How did the Japanese yen develop its safe-haven currency properties?

Author: Vivienna — BR Research Partner

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Recently, a sharp market fluctuation caused by the decline of the yen carry trade has made people look at the monetary policy of the Bank of Japan. Coupled with the uncertainty of the Fed's interest rate cut expectations, the market is in a state of panic. This article briefly sorts out the origin of the yen's safe-haven currency properties through some historical events and basic principles of economics. Historically, Japan has always found a way to use its unique monetary policy and carry trade to readjust the yen exchange rate. Is this time different?

Finally, this article wants to use the analysis of the factors affecting the exchange rate and value of the Japanese yen to draw out thoughts on national reserve assets. The following article will continue to explore the value of currency and the belief in Bitcoin from the perspective of economic theory. Therefore, this article can also be regarded as a citation.

Key words: Japanese monetary policy; carry trade; foreign exchange reserves; balance of payments; mercantilism; US dollar index; gold

Table of contents:

1. The historical background of Japan's long-term low interest rates

2. The development of carry trade has boosted the safe-haven properties of the yen

3. Changing monetary policy and inflation environment threaten yen stability

4. The last straw - foreign exchange intervention?

5. Overseas investment is the key to Japan's maintaining a balanced international payments

6. The battle for reserve assets — U.S. Treasuries or gold?

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1. The historical background of Japan's long-term low interest rates

Recently, a sharp market fluctuation caused by the decline of yen carry trade has made people turn their attention to the monetary policy of the Bank of Japan. Coupled with the uncertainty of the Federal Reserve's expected interest rate cut, the market is in a state of panic.

The carry trade of Japanese yen has a long history. The history of ultra-low interest rates of Japanese yen can be traced back to the 1980s when the United States launched a trade war against Japan.

In the 1980s, affected by the collapse of the Bretton Woods system and the oil crisis in the 1970s, the United States experienced the worst "great inflation" in history. Paul Volcker, then chairman of the Federal Reserve, adopted a violent interest rate hike to curb inflation, which led to a rapid appreciation of the US dollar in the international market. Although this attracted international capital to flow into the United States to a certain extent, it also caused US export goods to become more expensive in the international market, further exacerbating the US trade deficit. (For the basic knowledge of the establishment and disintegration of the Bretton Woods system and the US dollar index, please refer to the previous article: https://medium.com/@vivienna/From the Bretton Woods system to the US dollar index-a more detailed popular science of the US dollar index than Wikipedia-8fe7eddf2be6)

From the 1970s to the 1990s, the United States launched a long trade war and exchange rate war against Japan, then the world's second most powerful country and its largest trading partner.

The Japan-US trade war was fought over textiles, steel, color TV, automobile and semiconductor industries, and was accompanied by the transformation of Japan's industrial structure and the development of emerging technologies. The 30-year trade war did not stop the development of related industries in Japan as the United States expected, nor did it solve the problem of US trade imbalance.

But the results of the exchange rate war are quite significant. In the early 1980s, the USD/JPY ratio had been at a high of around 250. The Plaza Accord was signed on September 22, 1985 at the Plaza Hotel in New York by the finance ministers and central bank governors of the United States, Japan, West Germany (now Germany), France and the United Kingdom. The main purpose of the agreement was to weaken the U.S. dollar's exchange rate through coordinated intervention in the foreign exchange market, thereby alleviating the U.S. trade deficit, especially the huge trade deficit with Japan and West Germany.

After the agreement was reached, the countries agreed to take joint intervention measures to weaken the US dollar. As a result, the yen appreciated rapidly against the dollar. Since then, the yen has continued to appreciate despite Japan's reduction in policy interest rates.

Since Japan's GDP at that time mainly came from exports, in order to reduce the negative impact of the appreciation of the yen on exports, the Bank of Japan was forced to maintain low interest rates for a long time to help companies obtain financial support and promote social investment and economic growth. This policy also directly contributed to the Japanese real estate bubble.

Figure: Historical trend of USD/JPY exchange rate

Even though the current US trade war against Japan has long ended, the economic damage caused to Japan by Japan's long-term monetary policy system formed over time and the balance sheet recession after the bursting of the real estate bubble remains.

