The webinar took place on Thursday 21 May 2026, hosted by Guido Baldi of IMEN Economics. The speaker was Jonathan Davies, economist by training and a thirty-year veteran of investment banking and asset management. His title was deliberately calibrated to the question that has occupied currency desks since 2022. Is the Japanese yen, at the lowest real effective exchange rate in its post-Bretton Woods history, a temporary aberration that will mean-revert, or has the equilibrium itself shifted? Davies presented the orthodox investment-banking framework with considerable rigour. The Meridian was in the audience. At the conclusion of the formal presentation, a question was submitted from the floor on behalf of this publication. The question was not addressed in the time available. There is no criticism of the speaker in observing this. A live Q&A session has finite time. The moderator selects from the queue. Not every question can be answered. But the question stands, and in the four days since the webinar it has become clearer that the question is not a peripheral inquiry to be slotted into an orthodox framework. It is the question that exposes the framework's edge.

The wording of the question is reproduced here in full so that the reader may judge for themselves whether it was a fair inquiry to put to the speaker, and so that the analytical move the question attempts may be seen plainly.

Before The Meridian advances its own position, fairness requires that Davies's argument be reconstructed accurately. The orthodox view deserves to be stated at its strongest, not its weakest, because the analytical departure that follows is meaningful only if the departure is from the best version of the view being departed from. Davies's analysis is the best version available in the institutional discourse this month.

Jonathan Davies IMEN Economics webinar 21 May 2026 yen real effective exchange rate BIS

Three of Davies's observations are not seriously contestable. The first is that the yen's real effective exchange rate, measured against the Bank for International Settlements narrow and broad indices using consumer price levels, is at or near its lowest level since the breakdown of Bretton Woods in the early 1970s. The deviation from purchasing power parity is at an extreme that has historically been associated with eventual mean reversion. Davies noted that he has, in earlier work, used simple value-investor trading rules built on real exchange rate thresholds, and that these rules generated extra returns until approximately 2020, at which point the rules broke down because the yen simply continued to weaken without reverting.

The second is that none of the standard fundamental variables has materially deteriorated alongside the recent yen weakness. Real GDP growth in Japan has been weak for decades, but no weaker than its historical pattern. Inflation has risen in Japan as it has globally, but the gap relative to advanced economies has actually narrowed and is now broadly similar. Net government debt, while higher than most advanced economies, is not dramatically higher than the United States, the United Kingdom or Italy. Gross government debt is exceptional, but Japan's gross debt has been exceptional for decades. The recent yen weakness cannot be explained by a fundamental shock to any of these variables.

The third is that the most plausible candidate explanation for the weakness, on Davies's reading, is a market narrative around debasement fears combined with carry trade positioning. Bank of Japan balance of payments data, which Davies presented in chart form, show that cumulative short-term cross-border yen loans have reached approximately seventy trillion yen since 1996 when the series began, with a meaningful share of this stock accumulated since 2020. Investors borrow at the low yen interest rate and deploy the proceeds into higher-yielding assets, whether Mexican peso, US equities, or any other currency or asset class offering positive carry. The position is profitable while yen weakness persists. The position is unstable because any rise in market volatility forces risk-management unwinding.

To these three observations Davies added a household inflation expectation survey by the Bank of Japan that suggests genuine fear of inflation among Japanese households. The median five-year-ahead inflation expectation was approximately five percent. The mean was approximately ten percent. The asymmetry implies a meaningful minority of households expecting twenty or thirty percent inflation. That minority is rationally buying foreign currency and gold. Their behaviour itself constitutes a driver of yen weakness. This is a careful, evidence-grounded, institutionally informed analysis. It is the orthodox view at its best.

Japan US Treasury holdings 1.13 trillion largest foreign holder net international investment position

Where The Meridian departs from Davies is not on the data but on the framework. The orthodox investment-banking analysis treats the yen as a price discovery problem within a value-investor mental model. The relevant question, in that frame, is whether the current price represents misvaluation or a structural shift, and whether profitable arbitrage opportunities exist. This is a legitimate question for a portfolio manager. It is not the only question available to a political economist.

The structural buffers cited in the floor question deserve to be set out with precision, because their cumulative weight is what shifts the analytical ground. Japan's foreign asset position is not a footnote to the currency analysis. It is the configuration that determines what currency analysis means for Japan specifically.

What these numbers describe is not a country drifting toward fiscal crisis. It is a country that has, over three decades, built one of the most structurally insulated monetary positions in the modern world. Japan is the largest foreign creditor of the largest debtor sovereign. Japan owns 12.8 percent of every dollar of foreign-held US federal debt. The dollar that the orthodox framework assumes Japan is competing against is, to a substantial degree, a dollar Japan has chosen to fund.

