If Japan doesn't change course, it will have a major crisis within the next decade.

If. But what people need to understand is, the Japanese government does have the power to avert a crisis. It is not inevitable.

There is one way that the crisis can definitely be averted: Raise taxes. Japan's fiscal woes can be boiled down to one sentence: Japan has European levels social spending and European levels of aging with American levels of taxation. But this could change; if Japan raised taxes to European levels, crisis would be instantly averted. According to analyses I've seen, this would require raising Japan's taxes from their current level of 32.5% of GDP to somewhere between 40% and 50% of GDP. That's comparable to France or Sweden. Painful, but not impossible.

Now for the rumor (rumor always being a large component in Western analyses of Japan). My sources at the Bank of Japan and Ministry of Finance tell me that domestic Japanese investors are betting that, after all the grumbling and fighting and ending of political careers, Japan's government will suck it up and raise taxes. This, my shadowy sources say, is why pension funds are still willing to put the Japanese people's money into JGBs.

But this story is not really outlandish. It's similar to what we're observing in America right now. U.S. borrowing is at all-time highs, but demand for Treasuries shows no sign of flagging, and most of that demand - more than in the past - is from domestic U.S. investors. Yes, we have shown a reluctance to raise taxes - witness the apocalyptic debt ceiling fight from last year. But if the public really thought the U.S. government was willing to default, domestic Treasury buyers would be heading for the exits. That they are not heading for the exits probably indicates that they believe that when push comes to shove, the U.S. government will suck it up and raise taxes. There are signs that the Republicans are quietly recognizing the necessity of this. At this point, it's just a fight between Democrats and Republicans to see who takes the fall for raising taxes - that's what the "fiscal cliff" is really all about.

Japan seems to be in a similar situation. It is not really unusual or outlandish at all. Everyone in the country still seems to believe that the government will continue to function. The day that that belief falters - or is proven wrong by main force, when interest payments swamp the primary budget - is the day that Japan collapses (the same goes for the U.S.). But if Japan's government is less dysfunctional than the often skittish Western press believes, that day will never come.

(Anyway... oh yeah, I did mention that there might be two ways out of Japan's fiscal trap, didn't I? The other way is to use monetary policy to create negative real interest rates for a very long period of time. If that can be done in a stable way (without accelerating inflation) and if stable growth persists, then Japan can use an "inflation tax" to erode the value of its government debt instead of an actual tax. Econ bloggers (and commenters), who tend to believe that central banks can hit any NGDP target they want, will probably advocate this "solution"...)

But while a revolution is under way in the attitude to economic targets, the new tools and instruments required to hit these targets have hardly begun to be discussed. The unemployment and GDP targets suggested by Bernanke and Carney are empty promises in the absence of policy tools that could convincingly boost jobs and growth in the present deflationary environment. Which is where Japan comes in.

No other economy has (yet) suffered anything like Japan's 20 years of economic stagnation. It would not be surprising, therefore, if truly radical measures to deal with deflation were pioneered in Japan. Outside Japan, no central banker or politician has yet gone beyond pumping money into bond markets through quantitative easing. And nobody has suggested, at least officially, that central banks should directly lend to governments or finance one-off tax cuts.

The Japanese election on 16 December is attracting intense interest in the global financial markets. In part, this is because the LDP's election campaign, led by Mr Shinzo Abe, is based on forcing an entirely new monetary strategy on the Bank of Japan, with obvious consequences for the yen and the equity market.

On top of that, the Japanese election is the first in a major democracy where the role and mandate of the central bank has taken centre stage in a national political campaign. Is this the shape of things to come in other democracies facing low growth, subdued inflation and rising government debt ratios? Politicians in many other developed economies will be watching the Japanese experiment with rapt attention...

As the population ages, the savings ratio will fall further, and the government will be forced to look overseas for the financing of its rising debt burden. An important recent study by Takeo Hoshi and Takatoshi Ito concludes that this is likely to result in a government debt crisis well within a decade. Markets are forward looking, and will see this coming well in advance.

Japan has defied the debt crisis doom-mongers for more than a decade now, but its long term deteriorating trends on demography, government debt and export performance cannot be held at bay indefinitely. Shinzo Abe has concluded that the only way out of this dilemma is to force the Bank of Japan to raise the inflation rate and (though he does not say this specifically) push the yen down. Unsterilised purchases of foreign assets may be the only way the central bank can do this.

Of course, there are severe risks with the Abe programme. If inflation expectations rise, bond yields may follow suit, undermining the capital base of the financial sector which holds all the bonds. But the Japanese political wind is now blowing strongly in the direction of co-opting the central bank as an integral arm of the government. If Mr Abe does not do it, someone else almost certainly will.

I give the example of Japan because when you're looking at the United States, the Japan example, I think, is a very good example. We have -- Japan has total debt-to-GDP of about 500 percent, and it has government debt-to-GDP of about 270 percent. So it is way, way, way more leveraged, in a sense, than the United States is. And so then the question is, as we go through this, the magnitude of monetization. You have to go back to say, who are the buyers of the debt and what are the motivations?

There is a "greater fool" theory. The "greater fool" theory can go on for a really long time. The timing of when that shift takes place is very much dependent on that. So as we look in terms of, let's say, the United Sates, certainly it's the case -- and in Japan -- certainly it's the case that we can't support these kinds of debt. Anybody with a sharp pencil will know that we're not going to be able to support that. That doesn't mean there won't be adequate buy, just like in Japan's case. You can have plenty of buy. You provide enough liquidity, and the question is, what are the choices?

When the economic history of the 21st century is written, September 2012 is likely to be recorded as a defining moment, almost as important as September 2008. This month's historic events ¨C Ben Bernanke¡¯s promise to buy bonds without limit until the U.S. returns to something approaching full employment, Angela Merkel's support for the European Central Bank bond purchase plans and the Bank of Japan's decision to accelerate greatly its easing program ¨C may not seem earth-shattering in the same way as the near-collapse of every major bank in the U. S. and Europe. Yet the upheavals now happening in central banking represent a tectonic shift that could transform the economic landscape as dramatically as the financial earthquake four years ago.

To see why, we must go back in history 40 years, to the early 1970s. Maintaining full employment was at that time regarded as the main objective of all economic policy, and this had been the case for roughly 40 years, since the Great Depression. But by the early 1970s, voters had enjoyed decades of more or less full employment and were starting to focus on inflation rather than depression as the main threat to their prosperity. Economists and politicians were responding to this shift. Milton Friedman led a monetarist "counterrevolution" against the Keynesian obsession with unemployment, designing new economic models to challenge the Keynesian view that market economies were naturally prone to long-term stagnation. By restoring the pre-Keynesian assumption that market economies were automatically self-stabilizing, the monetarist models produced two powerful policy prescriptions directly opposed to the Keynesian views.

First, the monetarists insisted that price stability, rather than full employment, was the only legitimate target for monetary policy and government macroeconomic management more generally. Second, they argued that central bankers should not accept any direct responsibility for unemployment, since sustainable job creation depended solely on private enterprise ¨C full employment would be achieved automatically if inflation were conquered and market forces were allowed to operate freely, with the minimum of government interference or union constraints. A few years later, Margaret Thatcher and Ronald Reagan turned Friedman's intellectual revolution into practical politics. On top of its economic impact, monetarism had huge ideological effects by absolving government macroeconomic management of any direct responsibility for jobs and instead attributing unemployment to regulations, unions, welfare policies and other market distortions.