Is Japan the next big credit risk?

The Japanese trade deficit ballooned in July to 517 billion yen and the country has one of the highest debt loads of any developed country.

Yet the yen continues to rally on what seems like bad news. Why?

Japan’s total debt exceeds 225% of the country’s GDP, and with the exception of only Italy, Japan’s debt-to-GDP ratio is now more than twice that of any other G7 country.

Read: Japan’s economy sluggish

Despite having one of the world’s highest debt ratios, Japan’s debt remains in demand even though the yields on Japanese bonds are at their lowest in nearly two years and the yen continues to appreciate, in spite of efforts by the Bank of Japan to weaken the currency.

Considering how yields have ballooned for many Eurozone members, it appears that the investing community is not holding Japan to the same standard.

The big difference between Japan and Europe is the vast majority (~95%) of Japanese government debt is actually held by Japanese institutions and the people of Japan themselves.

Very little of Japan’s debt is held by foreign interests, and that helps the yen remain well-supported.

Adding to the yen’s appeal as a safe haven currency is the expectation that Japan’s inflation rate has been and will remain stable. This reduces the likelihood of future buying power being eroded by an unexpected rise in inflation and these are the factors investors look for when seeking to shelter assets during times of market turmoil.

Read: Yes, you can make money in Japan

There are few other currencies offering the degree of stability the yen represents, and with the growing uncertainty in Europe, the amount of money parked in the yen is likely to rise.

It is worth noting that Japan’s population as a whole is growing older and the demographics point to a future where retirees will soon outnumber workers. Japan’s retirees will also have little need to add to their savings and this could prove the event that forces Japan to turn to outside investors to bridge the swollen funding deficit.

Yields will unquestionably be forced higher. Given Japan’s current debt-to-GDP ratio and a structural annual budget deficit expected to top 15 trillion yen by 2015, investors may feel the new Japan represents too great a credit risk.