The following are some of the monetary policy operations that the Bank of Japan has taken in recent years to maintain the stability of the value of the yen:

• After the 2008 financial crisis, the Bank of Japan lowered interest rates to 0% and implemented a monetary easing policy (QE) to purchase assets on a large scale in order to revive the economy.

• After Abe came to power in 2013, he implemented a qualitative and quantitative easing policy (QQE), setting the policy goals as controlling the base currency, increasing the purchase of government bonds, Japanese stocks and other assets, extending the maturity limit of government bonds, increasing expected inflation, lowering real interest rates, and promoting the depreciation of the yen to boost exports;

• In January 2016, as the effects of Abenomics slowed, the Bank of Japan implemented a negative interest rate policy;

• In September 2016, the Bank of Japan maintained its negative interest rate decision and asset purchase scale, but abandoned the monetary base as a target and instead introduced the controlled yield curve YCC, maintaining the 10-year government bond yield at 0% to protect the profit margin of the financial industry.

These policies ensured that the yen remained in a low interest rate range for a long time. Although low interest rates eventually triggered the bursting of the real estate bubble and caused Japan to be in a state of deflation for a long time, it also made the yen the main financing currency for international carry trades.

2. The development of carry trade has promoted the safe-haven property of the yen

The so-called carry trade is a common transaction in the international foreign exchange market. In a carry trade, foreign exchange investors borrow low-interest currencies (such as the Japanese yen) and invest the purchased high-interest currencies in their domestic risk-free assets (mainly government bonds), thereby earning the interest rate difference between the risk-free assets corresponding to the two currencies. It is essentially a foreign exchange speculation behavior. The existence of interest rate difference is the main driving factor for carry trade.

For carry trades, which are a cross-border asset allocation investment method that requires comparing the expected returns of domestic assets with those of foreign assets, the expected return on investing in foreign currency should be considered before considering investing currency assets in higher-yielding financial products.

Taking the US-Japan carry trade as an example, when arbitrageurs lend Japanese yen to invest in US dollar assets, the expected rate of return should take into account the expected appreciation or depreciation of the US dollar, because the future calculation of investment returns needs to be converted back to the financing currency (Japanese yen) (according to the interest parity condition, investors are willing to hold domestic assets only when the exchange rate makes the expected rates of return on domestic assets and foreign assets equal). Therefore, the expected rate of return on US dollar assets measured in Japanese yen is equal to the sum of the interest rate on US dollar assets and the expected appreciation/depreciation rate of the US dollar.

Therefore, before the US dollar rate hike, the yen carry trade was actually mainly about the Australian dollar, which had a relatively higher interest rate, rather than the US dollar. It was only the widening interest rate gap and appreciation expectations brought about by the US dollar rate hike in recent years that made it a more important investment target.

As a foreign exchange speculation behavior, carry trade naturally takes exchange rate changes into consideration. In the economic world, the factors affecting exchange rates are mainly inflation, interest rates and balance of international payments. Referring to the US-Japan trade war and exchange rate war, international trade protectionism is also a very important factor in politics.

From an economic perspective, the first two factors can be understood using the purchasing power parity theory and the interest rate parity theory.

Purchasing Power Parity (PPP) is a basic theory in international economics that can explain the performance of exchange rates over a relatively long period of time. An absolute purchasing power parity theory holds that if there are no transportation costs, tariffs, or other trade barriers, the price of the same commodity in different countries should be the same. If the price of the same commodity can only be expressed in one currency (for example, all priced in US dollars), then the normal exchange rate is when the currency of the commodity producing country (such as the Japanese yen) has the same purchasing power as the pricing currency (the US dollar).

For example, for the same cup of coffee, the price is 150 yen and the price is 1 dollar, the exchange rate is 150:1. If the current exchange rate is 155:1, it means that the value of the yen is underestimated and there is an expectation of appreciation - because 150 yen originally has the purchasing power of 1 dollar.

Many carry traders will use this theory to help determine whether the current exchange rate of a currency is overvalued or undervalued.

Since inflation rates vary from country to country, the above absolute purchasing power parity theory has evolved into the relative purchasing power parity theory. In theory, if the inflation rate of one country is higher than that of another country, then the country's currency should also depreciate relative to the currency of the other country so that the purchasing power of goods in the two countries is balanced. The formula is as follows:

For example, the same cup of coffee is priced at 150 yen and 1 dollar, but Japan's inflation rate is 1% and the United States' inflation rate is 3%, with a ratio of 1:3. If the current yen/dollar exchange rate is 150:1, then the future exchange rate should be 147:1 (Note: relative purchasing power parity predicts the direction and magnitude of exchange rate changes, not the absolute value of the exchange rate).

