The Bear's Lair: Japan at rock bottom

By MARTIN HUTCHINSON, Business and Economics Editor  |  Feb. 11, 2002 at 7:13 PM
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WASHINGTON, Feb. 11 (UPI) -- If you believe the media, the Japanese economy is in terminal decline. The government is engaged in pump-priming exercises, the yen is sinking, the banks' loan portfolios are a black hole, and there is a terrible risk of -- gasp! -- deflation. Fear stalks the land.

Current Japanese leaders are pushing a fear-inducing policy, no question about it. Prime Minister Junichiro Koizumi came to power last April and pledged to cut government spending, but in reality has done no such thing. His public borrowing ceiling target for 2002-03 of 30 trillion yen ($250 billion) has been history for several months now. Japanese public infrastructure spending doubles France, the next most profligate government in the world.

Late January, the Diet passed a $19.6 billion supplementary budget, increasing government spending still further, widening the deficit, and sending Japanese government debt spiraling ever higher than the 130 percent of gross domestic product, where it now stands. Keynesian pump-priming is alive and well in Japan. One wonders whether the economic insights of Milton Friedman and F.A. Hayek have ever been translated into Japanese.

The Japanese government relapsed still further into primitive interventionism Monday when it announced a shift in its policy priority to halting deflation (What was the purpose of Japan's huge public spending and deficits over the last decade, if it was not that?). The government will ease monetary further (by dropping 10,000 yen bills from helicopters?) and -- particularly bad news -- the government likely will use a $15 billion guarantee fund set aside for bank restructuring to buy stocks being sold by banks, thus both propping up the stock market and getting government into stock ownership in a big way.

Non-performing loans at Japanese banks hit $276 billion at the end of September 2001, up $23 billion in the preceding six months. Prime Minister Koizumi's popularity, damaged when he fired popular Foreign Minister Makiko Tanaka, has sunk from the 1980s where it stood throughout 2001 to the mid 40s now. The opportunity for economic reform seems to have been irretrievably lost.

The Japanese consumer is unlikely to be much help, either. December 2001 retail sales fell 5.7 percent from the same month in the preceding year, while overall 2001 saw a drop of 2.2 percent from 2000. Tokyo remains the most expensive major city in the world and Japan continues to run a substantial (albeit diminished) trade surplus.

The International Monetary Fund projects Japan's 2002 GDP growth as minus 1.0 percent, and consensus opinion among Western economists appears to agree. U.S. deputy trade representative Jon Huntsman last month nagged Japan on reform while Treasury Secretary Paul O'Neill told Japanese reporters that a weak yen would not fix the problem, that exchange rates "cannot improve productivity" and that Japan needs to move faster -- presumably by implementing a "stimulus package" similar to that which did a crash and burn to almost universal relief in the U.S. Congress last week.

The Japanese are a polite and deferential people, but when they submit to being lectured on trade by a country with a $400 billion deficit and on economics by a man with O'Neill's shaky grasp of the subject, their self-confidence must truly be at a low ebb.

Yet on the real economy side all is not black, far from it. For a start, O'Neill's lordly comments about productivity are wide off the mark. According to the U.S. Bureau of Labor Statistics, in the decade 1990-2000 Japanese labor productivity increased by 3.5 percent per annum, a highly respectable rate, above that of Germany, Italy, Britain and Canada, and only a little below the United States' 4.1 percent per annum. However, in that decade the U.S. had a huge boom, greatly increasing the capital intensity of output (and hence labor productivity), while Japan was mired in a ten year economic slump, with corresponding negative effect. Indeed, Japanese output increased by only 1.0 percent per annum during that decade, with productivity increasing by the most difficult of means, that of Japanese companies abandoning their lifetime employment system and shedding surplus labor.

The combination of rapidly improving productivity, a continuing trade surplus, Japanese consumers' continuing high savings rate and Tokyo's exorbitant cost of living indicates what Japan really needs -- a bonfire of import restrictions, a drop in the exchange rate and a combined boom in both imports and exports. Naturally, the government is determined to prevent this. While slightly positive to a lower yen, the government remains violently protectionist, as evidenced by the refusal last week to permit a foreign takeover of Snow Brand Milk Products, a corrupt and loss-making company in a wholly non-strategic sector. Naturally, O'Neill too rejects the possibility of a lower yen -- in this case rightly from his own selfish point of view; a surge in Japanese imports to the U.S. might finally push the over-consuming debt-ridden, financially corrupt U.S. economy into the deep, purgative recession it so urgently needs and richly deserves.

A fall in the dollar-yen exchange rate and a simultaneous removal of Japanese import restrictions -- particularly in the agricultural sector -- would make the glory of the Japanese economy, its exporting manufacturers, once more highly competitive in Western markets, and indeed markets worldwide. This would boost Japanese output, and reflate the Japanese economy from its recessionary stupor. At the same time, the surge of imports would prevent any significant real income loss for Japanese consumers, and would reduce the trade surplus that could otherwise destabilize world trade patterns.

A surge of both imports and exports produced in this way would produce a corresponding surge in Japanese government revenues, which would go far to addressing Japan's fiscal problem, and would reduce the excuse which the Liberal Democratic Party barons have used for the past decade to inflate infrastructure spending beyond all reason. At the same time, it would doubtless produce hardship, not just among the "Snow Brand Milk Products" employees, but among the tiny farmers that have benefited for so long from Japanese agricultural protectionism. At this stage, however, many such farmers are of retirement age, and their greatest single asset is their landholding, which if planning restrictions (another huge Japanese government boondoggle) are removed, can be sold to developers and relieve finally the acute Japanese housing shortage -- as well as bailing out the beleaguered construction industry.

The corollary for this would be a sharp fall in the value of Japanese urban real estate, whose quantity has been artificially restricted by government and in turn a further deterioration in the asset quality of the Japanese banking system. There is however a cure for this, too, and it is monetary.

With a high savings rate and a permanent trade surplus, Japan is an ideal candidate to be the first country to restore the gold standard, which Japan left in 1933 after having returned to in 1930. This would preferably be done at a slightly inflated gold price of about 45,000 yen per ounce (today's price is about 40,500) and would of course include the full scale production of high denomination gold coins, which would become a store of value for Japanese savers. In recent weeks, the rise in the gold price briefly above $300, apparently on Japanese buying, suggests that Japanese savers themselves are beginning to think about this possibility.

In Japan's situation where price deflation stalks the country, a return to the gold standard would be reflationary and stimulative. It also would give Japanese savers an alternative channel of saving to the banking system, thus restoring economic confidence. The likelihood of bank failures would remain, but not be increased as the banks' problem is one of solvency, not liquidity. By removing a portion of savers' deposits from the banking system, a restoration of gold would reduce the possibility of a bank "run" and exhaustion of the deposit insurance fund.

Of course, in the long run Japanese savers need to invest in the stock market for the economy to prosper, but with a lower yen and booming exports, profits and hence stock market prices are also likely to recover sharply, thus drawing retail investors back.

These changes would stimulate the Japanese economy, the least efficient sectors of the economy would shrink, and Japanese savings would be directed away from the banking system and real estate and toward stocks and gold. The Japanese economy would perform the "locomotive" function which the world economy as a whole, sinking ever further into recession, is going to need so badly.

There is one problem. The Japanese government will not do this, or anything like it. As Franklin Roosevelt should have said but didn't in 1933, the Japanese people have nothing to fear but government itself.

(The Bear's Lair is a weekly column which is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the last 10 years, the proportion of "sell" recommendations put out by Wall Street houses has declined from 9 percent of all research reports to 1 percent. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)

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