David Sterman
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In the summer of 2010, a little-noted milestone took place. China passed Japan to become the world's second-largest economy. Now, Japan needs to keep an eye on the rear-view mirror. Germany and Brazil are gaining ground and may overtake the Asian country in coming decades as well.

Japan's steady decline  -- relative to other economies -- can be attributed to a pair of factors: A rapidly-aging population and a too-strong currency. These two factors are crimping demand for goods and services at home, as well as foreign demand for exports.

This isn't a new story. The Japanese economy has barely budged in the past two decades after a 40-year spurt of strong growth. Though the economic weakness has been mild, helping the country maintain full employment, cracks have begun to emerge and the pace of economic erosion may soon accelerate. 

Problem is, this is not just worrisome for Japan, but also its neighbors in Asia, along with the United States and key European trade partners. That's why investors need to stay abreast of events in Japan. 

Short sellers have been surely aware of the troubles in the Asian country. In just the two weeks ended Oct. 31, the short interest in the iShares MSCI Japan Index fund (NYSE: EWJ), has doubled in size, to a whopping 19 million shares. 

Debt and trade: worrisome signs
To see why short sellers are piling on, you need only look at Japan's balance sheet and its cash flow statement. On the balance sheet, you'll find a country with a staggering amount of debt. Here in the United States, our national debt is now more than 100% of gross domestic product (GDP). In Italy, that figure has risen to 120% while in Greece, it's up to 160%. Japan's debt-to-GDP: roughly 230%. Japan's government debt is now larger than all 17 Euro member nations combined.

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David Sterman

David Sterman has worked as an investment analyst for nearly two decades. He is currently an analyst for StreetAuthority.com