Therefore, if a country has a relatively low inflation rate and its currency is undervalued, the country's exports will become relatively cheap, thereby increasing export demand and bringing about expectations of currency appreciation and a return to purchasing power parity levels.

Take Japan as an example: Japan has won the favor of importers for its high-end manufacturing products with its quality and reputation, and its asset prices are relatively underestimated when denominated in foreign currencies, so the value of the yen has also been undervalued for a long time; at the same time, Japan has been experiencing long-term deflation, and its currency purchasing power should also appreciate relative to foreign currencies. Therefore, if it is not affected by trade barriers such as transportation costs and tariffs, the long-term appreciation of the yen is expected to be stronger.

But the fact is that in the case of high inflation, the United States can still make the dollar appreciate by relying on high interest rates, in addition to increasing tariffs and other methods, while the yen is forced to continue to depreciate.

The reason is that although expectations of currency appreciation and inflation rates are the basis for carry traders to calculate expected returns, when the difference in inflation rates is not large (there is no hyperinflation like Zimbabwe or Venezuela), this factor has little impact on the exchange rate, and the more important factor is the interest rate differential.

Interest Rate Parity (IRP) is a basic theory in monetary finance that explains how interest rate differences between different countries affect currency exchange rates. Generally, when there is a difference in interest rates between two countries, funds will flow from the country with a low interest rate to the country with a high interest rate to seek profits. Therefore, the interest rate difference will be adjusted through the change of the exchange rate, so that no matter which country the investor chooses to invest in, the final rate of return should be equal based on the adjusted exchange rate.

Since the implementation of Abenomics in 2013, its policy stimulus has been beneficial to the stock market (the government has invested in the purchase of government bonds and Japanese stocks), which has led many foreign investors to adopt a "long Japanese stocks + short Japanese yen" investment portfolio - that is, using the low-interest Japanese yen as a financing currency to invest in the Japanese domestic stock market - which not only avoids exchange rate risks, but also obtains asset appreciation returns. When the financial market is turbulent and Japanese stocks fall, foreign investors need to buy back Japanese yen to close their original investment portfolios while selling Japanese stocks, causing the yen to appreciate. Therefore, this also creates a relative consistency in the trend of the US dollar/yen exchange rate and Japanese stocks - when Japanese stocks fall, the yen appreciates against the US dollar.

Figure: Nikkei 225 trend and USD/JPY exchange rate trend

The Japanese yen is therefore regarded as a safe-haven currency - once there is volatility in the financial investment market, carry trades will have to sell assets and buy back Japanese yen to cover their loan positions in order to escape risk, and the yen will appreciate.

Therefore, the yen carry trade can maintain the safe-haven properties of the yen mainly because it is supported by Japan's long-term low inflation (even deflation) and special low interest rate environment, while the government's investment in purchasing government bonds and stocks provides security.

3. Changes in monetary policy and inflationary environment threaten the stability of the yen

But the environment for the carry trade has changed dramatically recently.

Japan began to implement negative interest rates and YCC policies in 2016. The allure of this seemingly safe leverage arbitrage, backed by the government, has attracted more carry trade speculators around the world. In fact, carry traders may no longer be satisfied with investing only in Japanese stocks and US bonds, and more high-risk assets and commodities have also been involved. It is estimated that the carry trade of yen worldwide has exceeded 4 trillion US dollars.

It was not until March 2024 that the Bank of Japan officially announced the end of negative interest rates and the exit from the YCC policy. For the first time in eight years, the interest rate range was raised from negative interest rates to 0% to 0.1%. On July 31, the Bank of Japan unexpectedly raised interest rates again to 0.25%, and the carry trade risk of the yen was once again pushed to the forefront.

On August 5, the liquidation of carry trades due to the expectation of a narrowing of the interest rate differential between Japan and the United States caused by the yen rate hike and the dollar rate cut led to a major collapse of the Japanese stock market, and even the stock markets in the United States, South Korea, Australia and other regions were affected and suffered a large retracement and even circuit breakers, which greatly increased the market's attention to the next monetary policy of the Bank of Japan. Although Goldman Sachs and Morgan predicted that the leverage of carry trades has been liquidated by half and the short position of the yen has gradually been cleared, we have to be vigilant. Is there a deeper crisis lurking in the leverage accumulated over the years?

