For years, Japan let the world borrow from it on the cheap. Now, that system is collapsing.

CFA coach Laukik Shah explains it plainly: Japan kept interest rates at or near zero—sometimes even negative—for decades, trying to pull itself out of a spiral of low growth, deflation, and demographic decline. 

The Bank of Japan (BoJ) flooded the system with money, buying up government bonds and promising to keep borrowing costs low. The idea was to make loans cheap so businesses and households would spend and invest. But it also created something bigger: a global arbitrage machine.

The yen carry trade was born out of this setup. Investors borrowed yen at near-zero rates and parked the money where returns were higher—emerging markets, U.S. equities, global real estate. 

The math was simple: borrow at 0%, earn 5%, pocket the spread. As long as Japan kept rates low and the yen stayed weak, the trade worked.

Then came the reversal.

In March 2024, with inflation finally creeping up and the yen sliding too far, the BoJ began raising interest rates and stepping away from its ultra-loose policy. That shift cracked the carry trade. 

Investors rushed to unwind positions. The yen appreciated—just like it did in 2007, when a similar spike killed the trade.

Japan is now caught between two pressures: tame inflation and protect the yen, or hold rates low and risk capital flight. Shah makes it clear: the old playbook doesn’t work anymore. 

The very tools that once held Japan’s fragile economy together—zero rates, massive bond buying, a weak currency—are now backfiring.

This isn’t just a Japan problem. It’s a warning for a global financial system built on decades of cheap liquidity. The leverage, Shah notes, always had a cost. It’s just showing up now.