Despite carrying public debt more than twice the size of its economy and suffering from poor growth and an aging population, Japan's government can still borrow money for 10 years at just over 1 percent.
The big story in global markets, perhaps even in global economics, in 2011 has been the transformation of government debt markets, which are now being driven by the realization that sovereigns can and sometimes do default.
So far that has actually been good for borrowing rates for big economies blessed with their own central banks, such as the U.S., Britain and Japan. There is a growing chance that in 2012 the wolves, having picked off Italyand others in the euro zone, move on to target the hindmost of the rest of the pack, which, given its poor medium-term fundamentals, may well be Japan.
"Recent events in other advanced economies have underscored how quickly market sentiment toward sovereigns with unsustainable fiscal imbalances can shift," the International Monetary Fund said in a paper released last week on Japan. here
In the understated bureaucratese of the IMF, that is the equivalent of shouting a warning from the rooftops.
"Higher yields could result in a withdrawal of liquidity from global capital markets, disrupt external positions and, through contagion, put upward pressure on sovereign bond yields elsewhere."
The math gets ugly for Japan pretty quickly if its rates start to rise. Interest payments are modest now, only 2 percent of GDP, but an increase of just a percentage point in JGB yields would double the annual interest bill.
The circle could easily become vicious. As banks hold large amounts of JGBs, a spike in rates will deal them large capital losses, potentially making others unwilling to lend to them and forcing a sell-off of assets to raise funds. If they sell their good assets, i.e. those abroad, this will drive the yen up as they bring the money home, further suppressing economic growth and adding to overall pressure.
Just as John Exter predicted with his inverse liquidity pyramid, when the markets get tough, the tough go into Yen & Dollar currencies and gold.
Japan has been living on its citizen's savings, spending more than it collects in taxes for nigh 20 years now.
So we must ask this question.
Has the Japanese economy been boosted to a new level of productivity and era of prosperity?
Or has it stagnated, feeding zombie banks and corporations the savings of its citizens?
The next 12 to 18 months should be telling as I expect we will see a significant increase in bond yields in Japan and an eventual realization that the debt to its citizens will end in default.