A more significant change than the short-term interest rate differential is that Japan's current long-term low-interest rate monetary policy and low inflation environment are gradually changing.

Due to the surge in international oil prices caused by the Russian-Ukrainian war, Japan's domestic inflation has risen to 2.7% and is still on the rise. In addition, Japan has officially announced its withdrawal from negative interest rates and YCC policies in March. In recent years, Japan's long-term interest rates have also risen rapidly. Although it remains at a low level, it is clear that the Japanese government bond market will face a more uncertain future.

Currently, the Bank of Japan holds 50% of Japanese government bonds, not to mention that Japan's debt/GDP level of more than 250% is already the highest in the world. With the increase in interest rates, the history of the Japanese government's zero-interest lending will also be gone.

Figure: Global Debt/GDP Ratio Ranking, Japan Ranks First, and the United States Ranks First in Total Amount

If we accept that the yen carry trade can be maintained and that the yen's safe-haven properties are supported by low inflation and low interest rates, then with Japan's inflation picking up, the central bank exiting negative interest rates and YCC policies, coupled with the Bank of Japan's desire to normalize monetary policy, high debt, and expectations of exiting loose monetary policy, can the yen's safe-haven properties be maintained?

4. The last straw - foreign exchange intervention?

On August 5, after the carry trade retreat caused a sharp drop in Japanese stocks, the Bank of Japan's top brass made an urgent statement, saying that if the financial market is unstable, it will suspend interest rate hikes. Subsequently, the yen began to appreciate and rebound rapidly. The market is also speculating that if the Fed starts a rate cut cycle, even if the yen will not dare to continue raising interest rates for the time being, the influence of the carry trade retreat that has not been released may return again, posing a threat to maintaining the stability of Japan's domestic financial markets.

In addition, Japan's room for macroeconomic regulation using normal monetary policy has once again been limited. Faced with rising inflation, the Bank of Japan is currently in a dilemma. So, in addition to interest rates and central bank balance sheet management tools, what other methods can be used to stabilize the value of the yen? One answer may be through foreign exchange intervention.

According to the interest rate parity theory, in theory, if the interest rate of one country is higher than that of another country, the currency of the country with the high interest rate will be at risk of depreciation in the future (because the opposite of an interest rate hike is the expectation of a rate cut), which may offset the benefits of higher interest rates. For example, recently, as expectations of a US dollar rate cut have increased, major central banks in Europe, Canada and other countries have entered the interest rate cut range one after another, and the US dollar index has continued to fall to around 100.

In view of this, investors generally use forward exchange rate contracts to hedge exchange rate risks. By signing a forward contract, they can lock in the current exchange rate to ensure that they can convert foreign currency into local currency at a predetermined exchange rate in the future to avoid losses. However, sometimes the government intervenes in the exchange rate to depreciate or appreciate the currency in the forward market, making this arbitrage opportunity disappear.

Figure: USD/JPY exchange rate (144.37) on August 24, 2024 and forward exchange rates of different maturities

The Japanese government also has a long history of foreign exchange intervention.

In the early 1990s, after the Japanese economic bubble burst, the yen exchange rate rose to a post-war high of 79.75 yen to the dollar in April 1995. The Japanese government carried out large-scale intervention, causing the yen exchange rate to fall back to more than 100 yen to the dollar in the following months.

In 2003 alone, the Japanese government spent more than 20 trillion yen (about $200 billion) on intervention to keep the yen-dollar exchange rate around 110 yen to the dollar.

Since the Federal Reserve began raising interest rates in March 2022, the depreciation of the yen against the U.S. dollar has forced the Japanese monetary authorities to intervene.

As the yen depreciated from September to October 2022, the Japanese Ministry of Finance implemented three yen purchase interventions, with a total investment of 9.1 trillion yen; after a brief appreciation, a year later, the yen-dollar exchange rate fell below the 160:1 mark again. From April 26 to May 29, 2024, Japan again conducted foreign exchange interventions, with a total amount of approximately 9.7 trillion yen.

