The Magazine


Jun 16, 1997, Vol. 2, No. 39 • By DAVID M. SMICK
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Prime Minister Hashimoto appeared to be on board, as did the Diet. With soaring rhetoric, Hashimoto offered to deliver the so-called big bang financial reforms. The lower house of the Diet approved foreign-exchange liberalization legislation, which would ease cross-border transactions. Beginning April 1, Japanese pension funds were ordered to change their reporting practices to reflect the true market value of holdings. Hashimoto and his coalition, led by his Liberal Democratic party, were responding to, among other things, pressure from the pro-reform opposition.

But suddenly, the reform drive stopped. The big bang reforms look vague and weak as bureaucrats fill in the details. Government strategists insist the reform effort remains alive, but those in the private sector believe the pendulum has swung the other direction toward the old, go-slow, status quo approach. One example: the failure to forge a solution to the troubles of the life-insurance industry. During the financial bubble of the 1980s, investors were guaranteed a 5 percent annual return for 30 years. Now, government bond yields have dropped to a fraction of that rate, which means the "5 percent promise" threatens to bankrupt the entire industry.

But continuing with the old inflationary approach will stretch out rather than solve Japan's acute problems. Going slow was always the approach favored by many in the ruling LDP, whose political and financial base consists largely of Japan's mid-sized and smaller corporations and financial institutions. Under an abrupt liberalization and deregulation, they would be most at risk. The status-quo option means continuing government jawboning to stabilize the yen-dollar rate. And it involves continued buying by government pension funds on the Japanese stock market along with the injection of quick amounts of stop-gap cash from the Bank of Japan in the event of an occasional bank failure. This is pure Keynesianism, and it's a policy that Japan's leaders, despite rhetoric to the contrary, seem unwilling (or unable) to abandon, absent a powerful external shock.

Watching this drama for signs of the future are Japan's largest corporations -- the Toyotas and the Sonys. Notice that the top 25 or 30 industrial giants account for roughly 75 percent of Japanese exports. Most are in manufacturing, which represents 25 percent of the economy but 68 percent of the Nikkei 225 (Japan's Dow Jones Industrial Average), a fact that creates considerable confusion for policymakers. These 25-30 large firms are the core of the industrial base. Their position today is similar to that of many large U.S. corporations at the beginning of the 1970s: Having concluded that the U.S. political and economic situation involved too much uncertainty, these companies moved offshore and transformed themselves into broadly diversified global conglomerates. Today, many of Japan's industrialized giants are also moving offshore, regardless of exchange rate considerations and other promised policy changes. It is a process that threatens to hollow out further the beleaguered domestic industrial sector.

Japanese individual investors are thinking along the same lines. The dollar has until recently appreciated against the yen in part because Japanese individual investors are moving offshore in search of greater yield. This will accelerate with the pending regulatory changes forcing the huge pension funds to disclose their poor return on investment. Indeed, the yen today would be far weaker if Japanese tax authorities had not been deliberately vague and slow at communicating to the public the tax advantages of individually owned offshore accounts. Again, the go-slow, holding-pattern approach at work.

Somehow, Japan will likely muddle through and avoid catastrophe. Yet one cannot help but reflect on the old U.S. "revisionist" crowd that throughout the 1980s thought Japan would run the world. American-style capitalism, the revisionists firmly believed, was becoming obsolete. Today, many of these folks are completely befuddled by the U.S. stock market's robust performance. Most failed to predict the massive U.S. corporate restructuring that has taken place since the mid-1980s.

The truth is that developments in the U.S. market, in Japan, and elsewhere are probably more interrelated than we think. The great global financial market is like a beauty pageant, says an official from the New York Federal Reserve. Out on the runway walks Miss Japan. Though she has potential, she hardly looks very beautiful these days. Out walks Miss Germany. Plagued by huge uncertainties over monetary union as well as the public and private sector's reluctance to initiate painful restructuring, Miss Germany looks even worse. The same with Miss France, who now sees currency devaluation -- a new, but weak euro -- as her only hope.