Last August’s ‘flash crash’ of Japanese stocks was a high-frequency reaction to the end of the carry trade. Japan’s low interest rates had previously encouraged investors such as hedge funds to purchase overseas holdings, financed by the yen. The prospect of interest rates rising to zero and beyond triggered an appreciation of the yen, and margin calls among those shorting it.

Speculation was rife at the time that the readjustment process would become a broader phenomenon, and indeed, it has now spread to the much slower-moving bond market – as well as to Taiwan, whose recent currency movement was also a reflection of the same forces. In Japan, which has the world’s highest sovereign debt-to-GDP ratio, 30- and 40-year bond yields have risen 60 and 70 basis points this year respectively as the central bank has exited its long-term yield control. As the main buyers in this extremely long-dated market, life insurers played an indirect, yet inevitable role in this price decline, simply by failing to fill in the gap. International Financial Reporting Standards (IFRS) rules implemented in April had previously provided a short-term boost as insurers rushed to match their asset term structure with their liabilities.

Both the Japanese and Taiwanese cases have been influenced, yet not determined by international politics. Widespread rumors have linked Taiwan’s currency appreciation to political negotiations with the US, but it was the depreciation of the US dollar which came first, causing TWD losses among holders of US assets. Japan’s trade negotiations with the US have also touched on monetary policy, meanwhile, although it remains unclear exactly heavily this is weighed compared to traditional trade issues.

The US will be affected by these developments as much as Asia: in August, contagion from Japan had caused jitters in US stocks, as well as Bitcoin trading. The rise in US 10-year US bond yields has proven to be a binding constraint on many of the domestic and international policy priorities of the administration of President Trump. It forced the 90-day pause in so-called “reciprocal tariffs,” and has also contributed to the downgrade in its debt rating by Moody’s amid the ongoing budget negotiations. International ‘bond vigilantes’ have probably also increased the confidence of the Fed in standing up to pressure from Trump to lower rates, as well as limiting the growth potential of equities.

It is possible to attribute the problems in Japan, and to some extent in Taiwan, to inexorable demographic changes. As the need for retirement savings gradually plateaus, people will stop buying life insurance policies, raising interest rates, and capital will stop flowing abroad, appreciating the currency. As inevitable as this trend may be, however, Japan’s problem is in some ways simpler than that of the US, or of the Trump trade agenda: it simply needs to increase asset prices across the board, including through attractiveness to global investors. Doing so would not only allow the central bank to gracefully exit its decades of market support, but also increase the productivity of capital to ensure continued growth in a greyer society.

Trump, in contrast, is hoping for several contradictory outcomes from the ongoing trade talks. On the one hand, the “reciprocal tariff” formula penalizes trade surpluses with the US, which occur when a country invests the dollars it earns from exports to the US, rather than spending it on imports from the US. On the other, however, he also hopes that trading partners will invest more in American manufacturing. The net result of these policy impulses seems to be a change in risk profile simply from safe American reserve assets into American direct investment. TSMC’s pledged $100 billion investment in US production, for instance, probably came largely out of other domestic investments, such as bonds, leaving other potential investors in American projects – or else potentially tax revenues – to fill in the gap.

Rather than discouraging investments of existing holdings in US debt, Trump’s trade agenda (as expressed by the trade deficit formula) would be better served by negotiating to reduce barriers to investment into the Japanese private sector. Capital inflows would cause the yen to appreciate, and give Japan more dollars with which to buy American exports. They would stimulate the economy while increasing capital supply, allowing Japanese savings to help fill in any government financing gap, while also creating profitable opportunities for American investors to offset the more difficult fiscal environment.

Most importantly, financial reforms would also address Japan’s management culture, the most important bottleneck in its economy. Japan ranked 198^th out of 200 countries in terms of foreign direct investment by GDP in 2023, according to the UN Conference on Trade and Development.

It is unfortunate that the US will not play a positive role in planning for the end of the carry trade, but Japan can still implement its own internal reforms. It has understood the interplay between stagnant asset prices and corporate culture at least since the era of Abenomics, but now it also needs to focus more specifically on foreign investors. Taiwan should also watch Japan’s macroeconomic policies and trade negotiation process carefully, as it shares many characteristics in common with its neighbor.