Not many things keep me awake at night, but recent developments in Asia are a cause for concern. The increasingly destabilising policies being implemented by Japan have the potential to ignite a global financial conflagration with consequences even more severe than the recent crisis.

Japanese authorities have embarked on a precarious policy of depreciating the yen, raising domestic inflation to 2 per cent, and running larger fiscal deficits in an attempt to end decades of chronic stagnation. This policy cocktail, designed to increase domestic spending while improving export competitiveness, threatens to rekindle uncertainty and upheaval across the globe.

Rising domestic inflation would result in negative real returns for Japanese government bonds, while the depreciation of the yen would further discourage foreign investment. This could lead to capital outflows as global investors seek to escape the certainty of negative real returns on yen-denominated assets. Even Japanese equities would fail to attract hard currency investment as investors would hedge their yen exposure.