First we get rid of the lawyers, then the economists.

Nurev at Kreative.net Nurev at Kreative.net
Sun Jun 28 03:26:25 PDT 1998


Five Strong Signals Of Japan's Coming

Crash

By Kenichi Ohmae

Sunday, June 28, 1998; Page C01

TOKYO—As the Golden Age of Japan Inc. comes to a dangerous

end, a nervous world is suggesting remedies for the country's economic

recovery in the hope that a sustained crash of the Japanese market can be

averted. At stake is not only the prosperity of Japan, but the stability of the

euphoric European and American markets, all uncomfortably linked across

a borderless globe.

Japan's major partners in the Group of Seven industrialized nations have

demanded a quick fix in the form of economic stimulus or fiscal policy.

Historically, such measures have meant that fundamental problems are

momentarily forced into hiding--where they tend to grow. Without a

proper understanding of underlying conditions, these kinds of remedies are

at best a palliative, and at worst could hasten the decline they are

supposed to prevent.

The United States, in particular, has asked that the Japanese stimulate their

economy with aggressive spending on public works and a simultaneous

"permanent" tax cut. One ought not to forget that in the past five years,

Japan has spent $600 billion on public works, in addition to its annual

budget appropriations. Nor should we overlook the recent $215 billion

packages to bail out failing financial institutions and write off bad debts.

Regardless of the fact that these steps are clearly not sufficient in

themselves, senior American officials, from the president on down, are

pushing the stimulus program as "the best prescription for Japan," a notion

shared by Wall Street and the newly prosperous American army of 401(k)

holders who fear that careless Asians could puncture their high-flying

financial balloon.

This gloomy picture would look somewhat better if Japan had a political

leader with the intelligence to grasp the problems at hand, the courage to

explain them to the Japanese and their edgy partners, and the energy to

work for a consensual solution. Unfortunately, I see no such person.

There are five problem areas that could lead--singly or in concert--to the

crash of the Japanese market.

* Accounting.

Today's reality is that the Nikkei stock index is at 37 percent of its peak of

the 1980s. Tokyo real estate, which drove the Japanese boom, is at less

than 20 percent of its former highs. Yet corporate accounts books have

not been corrected to fully reflect the collapse in the value of assets.

It is routine Japanese practice for accounting firms, at the request of a

corporate client, to issue a "clean statement" to the Ministry of Finance.

This has sometimes meant that when financial institutions went bankrupt,

creditors discovered that a firm's liabilities were as much as 10 times

greater than the "audited" books showed.

The first grave indication of accounting mismanagement came as a surprise

in early 1997, during an event known as the Kyotaru shokku, the Kyotaru

shock. Kyotaru, the country's largest sushi chain operator, filed for the

Japanese equivalent of Chapter 11 bankruptcy after the company's

accountant refused to fudge the books any longer. Concealed bad debts

had risen to nearly $1 billion in diversified enterprises unrelated to the core

business.

So, if all over Japan the books are truly opened and the balance sheets are

made to reflect market reality, the shokku, or crash, will spill over the sushi

counter and most certainly be felt throughout the world.

* Letters of Awareness.

Japan was shaken last February when a prestigious and profitable

company, Daido Concrete, filed for bankruptcy and withdrew from the

Tokyo Stock Exchange. Hisatada Ishikawa, Daido's CEO, revealed that

the company had net debts of $153 million. Its problems stemmed from its

having given several banks shido nenshos, or "letters of awareness." The

nenshos were no more than unofficial letters written by Daido's managers,

stating that the company was "aware" that its Asian subsidiaries were

borrowing money from the banks. The nensho is not an official letter of

guarantee by the parent company for the subsidiaries' loans. In fact, the

paper has no legal significance whatsoever.

When clients with nensho loans decline to pay, banks act collectively in the

absence of legal protection, forming "wolf packs." For example, Daido

refused to accept responsibility for the loans of its overseas subsidiaries,

preferring to let them go bankrupt. As a result, when Daido's own

short-term borrowings came due for renewal, the banks acted in unison,

refusing to roll over the loans. This meant that when Daido had to generate

cash in a hurry, no bank responded.

The Daido shokku becomes significant because it draws attention to a

widespread practice peculiar to Japan. Japanese banks have tended to

lend money almost casually to longtime clients, with many large loans going

unsecured. For many years this was not a problem because the

corporations honored their oral promises. In such a climate, nenshos

written on scratch paper were deemed sufficient assurance. Not now.

Following the Daido shokku, banks began asking their clients to provide

formal letters of guarantee or surrender adequate collateral. For most

borrowers this is difficult, and they are resisting Although the overall sum of

nensho liabilities is not known, some well-informed insiders say the total

amount of this type of unsecured off-the-books lending could exceed $1

trillion. It should be noted that nensho loans are in addition to the $1 trillion

in bad and nonperforming conventional loans already disclosed.

* Interest Rates.

Japan's popular postal savings program now offers 0.35 percent interest

for a one-year deposit. This is considered attractive compared with the

banks' time deposit rate of 0.30 percent. By comparison the average rate

for a six-month certificate of deposit in the United States is 4.65 percent,

more than 15 times the comparable rate in Japan. At present, the Bank of

Japan cannot raise rates for fear of an avalanche of failures of heavily

leveraged companies, mostly in property-related markets. Yet, if it doesn't

raise rates, Japan's national savings supply, which has prolonged the life of

many over-extended corporations, would eventually be drained by a

massive flight of capital to higher-yielding shores, notably the United

States.

