Akito f*ckanaga from RBS warned of a "financial shock" as banks and insurers comes under strain, and investors focus on the nexus of structured products linked to the yen.
"Preventive measures on the financial front are urgently needed. Sentiment has declined severely and there are concerns over capital erosion at financial institutions. Lower stock prices and yen appreciation are on the verge of triggering a credit crunch," he said.
The yen's violent move late Wednesday to a record ¥76 against the dollar - smashing historic lines of resistance - has gone far beyond levels that automatically set off secondary effects through derivative contracts.
The Topix index has regained some ground after crashing to 782 but is still at levels that leave Japan's top three banks barely above water on $1 trillion of equity holdings. The risk is that they will curtail lending as a precaution.
The Bank of Japan has already injected ¥15 trillion (£117bn) in liquidity and pledge to boost quantitative easing to ¥40 if necessary, but even this may not be enough.
The G7 finance ministers were to hold a conference call last night to discuss possible intervention to stabilize the yen, perhaps at bearable levels of ¥80 to the dollar. But there seems little consensus yet on the scale of action needed. Dow Jones cited a Japanese official pledging "battle" to cap yen strength.
The channel of contagion from Japan to the rest of the world is finance, not trade, just as it was during the US sub-prime crisis. The trigger mechanism is the rising yen, which eats into profits and hits share prices.
It is the bitter-sweet fate of Japan to have a currency that strengthens furiously in a crisis, even if the crisis is in Japan itself. This is the flip-side of Japan's envied role as top creditor with $3 trillion (£1.86 trillion) of net overseas assets, or 52pc of GPD. Switzerland has the same problem. "With the yen it is always up the stairs slowly, and down the elevator fast," said David Bloom, currency chief at HSBC.
The casualties are legendary. It was the 1995 Kobe earthquake that caught Britain's Nick Leeson on the wrong side of the yen, the Nikkei, and Japan's bond market. The venerable Barings was ruined in short order.
Such yen moves are known as the "repatriation effect", a hotly disputed theme. Citigroup said the effect would be "negligible". Nomura also played down the risk. Yet the somebody is buying yen.
The repatriation argument is that Japanese companies and households sell foreign assets to cover needs at home. These holdings are mostly bonds of countries such as Brazil, South Africa, Australia, or New Zealand with temptingly high interest rates. They hold $50bn of bonds issued in Brazilian real for example, and $27bn of "Uridashi" bonds in Australia. The reversal of funds can be swift.
Japan's authorities said there was no sign yet of a scramble by insurers or corporations to bring money home. "Rather, some institutional investors say this is a good opportunity to purchase foreign bonds," said Rintaro Tamaki, Japan's currency chief.
This raises the nasty possibility that the full force of repatriation has yet to begin. The currency moves we have seen so far may be "short covering" and foreign funds anticipating a yen surge, not the real thing.
The Bank of Japan can offset any inflows by stepping up purchases of foreign bonds. It launched a blitz in 2003, buying a quarter trillion dollars of US debt to weaken the yen and stave off a deflationary spiral. "They can print, and print, and never get tired," said Mr Bloom.
There is no danger whatsoever that the Bank of Japan will run down its $886bn holdings of US Treasuries to cover reconstruction costs at home. That would be suicidal at this juncture, strengthening the yen even further. The risk lies elsewhere: with the über-charged commodity and emerging market currencies.
Fiona Lake at Goldman Sachs said the repatriation effect is largely myth. The yen rise after the Kobe earthquake was really a dollar slide. The Deutchmark soared pari passu the yen.
She said most of the foreign bond holdings of Japanese funds and savers - equal to 35pc of GDP - are hedged with foreign exchange derivatives. The insurers are also hedged. "If firms do choose to sell foreign assets to finance insurance payments, the impact of repatriation is likely to be limited."
However, Goldman Sachs has other warnings. While the earthquake and tsunami have not "materially damaged" the manufacturing base, prolonged power cuts are another matter. "If the electricity shortage were to continue until the end of the year, we estimate that GDP would contract throughout 2011," said Ms Lake.
The danger of relapse of into deep deflation is all too clear. So is the danger that this will cause the budget deficit to balloon once again, and push Japan's public debt beyond the point of no return. At 225pc of GDP, the safety buffer is almost exhausted.
