uary 18, 2002

Japan faces financial implosion

Koizumi has failed to address his country’s problems

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LARRY ELLIOTT

There was bemusement in the financial markets last week when the price of gold went surging through $300 an ounce. Gold is supposed to be a hedge against inflation and a haven in times of war, but here it was going up when the United States has sorted out its local difficulty in Afghanistan, and the real threat is not of rising but falling prices. However, it did not take long for the markets to come up with an explanation: Japan. The buying spree was concentrated in East Asia, with a rush by Japanese investors to find an asset that looks safer than shares in domestic companies or bonds. Almost any asset looks safer at present than Japanese assets. Japan faces premier league political and economic meltdown: Argentina was the third-biggest economy in Latin America; Japan is the second biggest economy in the world.

This prospect has yet to make much impact on the rest of the world. Last weekend’s meeting of finance ministers of the Group of Seven leading industrial nations had its ritual show of concern about the need for stronger growth and structural reform. But there is a sense that Japan has already been designated a basket case: it has made such a limited contribution to global growth recently that it hardly matters if it continues to do badly.

Similarly, the idea that Japanese institutions will respond to a domestic financial crisis by selling off foreign-owned assets seems far-fetched. If you were a Japanese bank, would you rather be holding US treasury bonds or Japanese government bonds? No contest. The fact that the Japanese government was last week seeking to prop up the Nikkei index proves the point.

Even so, the West cannot afford to be complacent about Japan. Action is needed, and quickly, as this is an economy that could soak up some of the world’s excess capacity if it were functioning properly. A strong Japan is not only essential for the long-term health of the global economy, it is also needed as a counter-weight to the growing power of China. A collapse in the Japanese economy could unleash a wave of extreme nationalism that would push it into conflict with China.

Japan's problem is that it is financially and politically bankrupt. It is a country crying out for leadership, and there was hope that Junichiro Koizumi would offer the country a way out of its downward spiral.

Koizumi, however, is struggling to cope with interlocking problems. The first is the damage to his credibility caused by the sacking of his foreign minister under pressure from reactionary political elements. When he became prime minister last April Koizumi was supposed to be the clean-up kid who would bring about reform. That now looks like a forlorn hope. It also has implications for the government’s ability to cope with the coming financial typhoon.

Charles Dumas of Lombard Street Research believes a full-blown financial crisis is likely “in weeks rather than months”. Koizumi's loss of credibility has ensured that the government can only react to the banking crisis after it has occurred rather than take the action now to head it off.

The imminent financial crisis is only a symptom of a wider economic malaise that is partly the result of the collapse of the bubble economy at the end of the 1980s. What happened in the subsequent decade is that what were once seen as virtues of the Japanese system have become weaknesses.

By Western standards Japanese firms are unprofitable, and many of them have been kept going only by virtue of the generosity of banks that are now sitting on a mountain of bad debts. Consumer confidence is weak; deflation is making monetary easing less effective; the limits to fiscal pump-priming have been reached.

Koizumi’s plan to make the banks clean up their balance sheets by getting rid of bad loans would only intensify the slump. “The only solution to Japan's difficulties lies with outright nationalisation of the banks. But few politicians in Japan appear willing to countenance such a proposal,” says Graham Turner of GFC Economics.

During the 1960s and 1970s Japan's policy of outward-looking protectionism worked But command and control has its limits. Japan’s first moment of truth came in September 1985 when its pivotal role in the Plaza accord to drive down the dollar showed that the country had come of age. This was the moment to re-culture its corporations, to deregulate, but it went the other way.

The second date with destiny came in January 1995, the Kobe earthquake. The government froze; it was incapable of coping with the disaster.

Now Japan should do what it failed to do 17 years ago: liberalise, become less racist, sexist and chauvinist. There are painful times ahead even if it does. If it does not, the risk is of domestic implosion and conflict with China. Scary stuff.

-- The Mail&Guardian, February 18, 2002.

http://www.mg.co.za/mg/za/archive/2002feb/features/18feb-japan.html

-- Martin Thompson (mthom1927@aol.com), February 18, 2002

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-- Martin Thompson (mthom1927@aol.com), February 18, 2002.