Japan's current account surplus is no longer primarily a merchandise trade surplus. It is increasingly an income surplus, generated by the accumulated returns on overseas investment built up during the high-savings decades. This is the financial profile of a mature creditor economy. It is not the financial profile of an economy whose currency weakness reflects underlying fragility. And the robotics figures are decisive in a way that orthodox currency analysis does not register. A country facing the most severe demographic contraction in the OECD is deploying capital deepening at an intensity that compensates structurally for the shrinking workforce. Japan is not letting demographic decline translate into economic decline. It is engineering around it through automation, and it is producing the automation infrastructure that the rest of the world buys from Japan. The currency weakness, in this frame, is supporting that engineering.

Japan issues own currency holds own debt domestically borrows in yen Bank of Japan

The orthodox framework Davies deployed assumes that countries face roughly symmetric monetary constraints. Real exchange rates fluctuate around a fair value determined by relative price levels and productivity. Persistent deviations either revert eventually or signal structural shifts. The framework is internally consistent and, applied to most countries, broadly useful. It is less useful when applied to a monetary sovereign of Japan's specific configuration. The configuration has four components, each of which has been documented by separate institutional sources, and each of which alters the analytical ground in a way that compounds with the others.

First, Japan issues its own currency. This is trivially true but analytically essential. The Bank of Japan cannot run out of yen. There is no scenario in which the Japanese government defaults on yen-denominated debt for reasons of solvency. The constraint on monetary issuance is inflation, not insolvency. The orthodox emerging-market currency crisis transmission mechanism, which runs from currency weakness through balance sheet deterioration to external default, does not operate in Japan because the precondition for that mechanism is absent.

Second, Japanese government debt is overwhelmingly held domestically. The Bank of Japan itself holds an enormous share through its quantitative easing programme. Japanese commercial banks, insurance companies, and pension funds hold the bulk of the remainder. Foreign holdings of JGBs exist but are modest relative to the total stock. This is the inverse of the position faced by Sri Lanka in 2022, where foreign-currency-denominated external debt held by foreign creditors created an external default mechanism that did not require any domestic political failure to trigger. Japan's debt sits on Japanese balance sheets. The political economy of that debt is fundamentally different.

Third, Japan borrows entirely in its own currency. There is no yen-denominated debt that becomes more burdensome when the yen weakens against the dollar. There is no foreign-currency debt that becomes unserviceable in a currency crisis. The standard emerging-market currency crisis transmission mechanism, which runs from currency weakness through balance sheet deterioration to default, does not operate. The Mauritius Real Outlook 2025-2029 series published by The State of the Mind in January 2026 documented precisely this distinction as it applies in reverse to Global South sovereigns with dollar-denominated external debt. Japan is the polar opposite case.

Fourth, Japan has, over the last decade, demonstrated something close to unlimited willingness to absorb its own debt onto the central bank balance sheet. The Bank of Japan's balance sheet at approximately 100 percent of GDP is the largest in the developed world by that measure. The Bank of Japan owns approximately half of all outstanding JGBs. This is not a country running out of monetary tools. It is a country that has shown it will deploy its monetary tools at unprecedented scale.

What this configuration produces is a country for whom the exchange rate is genuinely a policy variable, not a market outcome that must be defended. Japan can let the yen weaken because the costs of weakness, in the orthodox framework, do not transmit through the channels that operate in dollar-denominated emerging markets. There is no external debt servicing crisis. There is no domestic balance sheet collapse. There is imported inflation, but Japan has structural buffers against that too, including its accumulated overseas income, its industrial export capacity, and its automation-driven productivity gains.

purchasing power parity real exchange rate mean reversion equilibrium theory monetary sovereign

Purchasing power parity, in its absolute form, holds that exchange rates should adjust so that a basket of goods costs the same across countries when expressed in a common currency. In its relative form, it holds that exchange rates should adjust to reflect changes in relative price levels over time. Davies noted the well-known empirical observation that real exchange rates often behave statistically like random walks, with mean reversion difficult to demonstrate at the conventional ninety-five percent confidence level. This is not a feature of the data alone. It is a feature of the framework's incompleteness.

The framework was built around an implicit assumption that the countries being compared face symmetric monetary constraints. When the comparison set includes a country that has structurally exempted itself from the symmetric constraint, the framework's predictions become correspondingly less reliable. Japan is not failing to mean-revert because the data are noisy. Japan is failing to mean-revert because the equilibrium the framework predicts is not the equilibrium Japan is operating toward.

The equilibrium Japan appears to be operating toward is one in which the yen settles at whatever level supports domestic demand, domestic industrial competitiveness, and domestic demographic stabilisation. The exchange rate is a residual of those policy priorities, not an independent variable that markets clear independently. If this is correct, then the orthodox question of whether the yen is undervalued or has reached a new equilibrium is the wrong question. The yen has reached an equilibrium consistent with Japanese policy preferences. Whether that equilibrium is also consistent with foreign value investors' preferences is a separate matter, and not one Japan is obligated to prioritise.