In the first month after the deregulation of the foreign currency exchange

laws on April 1, as much as $20 billion fled Japan. During the same month,

the Bank of Japan injected $20 billion, or 10 percent of its entire reserves

of foreign currency, to reverse the decline of the yen--to no avail. The slide

will not stop until the spread in the interest rates between Japan and other

key countries narrows. However, if the Japanese interest rate goes up,

even slightly, the inevitable crash will happen as massive corporate

bankruptcies occur.

* The Yen.

The yen has weakened against the dollar by more than 50 percent in the

last two years, and nothing seems able to arrest its decline. Not even the

recent intervention by the U.S., German and Japanese central banks is

having much effect. The result is a "triple low" for Japan: low interest rates,

low-value currency and low stock prices, leading to a massive capital flight

as the yen continues to depreciate. This threatens other Asian economies,

as China, for example, loses its export competitiveness and quickly runs

short of capital. In fact, because of the jitters on Wall Street, the declining

yen could be the reason for a global crash, originating in New York. The

United States benefits from the injection of fresh capital fleeing Asia, and

yet Wall Street could be deflated by the fear of a plunge by China and

other Asian economies. This was the reason behind the massive currency

manipulations this month, and the resulting volatility in markets all over the

world.

* A Liquidity Crisis.

The so-called "Japan premium," the added cost for Japanese banks to

borrow in the inter-bank market, has fluctuated between 0.20 percent and

1.5 percent, or 20 to 150 basis points. Since banks operate with only

about a 25-basis-point margin, the Japanese banks have effectively been

forced out of the international market. The Bank of Japan is

understandably concerned. So is the U.S. Federal Reserve: If Japanese

banks are hit by a liquidity crisis, they may have to sell U.S. Treasury

bonds, which they have held in large quantities since the 1980s. A strong

sell-off could have the effect of pushing down bond yields and rattling Wall

Street.

The liquidity situation in Japan became serious last November when Sanyo

Securities and Hokkaido Takushoku Bank failed and the world financial

community worried about other possible casualties. Due to emergency

liquidity (some $200 billion) injected into the system by the Bank of Japan,

and with the help of the U.S. Federal Reserve, the level of concern abated.

Then this month, the troubles of the once-prestigious Long Term Credit

Bank raised the issue anew, and Japan finds itself in the middle of its

second liquidity embarrassment in less than a year.

Many Japanese banks are facing a struggle for survival, putting government

policy to a test. On the one hand, the Ministry of Finance has promised

there will be no more bankruptcies of major financial institutions; on the

other, the Japanese government is committed to deregulation of the

financial markets, the so-called Big Bang, which implies survival of the

fittest and extinction of the weakest.

In reality, the contradiction may not matter. When they fall, the banks will

likely all fall together. Since Japanese banks traditionally form syndicates to

finance large projects, no bank will be absolutely safe should one of its

members fail. In effect, there is no "good bank" or "bad bank" in Japan. If

a "good bank" wants to write off bad debts and separate itself from the

syndicate, the remaining banks threaten to withdraw funding from the

projects the good bank is leading.

The overall situation is worsening. The Japanese economy is now classified

as deflationary as unemployment reaches a high of 4.1 percent and

consumer spending and confidence levels decline at alarming levels.

The outlook is clearly bad, but there are reasons to believe that panic can

be avoided, provided the government is candid enough to explain the real

situation to the Japanese people and the rest of the world, since the matter

is of global concern.

First of all, the Japanese government has more than $4 trillion worth of

assets and properties hidden in its balance sheet. This is more than enough

to clear the country's financial problems, and may even be enough to cover

all of Asia's troubled debts. Furthermore, Japan's consumers have $12

trillion in personal savings in addition to $28 trillion worth of assets.

Unlike its Asian neighbors, Japan has no foreign debt. Japan's problems

are entirely internal. Despite the prevailing negative sentiment, Japan still

retains a very strong consumer sector, powerful industries with ample

exporting capabilities and, above all, diligent people. Trouble became

acute primarily because the government tried to hide the facts and rescue

the wrong industries at the taxpayers' expense.

What Japan needs to do is to create an institution, independent of the

Finance Ministry and the Bank of Japan, with lines of credit backed up by

the national assets. This way, when the chain reaction of bank failures

begins, the relatively strong ones could gain refuge and separate good

assets from the bad. As in Sweden in 1994, this approach makes sense in

a country where there is a good deal of accumulated public wealth and the

people are relatively docile and cooperative. To do this, Japan requires a

political visionary strong enough to allow bad banks and corporations to

fail, and smart enough to open the economy to the globally competitive

ones. In the process of Japan's "normalization," the American and other

markets will fall a little. But the recovery will be fast if the enormous

amount of wealth, currently hijacked by the Finance Ministry to rescue the

wrong people, is used for everyone's benefit. The solution is quite obvious:

Improve the quality of life, at the lowest possible cost, by allowing goods

and services to come from anywhere in the world.

Instead of demanding that Japan spend more on public works and the

artificial creation of jobs for special interests, the U.S. government should

work to secure long-term benefits for both countries. This means, though,

that in the short term it has to warn its own people to prepare for a rough

patch ahead.

Kenichi Ohmae is managing director of Ohmae and Associates, a

management consulting firm, and has written many books on the

globalization of the economy, including "The Borderless World" (Harper

Business, 1990).

© Copyright 1998 The Washington Post Company

When do guys like Ohmae take responsibility for the disasters of global Capitalism? He is widley known as one of today's top business gurus who also wrote Triad Power, and The End of the Nation State ( The Rise of Regional Economies),how new engines of prosperity are reshaping global markets.

I wonder if his consulting fees have gone up or down recently?

Joshua2



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