I studied Japanese business practices intensively in the early 1980’s. This was the peak of Japan’s success. They were doing everything better than America. Toyota and Sony taught us how to make our products better. Even today it is hard to find a better television than a Sony or a better car than a Lexus. Now that nation may fail. Why? Well it is certainly not because they don’t make good products.
The truth is especially hard to believe if it requires that we take action – if it requires that we change. If humanity is to have a future, we must take action – we must change. If humanity is to have a future, we must believe the truth.
If the world could be saved by making better products than surely the Japanese would save us. That’s not the problem. We have to find the problem. And as Paul Erdman explains, we better find it soon.
Paul Erdman
CBS.MarketWatch.com
Japan is a major accident waiting to happen. To be sure, as with Argentina, what is happening there resembles a train wreck in slow motion, one that has been unfolding for a long time. But if Japan finally and suddenly crashes and burns, the consequences will make those arising today in Argentina, or what happened in Russia a few years ago when it went into default, look insignificant by comparison. Because Japan is the world’s second-largest economy. It is the world’s largest creditor. The yen ranks third in the world in terms of its use in international commerce and finance after the dollar and the euro.
We are talking major-league trouble. The signs that the crisis in Japan is becoming ever more imminent continue to mount.
Third recession in a decade
It starts with the state of the economy. Japan is back in recession for the third time in ten years. This recession promises to be of a very serous nature, and it comes at a time when the Japanese economy is already in a weakened state after a decade of stagnation.
According to Lakshman Achuthan, managing director of the Economic Cycle Research Institute, which has a very good record in tracking business cycles on a global basis, Japan is doomed to remain the odd man out in the U.S.-led synchronous global recovery that is now in its infant stages. His long-term indicators point to a deepening recession there—in fact, one that will become Japan’s worst ever.
Then we have the Japanese banks, which are burdened with over $1 trillion in bad debts. This week, Standard & Poor’s again lowered the credit ratings of seven leading Japanese banks, citing a mounting load of bad loans and insufficient capital to fund operations.
In an act of almost singular bad timing, despite all this, on April 1 the Japanese government will begin removing its insurance on bank deposits over the yen equivalent of $75,000. Yet despite the urging of the finance ministries of the entire developed world, the Japanese government has still failed to come up with a plan to clean up the banking system. The danger that one of the key banks in that system could collapse continues to grow, as do fears that this could set off a domino effect and bring others down with it.
The recent performance of the Japanese stock market reflects growing apprehension concerning Japan’s economic and financial future. This week, the Nikkei 225 dropped below 9,500, its lowest level since December 1983. In fact, it fell below the Dow Jones Industrial Average for the first time since 1957. Market sentiment was hardly helped by Trade Minister Takeo Hiranuma’s saying, “We have a plan in case the Nikkei Stock Average drops to around 9,000. Naturally, we should make a decision if the yen’s fall accelerates because of share-price declines.”
Fearing 9,000
His words were interpreted by market participants as meaning that the government does not plan to take action until the Nikkei average plunges below 9,000.
To the dismay of foreign investors in Japanese equities, when the Nikkei resumed its decline in recent months so did the yen. If those investors came out of dollars, they have taken a double hit.
The Japanese currency has lost 14 percent of its value against the dollar since late September. And as the Bank of Japan keeps flooding the monetary system with liquidity—the monetary base rose last month by 23 percent—the yen’s depreciation is bound to continue, with some expecting the exchange rate to fall into the range of 150 to 175 yen to the dollar.
The Bank of Japan’s action also resulted in a plunge in Japanese bond prices this week, sending yields to 12-month highs. And it is here that Japan’s greatest, yet least recognized, vulnerability may lie.
In a very perceptive article in this week’s Barron’s, Jennifer Ablan suggested that “the biggest financial bubble still left in the world is the Japan government bond market.” And it is only a matter of time before it bursts.
We are talking here about a bubble of gigantic proportions. Japan’s total outstanding government debt will soon reach 140 percent of its gross domestic product. And remember, Japan’s GDP is the world’s second largest, topped only by that of the United States.
As long as banking-system problems persist, and as long as the Bank of Japan keeps flooding the system with liquidity to keep those banks afloat, the Japanese bond market will become increasingly vulnerable to abrupt, large sell-offs. This would, most likely, be accompanied by a capital flight from Japan, one that would accelerate as the yen plunged ever further.
The result would be a death spiral as the flight from equities, the flight from banks, the flight from bonds and the flight from the yen all reinforce each other.
This might inspire me to write another novel under the title “The Japanese Crash of ’02.” I hope, however, that it would remain work of fiction.
Economist and author Paul Erdman is a CBS.MarketWatch.com columnist.