The Magazine


Jun 16, 1997, Vol. 2, No. 39 • By DAVID M. SMICK
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IMAGINE YOU WERE GEORGE SOROS'S chief currency and bond trader. Throughout the late 1980s, you bet that an almighty Japanese juggernaut -- the new capitalist model for the 21st century -- was taking over the world, Rockefeller Center and all. Today, had you followed that line, you would not be George Soros's chief trader. Or imagine you were CEO in the late 1980s of an American computer chip manufacturer. At the time, you were convinced Japanese chip makers were so advanced you directed your company into other, less technologically competitive niches. Today, Japanese chip makers have fallen far behind their U.S. competitors. You would no longer be CEO.

The Japanese economic juggernaut that was to have owned us all has entered a period of crisis. Japan now finds itself wound in a series of frustratingly tight policy knots. Most Tokyo policymakers know in their gut they have one, messy solution left: bold liberalization and deregulation of the economic and financial systems. But it won't be easy, given Japan's rigid political environment. The best bet is that Japan is doomed to years of economic drift marked by slow growth and a lackluster stock market.

Not that Japan is a basket case. The country continues to have a high savings rate with some extraordinarily competitive, world-class companies. So Japan can never be entirely counted out. The system confounded conventional wisdom twice during the oil shocks of the 1970s, adjusting to new price levels with amazing speed.

But the situation is different this time. The tried and true policy tools are not working. Monetary stimulus, for instance, has been surprisingly ineffective. The Bank of Japan for years now has left short-term interest rates at the unusually low nominal level of 0.5 percent. Yet both the supply of and demand for credit have continued to decline. Meanwhile, the Japanese government, the last Keynesian stronghold in the world, enacted a multi-year series of massive supplemental budgets to pump up public-works spending. The exercise failed to spark much additional economic activity. Indeed, without the additional spending, real gross domestic product would have slightly declined over the last four years. Japan is now left with a deficit-to-GDP ratio of 7 percent (or perhaps higher, depending on how it's measured). In other words, Japan's deficit ratio is nearly twice that of Italy.

The lingering economic crisis has eroded the confidence of the Japanese people in their national leaders. Five years ago, a president of a large financial institution in private conversation would have been highly respectful of officials in the Ministry of Finance. Today, individuals at this level are sneeringly dismissive of finance bureaucrats. And they've lost faith in Japan's economic potential, too. Since 1994, domestic investors as a whole have been net sellers on the Tokyo stock market, the Nikkei. Only buying by government pension funds (the so-called price keeping operation or PKO) combined with sporadic buying by foreign hedge funds and mutual funds has stabilized the market -- at less than half its value at the beginning of the decade. Now on some days, transactions on the stock market are roughly the same as the daily transactions in the United States of one stock, Intel. True, it has been relatively easy to prop up the market artificially, giving the illusion of stability. But it is an illusion.

Until several months ago, Japan seemed headed toward the bold deflationary approach, coupled with deregulation of financial and economic systems. It would be messy, but at least it dealt with a fundamental cause of the private sector's dwindling confidence: today's still artificially ballooned asset prices. Under this approach, Japan's horrendous bank balance sheet problem would be tackled quickly through a bank restructuring not unlike the process that saved struggling U.S. banks five years ago. Indeed, many large Japanese banks today look enviously at institutions such as Citibank, which were mired in an ugly restructuring effort as the savings and loan crisis unfolded in the early 1990s. Citibank's stock price dropped to single digits. Yet once the restructuring was over, Citibank stock, propelled by a much healthier balance sheet, became one of Wall Street's biggest winners. Japanese reformers would like to emulate this success, but it won't happen until the all-important asset price floor is established, giving investors confidence in the system again.