These are scary times in Japan. The stock market looks to be teetering on the verge of a major corre...
These are scary times in Japan. The stock market looks to be teetering on the verge of a major correction and the central bank, the Bank of Japan, is threatening to raise interest rates.
But the real anxiety centres on the government's decision to pull the plug on Sogo, a major retailing chain. Sogo's bankruptcy and liquidation has introduced a new theme to investor thinking, namely the possibility that Japan has at long last entered its much-needed period of 'creative destruction'.
Creative destruction means that the zombie companies, those that are essentially dead but kept alive by government assistance and interference, may be allowed finally to expire.
For good luck, they ought to drive a wooden stake through Sogo's heart, Dracula style, just in case it tries to come back from the dead.
The retailer's troubles date back to real estate speculation in the country's so-called bubble economy of the 1980s. Its going belly up is a powerful image, because the chain has become the poster boy for Japanese creative destruction.
So let the process begin - out with the old and in with the new. Let the rallying cheers be mark-to-market accounting, bank mergers and capital market reforms. If these work, then after a time the old Japanese economy will disappear and a new, vibrant one will emerge.
In the meantime, nobody really knows how much creative destruction needs to take place. One estimate comes from Ryoji Musha and Mamoru Shimode of Deutsche Bank Group in Tokyo, who in a strategy report at the end of July wrote: "We expect creative destruction to persist throughout the 20 months to the close of (the) fiscal year (ending) March 2002 - a period likely to be viewed in the future as having been historically significant.''
For Musha and Shimode, creative destruction includes bankruptcies, unemployment, volatility in the stock and real estate markets and what they call "third and fourth waves of financial industry reorganisation". They predict further deflation in consumer prices and say they would be "unsurprised'' if the benchmark Nikkei 225 stock index fell beneath its 9 October 1999 low-water mark of 12,787.
Whenever someone in a major financial institution tells me something really awful is about to happen to his or her own country, I listen carefully. The only missing element in Musha and Shimode's analysis is a consideration of the Bank of Japan.
The bank is about to take its summer recess and I suggest that the bank's governor, Masaru Hayami, should do a little vacation reading. My pick is A Monetary History of the United States' by Milton Friedman and Anna J Schwartz. The governor should pay very close attention to chapter seven, entitled The Great Contraction, 1929-33.
The relevance to Japan is straightforward. If Musha and Shimode are only half right, then there could be significant changes in the Japanese banking system in the next few years.
Left unattended, this could result in an implosion in the broad-based monetary aggregates as banks fail and liquidity disappears from the system. That is how a no-growth economy like Japan's could develop into a full-blown depression similar to the US depression of the early 1930s.
Speaking about the Great Depression, President Franklin Roosevelt used to use the analogy of a freight train to describe the US economy in the 1930s. In one of his famous radio fireside chats, the president told Americans that the huge train, the US economy, needed to move backward a little before it began to move forward. If you have ever been close to a train, you will know what he meant.
With proper management of the banking system by the Bank of Japan, creative destruction could do the same thing for Japan. But if the Bank of Japan is not careful, then this big train will end up going off the rails and into the canyon.
David DeRosa Bloomberg newsroom
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