Mar 22nd 2001 | TOKYO
From The Economist print edition
Policy changes at the Bank of Japan, and more promises to
clean up the banks, seem to have convinced investors that
Japan does not, after all, face imminent collapse. But for how
long will they remain convinced?
HAS Japan at last stumbled
upon a cure for its sickly
economy? The stockmarket
seems to think so. On
March 21st, Japanese
shares soared by 7.5%,
with the Nikkei 225 index
closing above 13,100 for
the first time since February
26th. After another fall on
Wall Street the day before,
most pundits had forecast
trouble in Tokyo. That
would once again have
threatened Japan’s wobbly banks and its weakening economy,
which the central bank admitted (on the very same day that
traders were rushing to buy shares) had “come to a pause”.
The stockmarket was excited about two bits of news, which it
hopes are related. On March 19th, the central bank, the Bank of
Japan, in effect cut interest rates back to zero, completing the
reversal of its rate increase of last August, the first in ten years.
On the same day, Yoshiro Mori, Japan’s prime minister, who was in
Washington to meet President Bush, pledged to come up with a
solution to Japan’s debt problems within six months.
With the newspapers full of speculation about a grand economic
plan to restore the economy to health, this suddenly looked to be
just what the doctor ordered: the government would force the
banks to rid themselves of their bad debts, once and for all; as a
salve for the pain of the bankruptcies and job losses that were
sure to follow, the Bank of Japan would print lots more money; and
a side deal with the Americans would pave the way for the yen’s
rapid fall, to ¥140 to the dollar or lower. In the space of a single
day, Japan’s hopelessly muddled economic policy seemed, almost
miraculously, to have come together.
Dream on. Agreed, the Bank
of Japan pledged much more
than a rate cut: it has
abandoned targeting
interest rates altogether.
Instead, it plans to target
the quantity of money that
flows through the economy.
Its chosen measure is the
reserves that commercial
banks deposit with the
central bank. It wants to
push these up from ¥4
trillion ($32.5 billion) to ¥5
trillion, by flooding the markets with more money. This will have
the effect of driving short-term interest rates down to zero. In
another change of policy, the bank also said that it plans to hold
interest rates at zero until the country shakes off what the
government now admits is persistent deflation.
There is less to these changes, however, than meets the eye. The
Bank of Japan has promised not to raise rates until prices start to
rise again. It has also promised to increase the supply of money.
What it has not done is explicitly to link the two, by promising to
print money until it creates inflation. Yet this is what the Japanese
government and some economists have been urging it to do: print
lots of money, force the yen lower, and get people to start
believing that prices must soon start to rise.
In fact, not only has the bank made no pledges about the
circumstances under which it might print more money. It has only
agreed to print just enough to force rates back to zero. It is no
coincidence that, under the zero-interest-rate policy that the
bank ran before last August’s rate increase, commercial-bank
reserves deposited with it averaged around ¥5 trillion—exactly the
target that it has now adopted.
Mr Mori’s Washington “pledge”, meanwhile, lasted little more than a
day. On March 21st, Yasuo Fukuda, the chief cabinet secretary,
denied that the prime minister had meant he would clean up the
banks’ bad debts within six months. In fact, said Mr Fukuda, Mr
Mori was referring to the government’s debt problems, for which he
hoped there would soon be a plan.
The political background
Salvation is still possible: the government is floating all sorts of
ideas for helping the banks to rid themselves of their bad debts. It
is also true that the Bank of Japan’s policy changes bring it an inch
or two closer to printing money to create inflation. But there are
still as many uncertainties as there were at the beginning of the
week. For all the talk of a co-ordinated rescue package, the
government’s economic policy still seems to be in a muddle. And
the confusion looks set to continue. For behind the scenes rages
not one but three fierce political battles.
The first of them pitches the ruling Liberal Democratic Party
against the Bank of Japan. The LDP wants the bank to turn on the
printing presses, but the bank continues to refuse, despite what
was dressed up as a radical policy shift this week. Bolder measures
may come later, hints the bank, but only if the politicians get
serious about cleaning up the banking sector.
For the obtuse and hard of hearing, the Bank of Japan has put its
unorthodox agenda squarely in the open. To restore sustainable
growth, it said in an extraordinary footnote to its policy changes
this week, it is essential to reform the financial system, the
economy and industry. “Structural reform may be accompanied by
painful adjustments,” it warned. Without them, “neither
improvement in productivity nor sustainable economic growth can
be obtained.”
