Governor warned of rate hikes so many times. Although there was talk that the probability of a 25bp additional hike at the September meeting had risen to 87%, it seems everyone knows that this doesn’t solve the structure itself. If they maintain low rates, the weak yen, import inflation, carry trade outflows, and the exhaustion of foreign reserves continue to work in tandem. But if they sharply raise rates, government bond valuation losses will grow, the carry trade will be liquidated at once, shaking Asian stock markets, and the interest burden on government bonds for a government that wants to continue expansionary fiscal policy will increase. Since pressing one side only causes bigger problems on the other, it is fitting to call this a dilemma.

Reports that the U.S. Treasury Secretary has moved beyond verbal warnings to direct market intervention in coordination with the Japanese government can be read differently in this context. There must be a calculation that if the currency of the country that buys the most U.S. Treasuries in the world shakes, the repercussions could spread to the U.S. Treasury market. However, since mere verbal intervention doesn’t solve the structural problems, skepticism continues to grow inside and outside the market that they have reached a point where they can no longer hold out with just verbal intervention.

Why This Matters for South Korea

Honestly, when I first read these materials, I thought it was just about another country’s currency. But after seeing an analysis that the correlation coefficient between the won and the yen rose to 0.94 in the second half of 2025, my thoughts changed. It means global investors do not see South Korea and Japan as separate markets but as a single Asian asset class. In fact, the won/dollar exchange rate reached 1,559 won in early July, the highest since the 2009 financial crisis. At the time, one cause was that export companies were not bringing the dollars they earned back into the country but were hoarding them in overseas subsidiaries. Since then, there was a precedent where the rate dropped to the 1,400 won range after SK Hynix issued U.S. ADRs and some companies adjusted the speed of dollar repatriation. The prevailing analysis is that the exchange rate consistent with current fundamentals is roughly in the 1,400 won range, and that the near-1,550 won level is a matter for when special variables like the Iran crisis overlap.

So now, I plan to keep an eye on a few things: whether the BOJ actually raises rates after September, or if they just warn and postpone again. Whether the 30-year JGB yield exceeds 3%, and whether the fiscal expansion mentioned by the Takaichi cabinet is actually implemented at a scale of 10 trillion yen per year. Whether the pattern of yen carry trade unwinding leading to another Nikkei/KOSPI plunge repeats. And whether the dollars earned by our companies are steadily coming back home. If even one of these goes wrong, the picture could change significantly, so it is still too early to draw a conclusion on any of it.

So, the Conclusion

While writing this, I felt that whether it is government bond losses, the weak yen, or the carry trade, each has a plausible explanation when viewed separately, but when put together, they all stand in front of the same door. No matter which way the BOJ opens the door, the wind blows in from the other side. I am not sure if this is a problem that will be resolved clearly soon, or if it will be managed precariously like this for a few more years. However, at least it has become clearer that the question of “will there be a yen bank run or not” does not fully capture this situation.