Although the appreciation of the yen helps balance carry trades and stabilize domestic financial markets, it is very detrimental to the development of Japanese export companies. Therefore, despite the yen's good safe-haven properties, the Japanese Ministry of Finance (note that in Japan, the decision-making power of exchange rate intervention belongs to the Ministry of Finance, and the Bank of Japan is responsible for implementation) will not allow the yen to appreciate.

Since the 1990s, the Bank of Japan has intervened in foreign exchange when the yen has appreciated significantly, especially when the yen exchange rate falls to or falls below the break-even rate for Japanese exporters. This break-even rate is determined by a survey by the Japanese Cabinet Office: when the yen exchange rate is below (above) its level, Japanese exporters will lose (earn). Therefore, whether the appreciation of the yen has damaged its exports is the starting point for the Japanese Ministry of Finance to decide whether to intervene in foreign exchange.

It can be seen that the Japanese government's intervention operations are usually carried out when the yen appreciates or depreciates sharply, with the aim of protecting Japan's economic stability, especially maintaining the competitiveness of the export industry.

5. The key to Japan's maintaining a balanced international payments: overseas investment

When it comes to foreign exchange reserves and exports, we have to mention a very important concept - the balance of international payments. As we saw at the beginning of the article, the reason why the United States launched a trade war and exchange rate war against Japan was because of the excessive trade deficit. We often hear "surplus" and "deficit", which actually refers to the changes in the balance of international payments.

The main part of the balance of payments is the current account, which includes trade in goods and services and cross-border investment, etc. Cross-border investment includes primary income (Primary Income) - income from cross-border investment, such as interest, dividends, wages, etc.; secondary income (Secondary Income) - international transfer payments, such as grants, foreign aid, remittances, etc.

Other accounts include: capital account (such as immigration transfers, international gifts of fixed assets, etc.), financial account (capital flows of cross-border investment, including direct investment, stocks and bonds, foreign exchange reserve assets, etc.) and reserve assets (usually held by a country's central bank, including foreign exchange reserves, special drawing rights SDRs, reserve positions in the International Monetary Fund, etc.).

The impact of international balance of payments on exchange rates and economic activities is very important. Changes in the international balance of payments account reflect the overall situation of a country's foreign economic activities.

A current account surplus indicates that a country is in a favorable position in its external economic relations, while a current account deficit means that it may need to borrow to maintain external economic activities. A current account surplus may lead to an appreciation of the local currency, while a current account deficit may lead to a depreciation of the local currency.

This is also the reason why countries care so much about the balance between exports and exchange rates.

Figure: Japan's balance of payments account structure (current account; capital account; financial account; net errors and omissions)

Note: Balance of international payments (BoP) in Japan from 2013 to 2022, by category (in trillion Japanese yen) (The design principle of the balance of payments is to balance the sums of each account, that is, "total income" should be equal to "total expenditure". However, in the actual statistical process, the data often do not match completely. This difference will be recorded in "Net Errors and Omissions" to ensure the balance of the accounts on the surface)

Changes in Japan's balance of payments mainly come from the current account, especially the two sub-accounts of trade in goods and primary income. These accounts can have a significant impact on Japan's balance of payments when the global economic environment or exchange rates change.

Japan is an export-oriented economy, with a particularly strong manufacturing sector, and exports include automobiles, electronic products, machinery and equipment, etc. Therefore, a trade surplus in goods (i.e., exports are greater than imports) is usually an important source of Japan's current account surplus. Japan also basically maintained a trade surplus before 2013.

However, since the Fukushima nuclear leak in 2011, Japan has needed to import more energy. At the same time, after 2013, international oil prices soared and the yen began to depreciate due to policy. The combination of various factors has caused Japan's imports to exceed exports, and Japan has begun to frequently incur trade deficits.

However, Japan has a large foreign investment portfolio, especially direct investment and securities investment, which enables Japan to obtain a large amount of interest, dividends and other investment income from abroad. Therefore, even if the surplus in goods trade decreases, Japan can still maintain a surplus in the current account through the primary income account. This part of income has become the main pillar of Japan's balance of payments in recent years. With the aging of Japan's domestic market and the slowdown in economic growth, the importance of overseas investment income has gradually increased and become a key factor in stabilizing Japan's balance of payments. This is also the basis for Japan to conduct foreign exchange intervention.

