A pedestrian holding an umbrella walks past a stock quotation board in Tokyo on May 30 © Yuya Shino Reuters

Thanks, Japan.

Now we know what the crash that we're all so afraid of once the Federal Reserve stops flooding the financial markets with cash will look like, and how it will begin.

The 7.3% plunge in the Nikkei 225 index on May 23 --- with a total drop of 13% from the May 22 close to the May 30 close -- is a dry run for that future crash.

So, let's not look a gift crash in the mouth.

Let's see what the Japanese dry run tells us about what we might expect in a Fed-ends-QE3 crash. And what this Tokyo tale tells us about why it might not happen here at all.

First, we have nothing to fear but fear itself -- which is the problem.

You'll note that the May 23 plunge began with worry in the bond market that spread to stocks. That makes sense, since the monetary policies at the Bank of Japan (and the Federal Reserve) have been designed to suppress yields. The fear is that when intense pressure -- like that exerted by the Fed's $85 billion a month in purchases of bonds and mortgage-backed assets -- is eased, the markets will see a huge reaction.

Note that we're talking about "fear" here. Emotion. Extreme emotion.

image: Jim Jubak

Jim Jubak

Extreme emotion swings to excess.

The trigger here was a move in the yield of 10-year Japanese government bonds to 1% during trading on May 23.

The fear was that this was just the beginning of an uncontrolled, and uncontrollable, move up in 10-year yields.

Just one month ago, the yield on the 10-year Japanese government bond was 0.59%. In rough terms, the yield doubled in a month. Wasn't this the beginning of a move that would take yields not just to 1% but also to 2% or higher?

The halt in trading for the 10-year government bond fed into those fears. Trading wouldn't have been halted unless something really bad was about to happen, would it?

The sky hasn't fallen

In the moment, no one really focused on retreat in the 10-year yield to 0.86% by the end of the day or the fact that the 10-year yield had been 0.85% a year earlier and the sky hadn't fallen.

Second, the more everyone feels that we're in uncharted territory -- and the more untested the guides -- the easier it is for fear to grow.

Japan's dry run for a crash -- which officially moved to 10% correction territory with the May 30 drop in the Nikkei  -- offered fear the best of all growth media. The Bank of Japan's efforts to weaken the yen, increase economic growth and revive inflation in a country where deflation is deeply ingrained rely on a program of asset purchases that will pump an unprecedented amount of money into the Japanese financial system.

The amount envisioned is roughly equal to the Federal Reserve's ongoing program of asset purchases, but the U.S. economy is more than three times larger than Japan's. There are doubts about the effects of the Fed's effort, so imagine the suspicions about a program three times larger taking place in a country accustomed to deflation and where previous efforts to revive the economy have fizzled.

And, of course, there's the overarching unknown of the exact effect of extreme levels of government debt in Japan. There is a general consensus that running the world's highest debt-to-GDP ratio -- 215% as of the end of 2012 and a projected 230% by 2014 -- isn't a good thing.

The Japan bears argue that Japan is bankrupt -- a term of limited utility when applied to a country that can print money. The Japan optimists (I'm not sure there are Japan bulls in any meaningful sense) say that because of the country's huge reservoir of savings, it has more time to fix its debt problem and that the Bank of Japan effort might even work.

No one knows, of course, but the arguments of the Japan bears "feel" right. Saying "No one really knows" isn't exactly calming.

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Plus, the guy running the Bank of Japan, Haruhiko Kuroda, has been governor of Japan's central bank only since March. Kuroda isn't exactly an unknown in Japan's financial circles; he was the top currency official in the Finance Ministry from 1999 to 2003, for example. But he has never run a bureaucracy as complicated as the Bank of Japan. He also has limited experience in speaking to the financial markets and with his track record, he isn't likely to immediately calm them.

At the Finance Ministry, Kuroda was in charge of an earlier effort to drive down the yen. That leaves the market wondering if Kuroda is more than just a one trick, drive-down-the-yen pony.

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