Is Japan "Normal" Again?

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Japanese bond yields have been rising relentlessly over the past few years, especially at the longer maturities that were never directly targeted by the Bank of Japan (BOJ). Yields on long-term Japanese government debts are now higher than at any point since the 1990s. Yet the yen has not only failed to appreciate against the currencies of its trading partners—all of which have experienced either smaller increases in interest rates or falling rates since the middle of 2023—it still looks cheap relative to its history.At first glance, this seems extremely odd.Some have argued that the apparent interest rate / exchange rate disconnect can be explained by concerns about the Japanese government’s ability to continue servicing its debts. The central government currently owes about 1.3 quadrillion yen, or about 2x Japan’s national income. As that debt is gradually refinanced at new, higher, interest rates, the budget deficit may get pushed up, leading to even more debt issuance at even higher rates, etc.Those who believe that the debt is unsustainable believe that the government will eventually be forced to choose between outright default and “debasement” that would cheapen nominal yen claims relative to assets in other currencies as well as relative to real assets. For those who have spent decades warning—or scaremongering—about Japanese public indebtedness, the persistent (nominal) weakness of the yen in the face of rising (nominal) interest rates over the past few years therefore seems like vindication that this process is finally starting.As of now, however, there is a more b…