Davies, to his credit, acknowledged something close to this in his discussion of Bank of Japan policymaker perception. Drawing on the BoJ minutes, he observed that policymakers appear to quite like the depreciation because it stimulates the economy, and that they are particularly cautious about premature tightening that might re-anchor deflationary expectations after decades of struggle to exit deflation. This is precisely the policy preference reading. Davies treated it as a temporary positioning that would shift once deflation risk recedes. The Meridian reads it as a more durable policy stance reflecting Japan's structural insulation from the costs that would force a different choice elsewhere. The difference between Davies's reading and The Meridian's is the difference between treating Japan as a country that will eventually conform to the framework and treating Japan as a country that has demonstrated the framework's edge.

monetary sovereignty Global South IMF orthodoxy Mauritius Sri Lanka debt consolidation asymmetry

The implications of the Japan case for sovereigns elsewhere depend critically on which of the country's structural buffers can be replicated. Most cannot. Japan's industrial base, its accumulated overseas assets, its currency-issuance authority backed by half a century of credibility, its domestic savings pool, its automation infrastructure, and its institutional capacity at the Bank of Japan are not features that a smaller emerging market can adopt by decision. They are features built over decades through deliberate industrial policy choices and reinforced by demographic, geographic, and political conditions specific to Japan.

But the analytical lesson travels. The lesson is that exchange rate orthodoxy, including the IMF framework that conditions concessional financing on currency consolidation and fiscal contraction, is not universal economics. It is the economics of countries that lack monetary sovereignty in Japan's specific sense. Countries that issue their own currency, hold their own debt domestically, borrow in their own currency, and possess credible institutional capacity at the central bank face genuinely different constraints than the standard prescription assumes.

The Meridian's forthcoming companion piece, the IMF Avoidance Test, examines the inverse case. Mauritius at ninety percent debt-to-GDP is being told, by both domestic political class and external observers, to prepare for fiscal consolidation. Japan at two hundred and sixty percent debt-to-GDP is left alone. The asymmetry is not analytical. It is political, structural, and historical. A small island developing state that does not have Japan's structural buffers cannot replicate Japan's choices. But it can at least understand that the choices Japan has made are not the only choices the economic framework permits. Other configurations exist. Other equilibria are sustainable. The orthodoxy is not a law of nature. It is a description of constraints that apply to some countries and not to others.

carry trade unwind market volatility yen mean reversion policy choice coexistent equilibrium

The Meridian does not claim Davies's analysis is wrong. The carry trade is real. The seventy trillion yen of cumulative short-term cross-border yen loans is real. The household inflation expectation asymmetry is real. The risk of disorderly unwinding under heightened market volatility is real. Davies's framework is internally consistent and well-supported within its assumptions.

What The Meridian claims is that the framework's assumptions do not fully apply to Japan. The yen is not, in Japan's case, a price that markets are trying to clear toward a true fundamental value the markets are failing to discover. The yen is, increasingly, a policy outcome that Japan has chosen to permit because the structural buffers around it absorb the costs that would force a different choice elsewhere. The carry trade and the policy choice are not alternatives. They are coexistent. The carry trade exists because Japan permits it to exist. Japan permits it to exist because the yen weakness it produces is, on balance, supportive of Japanese domestic policy priorities.

The implication for the value investor is that mean reversion will be slower, more partial, and more conditional on policy choices than the framework predicts. The yen may well unwind some of its weakness under sufficient market stress. It is unlikely to unwind to the levels the framework would call fair value, because fair value as the framework defines it is not what Japan is targeting. The implication for the political economist is that monetary sovereignty, in its mature institutional form, expands the policy space available to a sovereign in ways the orthodox framework treats as marginal. Japan has not escaped the laws of economics. It has demonstrated which laws are general and which are conditional on a country's monetary configuration. That is a substantial intellectual contribution. It deserves serious analytical treatment rather than dismissal as anomaly.

Japan policy outcome monetary sovereignty framework limits Global South political economy

Jonathan Davies closed his presentation with a candid acknowledgement that the future path of the yen depends on what policymakers, both in Japan and globally, ultimately choose to do. He suggested that what the Federal Reserve decides will heavily influence what the Bank of Japan decides, and that he expects the United States will ultimately do what is necessary to keep inflation from getting out of control, with Japan following suit. That may prove correct. It may not. The honest position is that both outcomes are available within Japan's policy space.

The question that was not answered on 21 May 2026 was not a question with a single correct answer. It was a question intended to expose the limits of the framework being used to discuss the yen, and to invite the speaker to engage with those limits. The framework Davies deployed is the right framework for an investment-banking analysis of currency mispricing. It is not the right framework for an analysis of monetary sovereignty.

The Meridian's position, set out here for the record, is that Japan in May 2026 is operating in a different framework than the orthodox investment-banking analysis recognises. The yen at its current level is not a market failure. It is a policy outcome. Whether the policy is wise, whether the carry trade unwinds disorderly, whether the household inflation expectations prove correct or wildly wrong, are all separate questions. The first question, on which the others depend, is whether the framework being used to interrogate Japan's choices is the right framework. The answer offered here is that it is not.

The question remains open for further discussion. The Meridian will return to it.