Jack Lew's Gamble on Japan Monetary Policy

New Treasury Secretary Jack Lew's policies towards the incredible shrinking yen look to be a calculated risk that assume first, the U.S. economy can withstand a stronger dollar and second, that America will be better off long-term if Japan gets healthy.

In an interview with CNBC last week, Lew flashed what can at best be described as a yellow signal of caution to Tokyo on its new easy money policies to pump up the Japanese economy. Those policies have led to an historic decline in the yen's value from 80 to over 101 to the dollar, making Japanese goods more competitive. Lew declined to criticize the policy and instead simply cited G7 agreements on currencies — read by some as a go-ahead, but also as an unambiguous warning that there are limits.

"The world community has made clear that domestic tools that are designed to deal with domestic growth are within the bounds of what the international community thinks is appropriate (and that) policies that are targeted to effect exchange rates are not,'' Lew said. "We've made it clear that we're going to keep an eye on them."

The question for markets is how long will this even-keeled attitude remain? Will Lew stay cool on the yen at 120 or even 130 to the dollar?

(Read more: Currency Devaluation—How to Get Away With It

Lew's approach faces several potential challenges. The first is that Tokyo's new policies do little to boost domestic Japanese demand and all the positive effects come from a boost to exports spurred by the sharp yen devaluation. If that happens, a big part of Japan's gain will end up being America's loss.

To address this issue, Treasury officials will carefully watch Japanese political pronouncements and economic outcomes. They will be looking for positive changes in domestic asset prices and increases in wages as a sign that a change in domestic demand is driving improvement in Japan's economy. Another key: they will want to hear Japanese politicians jawboning wages higher and using this opportunity to enact structural reforms to make the Japanese economy more competitive and open to domestic and foreign competition..

An important gauge for U.S. officials will be Japanese inflation expectations: if they really move higher and there are signs that Japan has broken the back of its two-decade long deflation, then the risk will be one worth taking.

The Japanese Yen
Jon Boyes | Getty Images

The second challenge is that Lew is miscalculating that the U.S. economy is simply not strong enough to withstand a change in the terms of trade that sees not just the Japanese currency's move lower but, sympathetically, other Asian currencies as well. Those other countries, after all, will not long abide becoming less competitive relative to Japan.

And that would bring about the third challenge: that before the policy has any measurable impact, U.S. domestic politics becomes a factor as troubled American manufacturers and exporters complain about cheaper Asian imports and their complaints find voice in Congress.

To be sure, Lew's calculation could be right. Japan, the worlds' third largest economy, has been a problem for far too long. Some short-term sacrifices in the U.S. might pay big dividends on the back end.

For the past six years, the world has focused first on righting the U.S. ship and then stabilizing the European economies. It has become so inured to Japan's no-growth, deflation-exporting impulses that the country is barely mentioned in discussions of global prospects or even as one of its problems.

A resurgent Japanese economy, especially if driven by Japanese consumers, could add a critical piece to the global growth puzzle, especially since prospects for Europe appear muted.

The question could become one of mettle: how long does he let it go? If the yen should hit 125 to the dollar and if Congress starts criticizing U.S. policy on behalf of U.S. exporters and growth should dip below 2 percent, will Lew then turn the signal from yellow to red?

By CNBC's Steve Liesman. Follow him on Twitter: @steveliesman