If rates were to go up by 1%, let alone 2%, over time Japan's percentage of tax revenue dedicated to interest payments would double to 18% and then to 40% and then just keep going up. It's conceivable that it will take 100% of tax revenues in less than 10 years at the current trajectory. Why? Because Japan's going to have to start to compete with the rest of the world to sell its bonds.

Who but the Japanese would buy a Japanese bond at 1.3%? From a country that's rapidly going to 200% of debt-to-GDP? Doesn't really seem like a smart trade to me. And as the data shows, the ability of the Japanese consumer to buy more debt is rapidly waning. The Japanese government is coming to a crossroads with no good exits. Cut the budget drastically in the face of a deflationary recession? Monetize the debt and let the yen go the way of all fiat currencies? Can someone say Zimbabwe? Increase already high taxes in a very weak economy?

And yet the yen has been getting stronger over the last month. It's now at 92 to the dollar, up from 120 just 2 years ago. Why would a country with such bad fundamentals have such a strong currency? Shouldn't the yen be a screaming short?


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Let me offer 2 speculations that are mine alone. First, it's well-known that the Japanese are very involved in the reverse-carry trade. That is, since they can't find yield in Japan, they convert to another higher-yielding currency for income. So, maybe the retirees actually need to spend some of the money they have outside of Japan to live, so they have to convert it to yen.

Second, Japanese corporations are getting hammered. Could it be that they are bringing yen home to pay for current transactions like rent and payroll? Japanese corporations dependent on exports desperately need the yen to fall, yet the central bank can't seem to engineer a falling yen. I wrote about 5 years ago that the Japanese Central Bank has to rank as one of the most incompetent of all central banks, because they can't even destroy their own currency.

But I think the central bank is going to figure it out. If they don't monetize the debt, rates will have to rise over time (say the next 2-3 years), and that's most definitely a problem. Monetizing the debt would mean the yen would fall in value, which is something they actually want to happen. How much monetization? When? I don't know, and I doubt they do. If I were the head of the central bank or the government, I wouldn't sleep easy.