Free Lunch?

This country’s currency is at its weakest since 1986, debt levels are unsustainable and economic growth has largely stalled. Recently, its exchange rate’s precipitous fall forced the US Treasury to intervene and prop up the currency — the first time in 28 years. Before you start wondering, this is modern-day Japan.

Japan has suffered from years of economic stagnation. Prime Minister Sanae Takaichi has recently pushed a large fiscal stimulus in response. But since Japan already carries an eye-popping debt burden — a debt-to-GDP ratio above 200 percent — the stimulus is driving the yen down. Markets read more spending and more debt as fiscally destabilizing.

The yen’s slide is a function of investors’ low confidence in Japan’s fiscal future, and there is not much Tokyo can do about it. The surest way to stabilize the currency would be to raise interest rates, but the higher rates go, the more unsustainable Japan’s debt becomes. Given this catch-22, US intervention on the yen’s behalf has taken on added resonance.

US intervention in currency markets is an extremely rare event, but an activist pattern is now emerging under Treasury Secretary Scott Bessent. The US also intervened in October last year to support the peso when Argentina faced a severe political crisis.

While Japanese authorities are in a fix, US currency activism is music to the ears of some Pakistani policymakers. The inability to increase the dollar value of exports remains the Achilles’ heel of Pakistan’s economy. Every few years, a ballooning current account deficit forces a depreciation in the exchange rate, which in turn makes it harder to earn foreign exchange, since Pakistani exports carry a significant imported component. The exchange rate has remained stable over the last few years, but ominous forces — a widening trade deficit chief among them — have started to resurface.

Against this backdrop, Pakistan’s recent request for a $10 billion currency swap facility from the US Treasury’s Exchange Stabilization Fund comes into stark relief. The details are still fuzzy, but the facility would not involve an outright transfer of $10 billion. Rather, if Pakistan’s foreign reserves or the rupee came under pressure, Islamabad could receive dollars in exchange for rupees, with the borrowed dollars to be returned at an agreed-upon exchange rate. Given geopolitical uncertainty, such a facility could prove useful for paying for essential imports or calming a disorderly foreign-exchange market.

In Washington’s ledger, every currency swap comes with a column for what Pakistan is expected to provide in return.

Dr. Aqdas Afzal

But in the rush to celebrate access to a potential dollar lifeline, Pakistani policymakers have overlooked an important fact, perhaps best articulated by Milton Friedman: “There’s no such thing as a free lunch.” The US Treasury’s assistance always comes with strings attached.

In Argentina’s case, US assistance directly supported President Javier Milei, who has become the Trump administration’s ideological ally. Milei, for his part, stepped up attacks on Brazil’s President Lula, calling him a “thief” and a “convict.” The US also remains wary of a growing Chinese presence in Latin America and sees Argentina as a partner in forestalling it. The Chinese embassy in Buenos Aires recently accused Washington of trying to sabotage cooperation between Huawei and a local firm.

In Japan’s case, the most important reason the US has come to the aid of the beleaguered yen is that Japan holds the largest foreign stash of US Treasuries. If the yen keeps falling, Japanese authorities would most likely have to offload a significant portion of those holdings — currently over $1 trillion — triggering a rise in US interest rates. That is something Trump cannot politically afford with midterm elections around the corner.

The implication for Pakistan is clear. In the ongoing great-power contest between the US and China, American financial support would carry an ask. That ask might require Pakistan to deliver above and beyond its mediation in the Middle East. It could also require Islamabad to revisit its “All Weather Strategic Cooperative Partnership” with Beijing.

Pakistan’s policymakers would be best advised to negotiate the terms of the facility carefully while focusing relentlessly on increasing exports. American financial support can only ever be a temporary bandage — markets cannot price a currency away from fundamentals for long, something Japan may soon discover. Islamabad would do well to remember that in Washington’s ledger, every currency swap comes with a column for what Pakistan is expected to provide in return.

-Dr. Aqdas Afzal completed his doctorate in economics on a Fulbright scholarship.
X: @AqdasAfzal