Figure: Japan's Balance of Payments - Current Account - Prime Income (income from cross-border investment, such as interest, dividends, wages, etc.)

Japan's foreign exchange reserves in 2024 will be about 1.23 trillion US dollars. According to traditional views, a country's reasonable foreign exchange reserves should meet six months of import needs, or be able to pay short-term foreign debt due within a year, or should be 9% of a country's GDP to cope with capital account crises caused by sudden outflows of short-term capital. However, Japan's foreign exchange reserves account for only 0.84% ​​of GDP (according to mid-2024 data, China's foreign exchange reserves in the same period were 3.45 trillion, accounting for 21% of GDP).

Japan has been so keen on purchasing overseas assets such as U.S. Treasuries in recent years in order to leave it with more room for maneuver in the foreign exchange market.

Figure: Japan's Balance of Payments - Financial Account (capital flows of cross-border investment, including direct investment, stocks and bonds, foreign exchange reserve assets, etc., which is the account where U.S. debt assets are located)

Figure: Japan's Balance of Payments - Reserve Assets (held by the central bank, including foreign exchange reserves, special drawing rights SDR, reserve positions in the International Monetary Fund, etc.)

Although these government intervention measures can mitigate the impact of international financial and trade conflicts in the short term, their long-term effectiveness in maintaining the value of their own currencies is often constrained by global market forces and economic fundamentals.

When countries around the world compete to use US dollars/US bonds (rather than precious metals) as important reserve assets to try to ease currency crises and deal with economic and trade crises, are they handing their fate to a third party who can be an enemy or a friend? Is it necessary to make further plans for the possible reserve asset crisis?

So far, we have reviewed the efforts made by the Japanese government and central bank to maintain domestic economic development, international trade, and the stability of the yen value after the Plaza Accord, as the United States launched a trade war and exchange rate war against Japan. These efforts included responding to the trade war, adjusting domestic interest rates, controlling the yield curve, increasing foreign investment and foreign exchange reserves, foreign exchange intervention, maintaining a current account surplus, and balancing international payments. We also learned about the special safe-haven properties of the yen derived from the promotion of Abenomics in this process. Finally, we also discovered the potential risks behind the formulation of these macroeconomic controls and policies — the dispute over reserve assets.

6. The battle for reserve assets — U.S. Treasuries or gold?

In addition to foreign exchange reserves, gold reserves, and special drawing rights (SDRs), the reserve assets of countries around the world also include government bonds, foreign treasury bonds, and bonds issued by international organizations. Foreign exchange reserves occupy a dominant position in global reserve assets, followed by gold and SDRs, and the specific proportions vary from country to country.

Figure: Classification of Japan's official reserve assets and foreign exchange assets: Foreign exchange is the largest, and bonds are the main form of foreign exchange

In modern society, the history of advocating government intervention in the economy can be traced back to mercantilism, which was popular in the 16th to 18th centuries. The government protects and promotes its own industries through tariffs, subsidies, trade restrictions, etc. The country achieves a trade surplus and accumulates more precious metals (gold and silver) by expanding exports and restricting imports.

Mercantilism had a profound impact on the economic policies of European countries. Many early capitalist countries (such as Britain and the Netherlands) enhanced their national strength and wealth by implementing mercantilism policies.

The United Kingdom officially adopted the gold standard in 1821, becoming the first country in the world to implement the gold standard. Under this system, the value of the pound is directly linked to gold, with 1 pound corresponding to a certain amount of gold. This system has provided long-term stability for the pound, making it the world's main reserve currency and consolidating the United Kingdom's position as a world economic power.

The gold standard continued in the UK until World War I, but in 1914, due to huge war expenses, the UK was forced to temporarily suspend the gold standard. Although the UK tried to restore the gold standard in 1925, the system was abandoned again during the global economic depression in 1931, and the pound was finally decoupled from gold.

Looking back at the history of the pound's decoupling from gold has had a profound impact on the pound's status. Prior to this, the pound was the cornerstone of the global monetary system. The pound was pegged to the gold standard, meaning that its value was directly linked to a specific amount of gold. This link provided stability and confidence to the pound, making it the world's most important reserve currency.

