In the bloodcurdling programme notes, the Japanese bond market has a plot, a setting and a cast of characters that should logically guarantee a great horror show.

There is the monstrous spectre of public debt –— a bogeyman that has swollen to nearly 200 per cent of GDP and which the IMF predicts could burgeon to 246 per cent within five years. There are the hapless Japanese villagers, too old and weak to fight the debt beast and no longer able to sate its hunger from their gold stashes. There is the spooky old castle of Japan itself — a rickety shadow of its former glory with crumbling walls and dark secrets.

The most extreme hypothesis is apocalyptic and ends with sovereign default by the world’s second largest economy as the titanic Japanese Government bonds (JGB) market is finally exposed as the Ponzi scheme some believe it might be. The only happy ending, supposedly, is for those investors bold enough to short Japanese debt — a trade that has only ever led to disappointment and ruination.

Quite reasonably, some parts of the market are already worked-up in anticipation of all this financial gore.

Japan does owe a spectacular amount of money, mostly to Japanese, and a glance at demographics and economic fundamentals suggest it was always going to be hard to pay off.

If the servicing costs rise because the Japanese stop buying bonds, runs the chilling narrative, it all turns nasty. Yields on the 10-year note have indeed climbed to 1.47 per cent in a steady rise since September, although they tumbled to 1.37 per cent yesterday as the five-year auction was well covered and deflation concerns took over. Credit default swap (CDS) spreads have risen sharply and credit ratings agencies, though not actually changing their view, are sharpening their pencils in case net debt issuance takes another wild swing north.

Helping the hype is the fact that Japan has been a truly dreadful steward of its debt, postponing fiscal consolidation for 30 long years as the problem turned uglier. But, like so many mediocre horror films, much of the impact is lost in the detail and the plot is actually rather hackneyed. Nothing has changed substantially over the past few weeks, and there is no real reason to suspect that the Bank of Japan will not buy JGBs as disaster looms. With the scary music turned down low, you can see how a lot of the effects were done.

To start with, there is the question of whether gross debt to GDP ratio is deadly or even the right number to be looking at. Britain in the 1950s amassed gross debt above the 250 per cent mark and still managed to found the National Health Service. Looked at in terms of debt servicing costs, Japan is not especially more endangered than the US, UK, France or Germany.

Secondly, Japan’s debt is almost entirely held by Japanese. That does not remove the risk that JGBs will lose their appeal and yields will rise, but it does mean that the Government knows precisely the kind of investor it is dealing with: all it has to do is what it has always done since 1989 and used the law to make every other investment — from property to the stockmarket — unappealing. CDS spreads too are a financial instrument used mainly by non-Japanese: given that 94 per cent of JGBs are held by Japanese, it is just possible that CDS spreads are not the most accurate predictor of JGB market behaviour.

None of this can disguise, however, that Japan’s situation is extreme and fraught with the danger of chronic mismanagement. It does, however, have two potential saviours waiting in the wings.

The first would be to substantially lower the threshold where people pay inheritance tax from the current levels of Y60million (£400,000). As matters stand, only a small minority pay death duties: if that balance were shifted to become even a large minority, the fiscal position would quickly improve.

The second, says Nicholas Smith of MF Global, would simply be to insist that more companies pay the tax they should already be paying. That requires an acknowledgement that there is a highly abused tax regime in Japan, with the small and medium-sized companies as the suspected culprits. Corporate tax in Japan is the highest in the OECD but tax to GDP ratio is among the lowest. It is explained by the fact that less than 30 per cent of Japanese companies booked a profit for tax purposes in fiscal 2008, though a great many of those are certainly performing better than breakeven. For every company that pays its taxes, 2.4 do not because the regime is sloppy and Japanese politics has always secretly favoured the little guy.

It is a horror show, certainly, but if companies stop hiding profits and the dead pay their taxes, the X-rating is not a foregone conclusion.

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