Watch Tokyo

Japan: The Canary in the Coal Mine

For about seventy-five years, a coal miner in Britain went to work with a small cage in one hand.

Inside the cage was a canary.

The bird was not a pet, and it was not for company. It was the most important piece of safety equipment the miner owned. A canary’s body runs hot and fast - it breathes far more often, for its size, than almost any animal you will ever hold. That fast metabolism meant it pulled invisible, odourless gas - carbon monoxide, methane - into its blood long before a grown man felt the first symptom.

So the men watched the bird.

As long as it was singing and hopping on its perch, the air was safe. But when the canary went quiet, when it swayed and dropped to the floor of the cage, the message was simple and absolute.

You did not investigate. You did not climb down to check on the bird.

You ran.

Here is the detail I love. This was not some dusty Victorian custom. Britain used live canaries in its coal mines until 1986 - the year the compact disc went mainstream - when handheld electronic detectors finally replaced them. The practice had started back in 1911, after a physiologist named John Scott Haldane studied a mine explosion and worked out that a small bird would die of gas long before a man would.

For seventy-five years, the warning system was a living thing that absorbed the poison first, so the miners would not have to.

Keep that bird in your mind. We are going to need it.

For the last several weeks, I have been walking you down one long mineshaft.

The argument is simple: America is walking into a debt trap.

Energy shocks push inflation higher. Higher inflation makes bond investors demand higher interest rates. Higher interest rates make it more expensive for the government to borrow. And once the government is drowning in debt, the central bank eventually faces a brutal choice.

Protect the currency, or protect the bond market.

It cannot do both forever.

That is the trap closing around the United States.

But here is what I did not tell you last week.

America is not the first one into the shaft.

There is already a bird down there. And it has stopped singing.

Japan is running the exact experiment America is about to run. It is just further down the tunnel.

Why this matters today

Let me bring this to the present, because the symptoms are showing up right now, this month.

Of every wealthy economy on Earth, Japan is the one least able to feed itself. It imports roughly 97% of the oil it uses, and almost all of it comes through the Persian Gulf.

So when Hormuz closed and oil started to climb, ask yourself a simple question. Of all the rich countries in the world, which one gets hit first, and hardest?

The answer is the one with no oil of its own - and, as you will see in a moment, the most debt.

A quick word on how to read this: the strength of the Japanese yen is measured by how many of them it takes to buy one U.S. dollar - so when that number climbs, the yen is getting weaker.

Japan’s currency has been falling, and falling fast, lower than it has been in nearly forty years.

Why is it falling? Because oil is bought and sold in US dollars. To pay for it, Japan has to sell yen and buy dollars. With Hormuz closed and oil spiking, it suddenly has to sell far more of them.

A currency is like anything else: when more of it is being sold than bought, its value falls.

For a country that buys almost everything it burns from abroad, that is a tax on the entire economy: every barrel of oil, every shipment of gas, costs more in yen with each tick down.

And Tokyo is frightened enough to fight it. Here is the tell - a healthy country can usually let its currency move without panicking. A fragile one has to spend reserves, raise rates, or plead with markets to stop the bleeding.

That is not the signal you expect from the third-largest economy in the world.

That is the headline. The reason it matters is one level down - and it is the most important thing I can show you this week.

Japan got here first

To understand why Japan is the canary, you have to understand something most people never learn: almost everything the modern world calls “emergency central banking” was invented in Tokyo.

Stay with me, because this is the foundation of the whole argument. The policies America now treats as emergency economic tools were tested in Japan first.

At the end of 1989, Japan was the envy of the planet. Its stock market, the Nikkei, peaked near 38,915 - a number it would not see again for thirty-four years. At the top of the bubble, it was said the land under Tokyo’s Imperial Palace was worth more than the entire state of California. Stocks and property prices had gone vertical.

Then it burst. And it kept bursting, for decades. Economists gave the aftermath a name: the Lost Decades. Thirty years of stagnation, falling prices, and an economy that simply would not grow.

To fight it, Japan reached for tools no modern country had ever used.

It cut interest rates to zero in 1999 - nearly a decade before the U.S. Federal Reserve would do the same.

It invented modern money printing. The Bank of Japan launched the world’s first quantitative easing program in March 2001 - seven years before the words “quantitative easing” entered the American vocabulary in 2008.

Quantitative easing is central-bank money printing with a polite name: the bank creates new money and uses it to buy bonds, pushing interest rates down and bond prices up.

And in 2016, it pioneered the most aggressive tool of all: yield curve control. That is a complicated name for a radical, simple idea. The central bank stops letting the market set the government’s borrowing rate, and just pins it wherever it wants, by promising to print however much money it takes to buy the government bonds.

Sit with what that means. Everything the Federal Reserve did after 2008 - zero rates, money printing, pinning yields - Japan did first. Washington did not invent the modern central-bank playbook. It imported it from Tokyo.

