Now that prime minister Junichiro Koizumi has seemingly given up on reform, Japan could be re-entering the bad old days of its Liberal Democratic Party, and with it could come global fallout
In politics, it is said, a week can be a lifetime. Japanese prime minister Junichiro Koizumi is learning the same is true with economics.
Last month, Japan was merely in its third recession in a decade. Now, markets are buzzing about a full-blown financial crisis in the world's second-biggest economy. The Nikkei 225 stock average is even below the Dow Jones Industrial Average for the first time in 44 years.
Things have disintegrated so quickly that Koizumi can't go an hour without reassuring someone that Japan isn't about to crash. His controversial sacking of foreign minister Makiko Tanaka reminded the world that Japan's self-styled reformer hasn't changed a thing. The dismissal had the stench of the old Liberal Democratic Party-style politics he'd promised to change, and it showed how easily he could be distracted from the real task at fixing the economy.
Things look dismal. Consumer prices posted the biggest decline in 30 years in 2001. Retail spending fell for a fifth year, sales at big retailers dropped for a record 10th year. Factory production had its biggest slump in a quarter century. Unemployment finished the year at a record 5.6%. Even Japan's once-mighty trade surplus shrank to its lowest level in 18 years.
'Japan's reform proposals have quietly died,' says Paul Donovan, head of global economics for UBS Warburg.
Yet, those looking for an imminent crash may want to think again. Japan's financial system is still functioning, and will continue to, because the money still flows. Even if Japan doesn't fix its economy, it can still borrow enough money, print plenty of yen and draw on sufficient wealth to hold things together for a couple more years at least.
The conventional view is very different. To many observers, Japan's economy is like a jumbo jet, which has run out of fuel and should have crashed long ago. Yet, to the amazement of investors and analysts around the globe, it inexplicably continues to fly.
With all the dire predictions and hand wringing, it has been forgotten that Japan has developed the know-how to avoid a meltdown. After more than a decade in, and barely out of, recession, Tokyo has learned the art of indefinitely postponing repairs to its banking and corporate systems.
That, of course, is exactly the problem. Every time Japan edges close to a financial cliff, it teeters, then manages to stop sliding over the edge. That means the nation's economic problems are punted forward time and time again without ever being resolved. Every month that goes by with addressing the bad-loan problem, it gets worse.
Yet, Tokyo remains in all out damage-control mode. So far, it has done this by racking up the biggest debt load of the 30 members of the Organisation for Economic Cooperation and Development to fund economy-boosting public works projects. Tokyo shows few signs of ending its decade-long borrowing binge. By March 2003, national debt will reach ¥699 trillion, or 140% of gross domestic product.
The Bank of Japan's key interest rate is almost at 0%, and it's gone further to increase the amount of money banks can lend. Tokyo also has access to well over $1 trillion sitting in the government's postal savings system. The money, which comes from household savings, provides the government with a steady source of financing. Legal changes have made is harder to tap the funds, but it can still be done.
The lowest interest rates in the developed world are part of the scheme. Even though Japan has the worst credit rating among G7 nations, its 10-year bond yields at around 1.50%. The US, a top-rated economy, has to offer 10-year investors close to 5%.
Rates are so low because the government directs investment banks to buy the debt. Pension funds, wary of investing in Japan's sickly stock market, also load up on bonds. With just 6% of government bonds owned by foreigners, there's little concern about capital flight out of yen assets. So yields stay low.
So, while Japan's economic data looks bad, government officials argue, there's no lack of cheap money at the moment to build more highways, bridges, dams and tunnels to make sure people have jobs. Their motto: Have money, will fight change. Koizumi wants Japan to find a new economic model. But weaning Tokyo from its addiction to debt and forcing banks to write off the ¥151 trillion worth of bad loans has proved more difficult than Koizumi appreciated. When his approval ratings were 80%, he seemed to have a shot. Now that investors and voters alike are viewing him as another do-nothing prime minister, Koizumi's reform drive is finished.
In reality, Koizumi was through months ago. His revolution ended the second he began falling back on extra fiscal spending packages and weakening the yen to help the economy. Only now do investors seem to be realising that, for all his good intentions, Koizumi can't force change through the ultra-conservative LDP.
Such resistance explains why Japan is unlikely to change anytime soon. That's hardly good news for a global economy that could use some help from Asia's traditional growth engine. Worse, a crisis in Japan could send shockwaves around an already fragile global financial system. If Japan implodes, companies and investors might sell their dollars and euros to raise cash, slamming markets everywhere.
More likely, Tokyo will continue to patch things up, and delay serious change, for another few years. Even with Japan's large debt load, it's hardly destitute. Barring a crisis, its economy is looking at a few more years of muddling along, not thriving or crashing.
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