The Story of Japan has bewildered investors for a long time now. Ever since I was a young lad staring at charts, I have read about the abysmal state of Japan's economy, its incredible debt level and their looming demographic crisis. Here is a quick summary of the issues:

1- Japan has the distinct honor of being the most indebted nation in the world. With a debt load of around 230% debt to GDP (according to The Economist), Japan's debt levels are head and shoulders ahead of any other nation.

2- Their demographic situation has been described as a time bomb for the past decade or so - check out this Foreign Policy Blog post for a quick rundown. The Japanese also happen to be adamantly opposed to almost all forms of immigration, which is perhaps their only hope to stabilize their demographics. (Japan's population is expected to shrink by 1/3 by 2060, with seniors accounting for 40% of the population!)

3- The Japanese economy, which is still large from a global perspective, has been stagnant since their epic bubble collapsed in the early 90s. Since that collapse, Japan has experience what many have called Japan's Lost Decade.

4- Japan's 10 year debt yield is under 1%! - The strangest part of all this is Government Japanese government bonds yields are absurdly low. Who in their right mind would want to loan money to the most indebted nation on earth at less than 1% a year? (other than their own Central bank)

Despite all these unpleasantries, the Japanese Yen has always been seen as a "Safe Haven". One Forex trader I spoke to called Japan a "special exception", because it is always seen as safe despite its crippling debt. When Greeks are rioting and investors feel like the financial world is collapsing, the Yen has always surged. This may be due to the "carry trade" as the Bank of Japan (BOJ) has essentially pledged to keep rates at near 0 indefinitely  making the Yen a great currency to borrow in.

Here it is important to understand that Japan's government and central bank are actively intervening in the JGB market (and the stock market via the Bank of Japans intervention in an Japanese equity ETF). Not only does the Japanese central bank buy a lot of Japanese Government debt, but it puts pressure on Japanese banks to buy huge amounts of the debt. Another factor is that the Japanese public has been a major buyer of their own Government bonds. Since interest rates have been near zero in Japan for over 20 years, and there has been deflation (prices go down over time), a 0.78% return does not look so horrible to the Japanese public. There is also the perception that the Yen and JGBs are a safe-haven assets, which coincides with the rise of JGBs and the Yen in times of crisis.

But what would happen if Japan's inflation turned to deflation? If prices in Japan are no longer going down every year, then a 0.78% return does not sound so great any more. The ironic thing is that this is exactly what Japan is trying to do. The new Japanese government has instructed the Japanese central bank to focus its actions on raising inflation, in the hopes that this will get the country out of it's multi-decade economic stagnation. 

The big question for Japan, and the world's investors, is whether this can all continue as it has for decades. If Japan succeeds in raising inflation, in an effort to jolt their economy out of stagnation, one unintended consequence could be a rise in Japanese interest rates, making Japanese Government Bonds less attractive. If this does occurs, will Japan's population sells their precious JGBs? If there is ever a mass exodus from Japanese Government bonds, and the yield goes from 1% to say 3%, Japan is screwed.

If their debt servicing costs rise by 50-100% (which would happen if there were a rather small move from 1% yield to 2% yield on JGBs), they will be effectively broke and this strange situation will cease to be possible. In my view, Japan's financial future is a question of whether the Japanese authorities can continue to manage perceptions and intervene enough to somehow continue existing at 230% debt to GDP, as if everything is totally normal. Nothing to see here folks!

Here is a quick Video of Kyle Bass talking about Japan's debt situation. 

For those with the time, here is a long talk by Kyle Bass, he touches on Japan and a variety of other topics (they disabled the ability to embed, sorry)

*Please note, that there have been countless traders who have been burned (or have gone completley bankrupt) by trying to short Japan. Large macro-events are difficult to time and may in fact never happen. The country has managed to stay afloat over the past 20+ years, and there are a number of analysts and thinkers that beleive the country will be just fine.