And here is the bill for running the experiment the longest. Japan is today the most indebted advanced economy on Earth. Its government debt sits around 250% of its entire economy - roughly double the United States, which is itself drowning in debt at about 125% of GDP.

The bird has stopped singing

For thirty years, Japan got away with all of it, because of two things.

First, it was the bank to the world. Japanese citizens and corporations are voracious savers, and for decades, they shipped those savings abroad - its pension funds, insurers, and banks bought up American Treasuries, foreign bonds, and foreign companies by the trillions. For thirty-four years straight, Japan was the largest creditor nation on Earth: the country the rest of the world owed the most money to. It only lost that crown to Germany in 2024 - the first quiet crack.

Now hold that up next to the debt we just talked about, because this is the part that trips people up.

The Japanese people are savers - and they are the biggest buyers of their own government’s bonds. In other words, the Japanese government is financed by its own population. That 250% debt-to-GDP is owed almost entirely at home, not to foreigners - which is why Japan can carry the heaviest debt in the developed world without foreigners holding the whip. Japanese banks, pension funds, and the central bank hold the debt.

You might be wondering how both of those can be true at once - how a government can be this deep in debt to its own people, while the country as a whole is still lending money to the rest of the world.

The trick is that a government and its people are two different wallets. The Japanese people are some of the most disciplined savers on Earth; decades of selling cars, electronics, and machinery to the world have built a mountain of savings. That mountain is big enough to do two jobs at once - fund everything the Japanese government borrows, and still leave enough left over to lend abroad.

So the government leans on its people, and the people, even after bankrolling their own government, still have money left to be the world’s lender. That works for exactly as long as the savings pile stays big enough for both.

The closure of Hormuz is the first thing in a generation big enough to drain it.

An oil shock and a falling currency are a vice. Every time the yen drops, Japan’s oil bill gets bigger in yen - which forces it to sell even more yen to cover the next purchase. And every yen it sells drives the currency down another notch, which makes the next bill bigger still.

This is the doom loop: weaker yen, higher oil bill, more yen selling, even weaker yen.

Here is what makes it dangerous: it does not need a fresh shock to keep getting worse. It feeds on itself. Round and round, tighter and tighter.

You already know who Japan’s government borrows from: its own people, and its own central bank. For years, this worked because the Bank of Japan acted as the buyer of last resort. If private savers would not buy enough government bonds, the central bank would print yen and buy them instead. That kept borrowing costs near zero.

But the central bank cannot keep that promise now. Printing more yen to prop up the bond market would drive the yen lower and the oil bill higher - the exact spiral we just watched. So it is stepping back. And the moment the guarantee is gone, lenders want a real return again.

As we discussed in Two Wars, to attract new lenders, the government bond yields must climb.

The price Japan pays to borrow is now climbing to levels the country has not seen in a generation.

A currency that is falling and a borrowing cost that is rising, at the same time - that is the classic signature of a country losing the confidence of its lenders. It is the thing that normally happens to fragile emerging markets. It is now happening to the third-largest economy in the world.

When the canary needs cash, the first thing it reaches for is the most liquid thing it owns: U.S. Treasuries. And the selling has already started. In the first three months of this year, Japanese investors dumped about $29.6 billion of U.S. bonds - their largest exit in nearly four years. We talked about this exact mechanism in The First Domino. It is now happening in Tokyo.

The thing that turns Japan’s problem into your problem

Now let me explain the one piece of plumbing that connects a problem in Tokyo to the balance in your brokerage account. It has a name - the yen carry trade - and almost nobody outside of finance understands it.

But it is simple - and by the end of this section, you will understand how important it is.

You already know how Japan held its interest rate at zero - its central bank stood ready to print and buy the debt, so the government never had to compete for anyone else’s money. Here is the part that turns that habit into the whole world’s business: a central bank’s rate sets the price of money for the entire country. So when Japan pinned its own rate to zero, it made the yen the cheapest money in the world to borrow.

So the whole world borrowed it.

The carry trade is simple: borrow in the cheapest currency on Earth, convert it into a stronger currency, and buy assets that pay more than your borrowing cost. For decades, that meant borrowing yen at nearly zero, converting them into dollars, and buying American Treasuries, tech stocks, real estate, corporate bonds, or anything else with a return. The profit was the spread.

Think of it like borrowing money from a relative who charges you no interest, then lending it to a friend at five percent. It is the easiest money in the world. So you do it with as much borrowed cash as you can get your hands on.

It’s easy money - as long as your original loan stays free.

That is the carry trade. Stacked up over thirty years - trillions of dollars. Cheap Japanese money quietly poured into nearly every market on the planet, helping hold them up.

But here is the catch.

It only works while the yen stays cheap. The day Japanese interest rates climb, the math flips. That “free” loan suddenly costs real money. And everyone who took it is in a rush to unwind the trade at the same time - sell the stocks, sell the bonds, and pay back the yen.

