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In a rare intervention, the US has propped up the Japanese yen. The move is seen as a bid to hold off a further rise in yields for US government bonds – amid Japan’s sell-off of US Treasuries to fund its shoring up of the yen – a rise that threatens the US artificial intelligence bubble.
That the United States bought yen for the first time in decades – coordinating with Japan – had a bigger psychological impact on the market than Tokyo’s interventions alone. But give it three or four weeks and the yen-to-dollar rate is likely to snap back above 160.
The yen has been fundamentally weakened by a double shock: the rise in Chinese electric vehicles has hit Japan’s car exports and the energy price spike following the Iran war has hit the wider economy. Technical interventions will not stop its slide.
The car industry is Japan’s last economic stronghold but neither the government nor businesses are doing enough to pivot towards electric vehicles, and Chinese competition will only grow. Unless another export industry rises in replacement, the yen can only depreciate. Energy import costs are also rising rapidly in Japan, which depends on the Middle East for 90-95 per cent of its oil. The unexpectedly large trade deficit in June is an indicator of things to come.
Tokyo is obviously running down its reserves to keep the economy afloat. As the Iran war drags on, the odds are rising that oil infrastructure in the Middle East will be destroyed – which would leave Japan’s economy in mortal peril. Starting January, China has also banned “dual-use” exports to Japan in opposition to its remilitarisation, and has put dozens of Japanese companies on the export-control list. The Japanese economy faces a huge downside in the coming months.
Japan has essentially no room to raise its interest rates to defend its currency. National debt, at about 13.5 trillion yen (US$84.8 billion), is already more than twice the gross domestic product. To properly defend the yen, Japan’s rates will need to match US ones, which are 2-3 percentage points higher, but the resulting rise in interest payments on national debt will trigger a fiscal crisis.
Japan’s only viable pathway is to sell US government bonds and buy yen to smooth the decline. But this has caused US government bond yields to rise to levels last seen in 2007 – right before the subprime bubble burst and triggered a global financial crisis.
American AI companies have turned to debt financing for data-centre build-outs, causing analysts to warn of financial strain – and posing a striking similarity to the pre-subprime crisis picture. A further spike in bond yields may well pop the AI bubble.
But the far bigger challenge is the rise of China’s open-source, open-weight AI models. The US AI bubble has two legs of support: liquidity from pandemic-era quantitative easing and the promise of productivity gains. Growing pressure on US interest rates to rise threatens the first, even as Chinese competition caps what US AI companies can charge for their services.
No matter the truth of the stories of how useful or powerful AI is, the market value of American AI firms is ultimately defined by competition. And Chinese AI creators are offering equally effective services at far lower prices.
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Trump to steer billions from elite universities to AI to counter China
The market is starting to see how the American AI story is funded by off-balance sheet debt for data centres, with the money to service these debts to come from what the likes of OpenAI and Anthropic can charge. Chinese competition has guaranteed they won’t be able to charge enough. OpenAI just cut the price for one model by 80 per cent. Does anyone really believe Americans can win a price war against the Chinese? To keep the game going, US AI companies must raise hundreds of billions from the stock market.
Desperate times call for desperate measures. The US government is likely to ban Chinese AI on the grounds of national security ahead of the crucial listings of Anthropic and OpenAI. Their best scenario? Milk the US market. But would investors still give them hundreds of billions of dollars? If these listings fail, the AI bubble is likely to pop.
And this will bring down the far bigger liquidity bubble that has been growing since 2008. The US stock market capitalisation is 2.3 times the size of the economy, bigger than just before the 2000 dotcom crash and the 2007 subprime crisis – the biggest bubble of all time. When it pops, the sound will travel a long way down.