The Next Quake Is Close.(Japan bond market)

The form it will take is hard to forecast--an oil-price spike, perhaps- -but a shock is bound to expose Japan's bond market as a huge bubble, says John Alkire, chief investment officer at Morgan Stanley Asset & Investment Trust Management in Tokyo. "I don't know the date of the earthquake, but I sure think it's close."

A growing cadre of Japan analysts predict upheaval in the world's second largest bond market. Investors, who saw no limit for Japanese stocks in the late 1980s, now seem to see no limit for bonds. Since the 1989 stock- market crash, money has moved from stocks into the perceived haven of Japanese Government Bonds in amounts so excessive, it now puts the entire public-sector financial system at "high risk," warns PHP Research Institute, a Tokyo think tank. "There's a danger that the price of JGBs could collapse at any moment."

The problem is that the Japanese are making a dangerous wager against Japan. To buy a 10-year government bond at current interest rates (0.595 percent) is to assume that the economy will deliver negative growth until 2013--a run of stagnation unprecedented in modern economic history. Should Japan recover, all bondholders will suffer, but the biggest worry is Japan's weak banks. At the end of 2002 they held 31.4 percent of all JGBs in circulation, and could be driven under by a sudden price collapse. "Once anyone wants out, it's a disaster," says Akio Mikuni, president of Mikuni and Co., which rates bonds. "Nobody will support the market then. It will be like NASDAQ in 2000."

The difference is that the government is at risk, too. Japan's $8 trillion national debt is now a staggering 151 percent of GDP. Most has been amassed since 1994, when the government began issuing bonds to pay for huge pave-and-build stimulus ...