When that money gets pulled from international markets and sent back to Japan, every market it was holding up feels the floor drop at the same moment.

No one can say exactly how big this trade is. Depending on what you count - direct borrowing, swaps, derivatives, and hidden currency exposure - estimates range from the low trillions to far higher. The point is not the exact number. The point is that no one knows the true size because the trade is scattered through private contracts across the global financial system.

Why can no one pin it down?

Because it is not one thing in one place - it is millions of separate bets made by hedge funds, banks, and companies scattered across dozens of countries, and much of it sits in private currency contracts that never show up on anyone’s books. There is no central registry, no single ledger. No one is keeping count.

If that sounds like a reach, stay with me, because this is not theory. We saw the trailer in August 2024.

The Bank of Japan raised its interest rate by a quarter of a percent.

The smallest move it could make.

That alone was enough. The carry trade began to unwind, and the damage did not stay in Tokyo. Japan’s market fell 12.4% in a day, its worst since 1987. Within hours it was Wall Street’s problem: the S&P 500 had its worst day in two years, and the market’s “fear gauge” spiked to one of the highest readings ever recorded. From Seoul to New York to crypto, markets fell together, in the same hours, for the same reason.

Sit with the proportion of that. Japan chose to raise rates one quarter of one percent, and the tremor circled the globe in an afternoon. That was the gentlest tap anyone could give it.

The next move might not be gentle - because it might not be Japan’s choice.

Bring it Home

Last week, I laid out the choices in front of Kevin Warsh, the new American Federal Reserve Chairman.

Save the dollar by raising the interest rate and making dollars scarce - at the cost of crushing the economy underneath it.

Or

Save the bond market - print money, buy your own debt, and quietly destroy the value of the currency.

One path breaks the economy fast. The other breaks the currency slowly.

Japan is standing at the exact same decision.

Its yields are rising, and its currency is falling at the same time, which means it faces the identical choice.

Defend the yen, and Japan must raise rates into a mountain of debt.

Defend the bond market, and Japan must print yen into an energy shock.

One path breaks the treasury. The other breaks the currency.

Same trap. Same choice. Same rule we ended on last week: when forced to choose, every central bank picks the slow death.

There is only one difference between Tokyo and Washington. And it is everything.

America has cushions; Japan does not. It has the world’s reserve currency. It has the deepest, most trusted bond market on Earth. Those buy it time. Japan has none of that. It has a debt load near 250% of its economy, an energy bill it cannot pay in a falling currency, and creditors growing restless right now.

So Japan does not get to wait for the bond market to force its hand. It is being forced first.

And because investors around the world have borrowed cheap yen for decades to buy assets elsewhere, Japan’s choice does not stay inside Japan.

It comes home. From everywhere. All at once.

That is how a crisis in Tokyo becomes selling pressure everywhere else.

Watch Tokyo

Every tool the US Federal Reserve now reaches for, Japan reached for first - zero rates, money printing, a central bank buying its own government’s debt to keep the lights on. America did not invent that playbook. It imported it from Tokyo, a decade late.

And look where thirty years of that playbook has left them. A government buried under debt worth two and a half times the entire economy - so deep it can never raise interest rates again without blowing itself up. A generation of savers who earned almost nothing on their money for three decades. An economy that has barely grown since the 1990s. And now the final stage: a currency sliding to forty-year lows, and a central bank trapped, unable to defend it.

That is the destination. Here is America’s odometer: past 125% debt-to-GDP and climbing, $39 trillion and counting, the same zero rates and money printing already run, an interest bill that alone now tops a trillion dollars a year. America is not standing at the start of this road. It is halfway down it.

So when you want to know what the back half feels like - a government that can never stop printing because stopping would break it, savers with nowhere safe to earn a real return, a currency leaking value while the price of everything imported creeps up, the people who own hard assets pulling away from the people who don’t - you do not have to imagine it. You can watch it, live, in Tokyo.

And do not take comfort in being different. Japan thought it was exceptional too - in 1989, when its market was the envy of the world and the dirt under its palace was worth more than California. Exceptional is what every country believes, right up until the gas reaches it.

Japan is the canary. Same shaft, same gas, faster metabolism. It is absorbing the poison the rest of us cannot feel yet - and it is showing the symptoms first.

The bird has stopped singing.

So position not for the world as it was, but for the world that is arriving. The slow currency death is brutal for cash and for paper promises. It is kind to real things - energy, hard assets, gold, the boring stuff I keep writing about, the things that do not need cheap money to survive.

Why?

Because when governments solve debt problems by weakening money, the things priced in that money tend to rise - not because they changed, but because the measuring stick shrank.

The oldest rule of the coal mine still holds. When the canary stops singing, you do not climb down to study the bird. You head for the exit.

Honest question - what am I missing? Let me know in the comments.

---

That’s it for today,

Jay Martin

---