Akio KAWATO
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Today, May 7, the Japanese stock market surged, with the Nikkei reaching historic highs. Hopes for a ceasefire involving Iran also helped push stock prices upward.
Yet beneath the surface, the financial markets of both Japan and the United States are showing troubling signs. In both countries, long-term interest rates are rising—meaning confidence in government bonds is beginning to erode. We are approaching an era in which government debt can only be sold by offering increasingly high yields, and in which those higher yields themselves will later drive explosive increases in interest payments, putting severe pressure on the fiscal positions of both Japan and the United States.
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As a result, voices warning of a “Lehman 2.0” crisis resembling the financial collapse of September 2008 are growing louder in both countries. I myself have written repeatedly about this possibility.
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But when one compares today’s situation with September 2008, the differences are profound. We therefore need a careful simulation of “how things will move, and in what sequence.”
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First, the difference from September 2008. Back then, after the collapse of the housing bubble, markets had begun to expect economic stagnation, and long-term interest rates were falling. The housing collapse had triggered a plunge in the value of subprime securities created from mortgage loans, as well as growing distrust toward the major banks holding those securities. Capital fled into the safety of government bonds. In other words, government bond prices were rising. Demand for dollars also surged, and the dollar index continued climbing into 2009.
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Today, the underlying situation is fundamentally different. Interest rates are rising because confidence in government finances themselves is weakening. If inflation expectations push rates even higher, government bond prices will continue falling and may eventually face outright panic selling.
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At first, the dollar would probably continue rising as well. But once markets begin to suspect that the United States itself is becoming unstable, the dollar would start to fall.
At that point, the yen carry trade between Japan and the United States would rapidly unwind and reverse direction, likely producing a substantial appreciation of the yen.
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Around this stage, the Federal Reserve would almost certainly intervene, injecting liquidity and perhaps even resuming direct purchases of government bonds. The dollar would then recover to some extent.
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Developments in Europe will also be critically important throughout this process. A considerable portion of Europe’s trade and financial settlements is conducted through the eurodollar system. These are not dollars issued by the Federal Reserve, but rather dollar-denominated credit created by European private banks through lending activity. Based on oil revenues flowing in from the Gulf states and amplified through interbank transactions and derivatives, this offshore dollar credit structure has expanded enormously.
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During the Lehman crisis, banks began doubting one another’s solvency and abruptly froze credit in eurodollar. As a result, Europe experienced a severe shortage of dollar funding, creating major bottlenecks in international settlements. The European Central Bank overcame the crisis by obtaining dollars through currency swap lines with the Federal Reserve and supplying those dollars to private banks.
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This time as well, a shortage of dollars overseas and disruptions in settlement systems could easily occur. However, permanent swap-line networks with the Federal Reserve are already in place, so dollar liquidity would likely be supplied more quickly than in 2008.
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On the other hand, this time distrust may spread not only toward banks, but toward U.S. fiscal sustainability and even U.S. Treasury securities themselves. That is what makes the current situation more dangerous than 2008.
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Once distrust becomes dominant, something contrary to conventional wisdom may occur: the dollar could fall even while interest rates rise. In fact, this phenomenon was already visible during the market turmoil of April 2025.
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If the future decline of petrodollars leads to a contraction of the eurodollar system—or if Trump were to withhold dollar liquidity in an attempt to pressure Europe—the EU and Britain would likely develop alternative mechanisms to compensate for the shrinking eurodollar supply. “Euro-euro” may sound odd, but one possibility would be for Europe to stabilize the euro through swap agreements with institutions such as the Bank of Japan, while rapidly shifting part of the eurodollar system into euro-denominated credit structures.
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For Japan, all of this could become an ideal opportunity to escape the low-interest-rate trap created during the era of Abenomics. Japan should closely monitor interest-rate developments in Europe and the United States and cultivate both the institutional flexibility and the intellectual flexibility needed to respond quickly.
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What Japan must avoid is repeating the mistake of the Abenomics years (after 2013)—remaining rigidly committed to monetary easing while the West moved swiftly toward rate hikes, thereby producing an extreme depreciation of the yen from which Japan still struggles to escape today.
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