As havens go, Japan sure is an odd case. You would think that having the developed world’s largest public debt, an aging and shrinking population, deflation, few natural resources and the ever-present risk of a giant earthquake might give investors pause.

Since the global crash of 2008, though, they can’t get enough of the place. As a recession takes hold in Europe and the U.S. limps along, demand for yen assets has exploded. This is giving Finance Minister Jun Azumi and Bank of Japan Governor Masaaki Shirakawa fits as they confront pressure to halt the yen’s 33 percent surge since the collapse of Lehman Brothers Holdings Inc.

Try as they might, there is little they can do. The yen is in vogue because the dollar and euro look uglier, and its rise is beyond the control of the government or central bank. Yet something is afoot that might reverse the yen’s climb in ways Japan might not like, thanks to the world’s largest pension fund.

Demographic trends are prompting Japan’s Government Pension Investment Fund to trim its debt holdings. That’s huge news in bondland. The fund oversees $1.45 trillion of assets, an amount greater than China’s holdings of U.S. Treasuries and more than most sovereign-wealth funds have to invest. This bond whale makes the $263 billion Total Return Fund run by Bill Gross of Pacific Investment Management Co. look like a minnow.

Dumping Debt

The pension fund’s move may signal a weaker yen in three ways. First, as Japan ages, huge pension funds will have to invest more abroad for higher-yielding assets. Second, the Bank of Japan will have to add more liquidity to the financial system to absorb large bond sales, which is essentially another quantitative easing. Third, it means the big money will be bidding less on government debt auctions. All of this may have other major debt holders, Japanese or otherwise, considering sales of their own. And selling debt today might lock in much richer gains than a year from now.

Does this mean the day of reckoning that bears have warned of for so long is upon us? Is what’s arguably the world’s biggest bond bubble bursting? It’s a question worth asking. More than $10 trillion of savings in Japan needs a home somewhere, and public debt, negligible yields aside, will still have ample support. Yet 10-year Japanese yields, now at a nine-year low of 0.77 percent, are likely to rise at some point.

The most immediate issue is fresh volatility in currency markets. In a stable and rational financial world, higher yields might make the yen more attractive as investors seek fatter returns. But worries about Japan’s bond market could damage the nation’s refuge status. That would pressure hedge funds, portfolio managers, banks and individual investors to find alternatives.

The trouble is, where? Probably not the euro or even the U.S. dollar. Maybe commodity currencies such as Australia’s or Canada’s, though their dependence on China and its slowing economy is unnerving. One could opt for gold, but at more than $1,600 an ounce that could be a dicey proposition.

The risk is that a sudden drop in the yen leads to an uncontrollable unraveling. True, some yen weakening would be welcome in Tokyo, where business executives are demanding action. A quick look at the earnings trajectory of Toyota Motor Corp. and Sharp Corp. tells you all you need to know about the hollowing out that’s now taking place.

In reality, hollowing out in one form or another has been Japan’s lot since the mid-1990s, after the economic bubble imploded. High wages, overcapacity and bloated corporate structures led to painful downsizing. Factories closed, jobs went overseas, the lifetime employment that formed the core of Japan’s postwar boom went away, deflation deepened, rust-belt cities such as Osaka and Shizuoka lost their buzz, homeless shelters swelled and the interest rates were cut to zero.

China Effect

A decade later, China overtook Japan as the region’s dominant economic power. On the bright side, that scared Japan’s bank executives into disposing of the bad loans that had crippled the financial system for more than a decade. Economists credited then-Prime Minister Junichiro Koizumi and his financial guru Heizo Takenaka for cleaning up the banks. In reality, the credit belongs to China. Even so, Japan still hasn’t grasped the significance of China’s ascent, and is still struggling to adapt.

A third setback came with the yen’s post-2008 surge, which has been accelerating in tandem with Europe’s meltdown. Japan’s export industry, the lifeblood of the economy, is reeling. Profits are down and so is market share amid competition from South Korea and China. Disruptions after a giant earthquake in March 2011 further dented Japan’s standing as a manufacturing center and as a reliable link in the global supply chain. Calls for radical action on the yen are getting louder by the day.

So is the speculation about why Japan is tolerating an exchange rate that so many think imperils its growth and sovereign credit rating. One of the most intriguing theories is that it’s a generational phenomenon. A stronger yen mostly benefits the elderly, who are by far the largest voting bloc. It exacerbates deflation, enabling retirees to stretch their pensions and savings. Politicians may be loath to risk electoral support with a weaker yen.

Another theory is that Japan wants to encourage mergers and acquisitions to wring out inefficiencies, boost competitiveness and gain new markets. This month’s move by Dentsu Inc., the 111-year-old advertising company, to buy the U.K.’s Aegis Group Plc supports this idea.

The truth is, the yen’s strength is beyond control of Japanese officials. Currency intervention won’t work, and neither will flooding world markets with yen. The wild card is how yen-bond sales by big investors affect Japanese yields and global markets. Such sales may deprive the world of one of the few havens left. They also may introduce more chaos into markets that really don’t need it.

(William Pesek is a Bloomberg View columnist. The opinions expressed are his own.)

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Today’s highlights: the editors on housing as a campaign issue and on why Italians should deepen Monti’s reforms and reject Berlusconi; Meghan L. O’Sullivan on Mexico’s energy reforms; Ramesh Ponnuru on why Republicans will win the tax debate; Alexander Friedman and Kiran Ganesh on the butterfly effects of central banks; Carrie Lingo on the excitement of women’s field hockey.

To contact the writer of this article: William Pesek in Tokyo at wpesek@bloomberg.net.

To contact the editor responsible for this article: James Greiff at jgreiff@bloomberg.net.