Washington rescued the Japanese yen on July 31, but it was not with dollars but with euro reserves. Unremarkable? Not really; the events unfolded in a way that had never happened before.
When the Federal Reserve Bank of New York, acting on behalf of the US Treasury, sold euros to buy yen, they did not notify the European Central Bank (ECB). The ECB only learned of it only after the trade had closed; by that point, the damage and risk were done, and the euro underwent a four per cent devaluation as opposed to the yen during the exchange.
Since the end of WWII, Western monetary authorities have consulted one another before intervening in each other’s currencies. The decision by the US came as a shock and has the potential to undermine the trust between both central banks. Senior ECB officials, speaking anonymously to the Financial Times, called it an unprecedented breach of longstanding convention.
Why euros, not dollars?
Scott Bessent, US Secretary of the Treasury said that “We will do whatever it takes to support them in a way that helps the American economy, the American taxpayer, and stabilizes the global economy.”
Washington holds roughly €26bn in readily deployable foreign reserves, split between the Fed and the Treasury’s Exchange Stabilization Fund. Many analysts believed the holdings and decision would be too small to shift the euro for long. Despite the early drop, they are mostly right. By Tuesday night, the euro settled back close to its normal holding, but still remains weaker against the yen than before the operation.
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The risk did not concern the European currency’s market standing as much as the trust within the transatlantic relationship. Washington chose euros for two reasons: first, to avoid devaluing its own currency. Selling dollars to buy yen would have weakened the dollar, contradicting Bessent’s strong-dollar posture.
Second, Washington felt pressure to ease the declining yen, as Japan is the largest foreign holder of US Treasuries. Should Japan have been forced to sell down its hold of dollars, it would have pushed up American borrowing costs at a time when long-term yields sit near two-decade highs. Propping up the yen with euros removed that pressure but passed the risk of absorbing the cost across the Atlantic.
A precedent broken
The euro was the only large, liquid foreign currency the US holds in size, so the US had little other resource to choose from. Gold is the ultimate reserve backstop, which central banks are averse to selling off given the panic it signals.
But the question is, was this worth it? Did Washington really have to intervene and throw Europe under the bus, or could it have just done nothing? After all, a yen buyout does not solve the underlying conditions for its decline.
We will do whatever it takes to support them in a way that helps the American economy, the American taxpayer, and stabilizes the global economy. — Scott Bessent, US Secretary of the Treasury
In September 2000, the US bought euros in a coordinated intervention initiated by the ECB, alongside Japan, Canada, and Britain. In 2011 the joint action after Japan’s earthquake worked the same way. This latest yen bailout broke this long-held understanding.
A partisan Fed?
The political backdrop does nothing to help grow Europe’s trust in Washington. The Fed that executed the trade is now chaired by Kevin Warsh, a Trump appointee who took office this May. The transition was unusually turbulent as the result of Trump’s efforts to force out former Fed chair Jerome Powell.
Mr Warsh meets with Mr Bessent often and shares his critique of the central bank’s balance sheet. What would normally be a routine FX operation has thus made the Fed vulnerable to suspicion it is toeing the administration’s partisan line.
No European or ECB official has publicly commented on the Fed decision.
