The Bank of Japan has been struggling to defend the Japanese yen from debasement over the first four months of this year as the pressure of higher interest rates begins to crack the facade of 30 years of heavy monetary intervention. A couple of weeks ago the USD/yen pair popped above 160 for the first time since 1992. As the yen ran toward 160, the Bank of Japan attempted to stem the bleeding by intervening, but their interventions proved to be lackluster. The yen recovered to 152 against the USD early last week, but climbed back to 155 earlier this week.

The inability of the Bank of Japan to prevent the yen from running higher (read: rapidly debase) has obviously spooked the US Treasury and the Federal Reserve because yesterday morning it was announced that the US and Japan had agreed on an FX intervention plan via a swap line through which the US will supply Japan with dollars in exchange for yen. The reason the US is stepping up to help with this intervention is because Japan is the largest holder of US treasuries in the world and the last thing the US needs right now is for Japan to begin selling its treasuries en masse so they can get dollars to defend the yen. I imagine the conversation went something like this, "Don't touch those treasuries. We'll just give you the dollars."

While it may not seem like a very big deal to most, this is a strong signal that something is terribly wrong in both the Japanese and US economies. The Japanese have lost control of their yield curve, which they have been able to successfully manage via extraordinary monetary measures for decades. The pressure being put on them via the Federal Reserve holding rates for as high as they have and as long as they have is immense and there is little they can do to turn the tide at the moment. The Treasury and Fed over here in the US are petrified of more instability within the treasury markets because stable treasuries prices are critical to the smooth facilitation of the banking sector. The Spring of last year made it abundantly clear that banks aren't sufficiently capitalized to weather declining treasury prices.

With lackluster bond auctions becoming more common for the Treasury and the largest holder of bonds in the world getting to the point of forced selling, it makes sense that the US stepped in to bail out the Bank of Japan. They need to make the markets believe that everything is fine.

This situation becomes even more precarious when you factor in the fact that inflation has most certainly not been tamed here in the US. The Fed would like to keep rates elevated for much longer in an attempt to bring prices down as much as possible. Excuse me, scratch that, to make sure prices rise a bit slower than they have been for an extended period of time.

If this FX swap line proves to be nothing more than a band aid over a bullet wound and Japan is forced to sell their US treasuries to defend the yen things could get pretty hairy pretty quickly. Treasuries being offloaded by Japan could reignite the banking crisis here in the US, which could force the Fed to step in with more QE, which would make it impossible to properly tame inflation.

Don't look now, but M2 is on the rise again. It will be interesting to see what this growth rate looks like at the end of the year.

Final thought...

The feeling of an approaching cold is a bad feeling.