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One of the great questions puzzling  mainstream, neo-liberal economists and market pundits has been the low rates on Japanese bonds for the past 20 years despite extroardinarily high debt to GDP ratios.  One consistent theme of the market pundits has been that the bond markets were going to turn on Japan any minute, borrowing costs would soar and there would be a flight from Japanese bonds.

Hasn’t happened, and with a debt to GDP ratio of nearly 200% and multiple downgrades from the ratings agencies of their debt, Japanese bonds have the lowest yields in the world, with 10 year bonds yielding just over 1%.

Paul Krugman took up this theme in July, puzzling over the divergence between Japanese and Italian Bonds:

“A question (to which I don’t have the full answer): why are the interest rates on Italian and Japanese debt so different? As of right now, 10-year Japanese bonds are yielding 1.09%; 10-year Italian bonds 5.76%.

…I actually don’t have a firm view. But it seems to be an important puzzle to resolve.”

Now, with Italian debt yields soaring due to lack of investor interest, Krugman has finally found the answer:

“What has happened, it turns out, is that by going on the euro, Spain and Italy in effect reduced themselves to the status of third-world countries that have to borrow in someone else’s currency, with all the loss of flexibility that implies. In particular, since euro-area countries can’t print money even in an emergency, they’re subject to funding disruptions in a way that nations that kept their own currencies aren’t — and the result is what you see right now. America, which borrows in dollars, doesn’t have that problem.

Currency sovereignty matters.  The US is sovereign, and can always pay its debts.  At least, that’s what the markets are saying.

Warren Buffett also commented on this situation this past weekend:  ”Never give up the ability to print your own currency.”

So the academics and the investors understand this…how about the politicians?  Well, here’s Mitt (who would be king) Romney in a Republican Presidential debate:  ”This is a time to worry about America.  We see what’s happening in Italy.  What’s happening in Greece.  That’s where we’re headed if we don’t change our course.”  Oh, well.  I guess the Politicians are always the last to know.

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