When the pound was decoupled from gold, the automatic mechanism for controlling money supply and inflation disappeared. Without the support of gold, the value of the pound became more volatile, leading to instability and a decline in international investors' confidence in the pound. The pound gradually lost its position as the world's main reserve currency. As the stability of the pound weakened, countries and investors began to shift their reserves to the US dollar, which was still pegged to gold. This shift was one of the important reasons for the decline of Britain's global economic influence.

The end of the gold standard gave Britain a more flexible monetary policy, but it also led to higher inflation and a series of pound devaluations, further weakening its international position. London remains an important financial center, but the move off the gold standard reduced its dominance over global finance. As the dollar gradually became the world's reserve currency, the United States' influence rose.

It was not until 1971, after the collapse of the Bretton Woods system, that the dollar was also decoupled from gold. Major global currencies turned to a floating exchange rate system, and the dollar no longer maintained a fixed exchange rate, but floated freely according to the supply and demand in the foreign exchange market. This made the value of the dollar more volatile, but also gave the United States more autonomy in monetary policy.

Despite its break from gold, the US dollar has maintained its dominance as the world's reserve currency. Due to the widespread use of the US dollar in global trade and financial markets, many countries continue to hold large amounts of US dollar reserves. This has consolidated the dollar's position as the world's main reserve currency and settlement currency. So far, major countries seem to have become accustomed to the US dollar, which is issued by US Treasury bonds as an anchor, dominating the global economy.

The frequent trade wars and financial wars in the context of anti-globalization show that governments in modern society are still influenced by mercantilism, but the means of intervention are slightly different, and the form of accumulated wealth has changed from precious metals (gold) to US dollars and US bonds. Taking Japan as a mirror, we find that when the country's currency, economy, trade, and financial markets are under siege, sufficient US dollar/US debt reserves seem to be the only lifeline. Therefore, the economic lifeline of non-US countries seems to be deeply bound to the fate of the US dollar/US bonds.

At present, the US dollar still maintains its dominant position among reserve currencies, mainly due to:

• In the current international monetary system, the US dollar is still the anchor of other currencies, which makes the US dollar still at the core of the international monetary system;

• The widespread use of the US dollar in international trade settlement, cross-border financing, and international investment has synergistic effects and complementarity. The proportion of the US dollar in international settlement ranks first among all currencies. The US dollar is even more dominant among all foreign trade transaction currencies;

• Other currencies have not yet formed a sufficiently large, investment-grade government securities market to support the investment of central banks' reserves. However, U.S. Treasuries are internationally recognized safe-haven assets and are large enough to provide sufficient space for central banks to invest their reserves.

But the U.S. dollar/U.S. bonds also face the risk of depreciation:

• As the issuance of U.S. debt continues to rise, the interest expenditure of U.S. fiscal tax revenue is getting bigger and bigger. If there is no new productivity to create more tax revenue, and the U.S. government is allowed to borrow new debt to repay old debt, the risk of default of U.S. debt will increase.

• The reputation of the U.S. government in the global financial market is subject to geopolitical considerations, which affects the credibility of U.S. Treasury bonds and, in turn, the status of the U.S. dollar;

• Since the financial crisis in 2008, the main method used by the Federal Reserve and the Treasury Department to solve the economic crisis and debt crisis is to print money. If the amount of new money is greater than the total demand for social productivity, the value of the US dollar will inevitably continue to depreciate;

• The anti-globalization strategy has led the United States to launch trade wars and financial wars against many major trading countries in the world, affecting the free flow of financial capital, commodities, and even the flow of talent. However, the advantage of the dollar as the world's main reserve and payment currency comes from globalization. The anti-globalization trend is not conducive to the stability of the dollar's value.

Unlike gold, which is distributed and limited in total, the issuance of US dollars and US debt is completely controlled by the US government and has no upper limit. If US debt is a loan backed by the US government's future tax revenue and the country's future production capacity, what consequences will unrestrained borrowing and printing of money cause? Will the world return to the gold standard again?

The government's macroeconomic regulation has a far-reaching impact on the entire economy. After every crisis, the government will do everything it can to keep the currency value in a situation that is beneficial to all parties. If macroeconomic regulation is believed to have the ability to adjust the cycle, then why is the market still afraid of interest rate hikes or cuts? Does the market no longer believe that the government can save the crisis every time?

We will continue the discussion in the next article.

The article was originally published:

How did the Japanese yen develop its safe-haven currency properties?

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