Most of the things that are happening at the moment are pretty foreseeable: the carry trade is unwinding, and the yen is shooting through the roof. At the same time, Japan's export dependent economy is folding in on itself. So over the coming months we will get to see the full real economy impact of all the financial carnage we have all been so fascinated by.
When the dust settles, two fundamental questions will remain: why are Japanese interest rates forced to remain so congenitally low? And why is Japan's economy so export dependent and hence vulnerable to any sudden short sharp shock in the global economy?
Despite having relatively little exposure to a domestic housing boom Japan's financial sector is struggling, and my guess is that we are about to see a repeat performance of 1998, and possibly worse. In particular, with the debt-to-GDP ration currently running at around 182% (OECD 2008 estimate) Japan has very little room for any kind of fiscal stimulus, and it is very hard to see where they can find the money for the bank bailouts it seems they are going to need.
My own personal prediction is that when this whole current flap settles down then "the eyes of Sauron" are most definitely going to settle on developed economy sovereigns, and especially in those cases where fertility is the lowest (over the most extended periods of time) and where the pace of population ageing is the highest, since it is in precisely those countries that the pressure on debt will be the greatest (the hammering that Eastern Europe is taking at the moment gives us a foretaste, in my view). In this sense the problem was always coming, and the bank bailouts only constitute a little extra icing on the cake.
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