The second tussle is over the fate of Mr Mori. Japan’s stunningly
unpopular prime minister has already caved in to pressure by
promising to resign, albeit indirectly. But his supporters have not
yet given up hope. They are trying to use the economic crisis to
keep him in power for as long as possible. With the stockmarket
and the banks so weak, they say, economic policy must take
priority over the party’s leadership battle. Mr Mori’s opponents in
the LDP and the media, meanwhile, are taking every opportunity to
frustrate his policy initiatives. The result, up until now, has been
political paralysis.
The final and most important stand-off is between the LDP’s
reformist minority and its conservative mainstream, over the
much-scarred battleground of bank policy. Mr Miyazawa has
proposed what looks like a disguised, pain-free, bank bailout, with
taxpayers underwriting a fund that would take the banks’
troublesome ¥45 trillion ($365 billion) or so of shares off their
hands. These massive share portfolios have been the banks’
biggest headache recently, because the value counts in
calculating their capital. With the stockmarket so depressed, the
banks now face larger deductions from their capital bases.
The reformers, on the other hand, have been pushing a tough new
plan fronted by Hakuo Yanagisawa, Mr Mori’s minister in charge of
the bank clean-up. Mr Yanagisawa wants to write down all the
banks’ bad debts by March 2002. That, however, is likely to mean
a rash of bankruptcies and job losses in the struggling construction
and retail industries—which just happen to be the two most
important constituencies for traditional LDP politicians.
Adding to the political complexity is the possibility that the
outcome of one or more of these battles will influence the others,
with unpredictable results. The question of who succeeds Mr Mori,
for instance, is crucial to the battle over banking policy. But not
even Japan’s best informed political insiders have much idea about
the outcome.
Pacific contagion
The proximate cause of all the muddle lies not in Japan, but in
America. The weakening economy there and the collapsing market
for technology shares have hurt Japan badly. Since Japan’s
exports to America add up to just 3% of GDP (compared with, for
example, more than 8% in South Korea), the direct effects of
American weakness through trade flows have been small.
Moreover, contrary to widespread belief, export growth was never
important to Japan’s economic recovery in the first place.
Yet confidence has tumbled and the strength of the business
cycle, which has been nudging the economy forward, is now in
serious doubt. The recent fall in the growth of machinery orders, a
good guide to future business investment, has gloomier economists
predicting a business recession by the summer.
The explanation lies partly with the technology industry. One
defining feature of Japan’s latest recovery is that much of the
country has in fact stayed in recession, from its restructuring steel
makers and shipbuilders to its overborrowed high-street retailers.
Growth has instead been concentrated on high-tech
manufacturers, including chip makers like Fujitsu and NEC,
consumer-electronics firms like Matsushita, and a whole raft of
specialist mid-sized manufacturers. Richard Jerram of ING Barings,
an investment bank, calculates that in the two years to the end of
2000, the electrical-machinery sector (which has a strong
high-tech bias) contributed nearly two-thirds of Japan’s 9.5%
overall rise in industrial production. The sector’s share of
production, however, is just one-quarter.
Between October 1998 and February 2000, the value of Japanese
technology shares tripled. With demand for computers, mobile
phones, fibre-optic cable and other high-tech kit racing along,
massive new business investment followed. In the year ending
March 2001, for instance, Japan’s five big chip makers invested a
record ¥964 billion in new plant and equipment, up nearly 80% on
the previous year.
Yet just as the technology
industry’s extravagant hopes
had outsize effects on
economic growth last year, so
this year’s gloomier sentiment
threatens a wider recession.
Since last summer, the price of
64 megabit DRAM
computer-memory chips, an
industry benchmark, has fallen
by more than half, to less than
$4. A sudden drop in consumer
confidence in America, coupled
with fears about the enormous
investments of Europe’s
telecoms companies (along
with the debts that they have amassed to make them) has
deepened the gloom. Japan’s technology firms have rapidly
switched from record profitability to profit warnings. Business
investment plans have been hurriedly shrunk, even as share prices
have collapsed: since February 2000, high-tech stocks have
halved in value.
The stockmarket’s collapse has had unfortunate consequences,
particularly for Japanese banks. Over the past decade, the banks
have ditched more than ¥70 trillion of non-performing loans while
trying to scrub themselves clean. But with good loans souring as
fast as banks can provision against them or write them off, that
much and more still sits on their books. The banks themselves are
partly to blame for this: they have, until recently, been far too
optimistic about the prospects for their worst borrowers.
But it is the stockmarket’s tumble that has done the most damage.
The banks’ huge equity portfolios, until recently the source of
unrealised gains which they have used to pay for bad-loan
disposals, are now full of losses. With the benchmark Nikkei 225
index hovering near a 16-year low, the holes are getting bigger.
After next month, when a new method of accounting (based on
market values) is introduced, these portfolio losses will hurt the
banks’ capital bases, from which they will be subtracted. If the
broader Topix stockmarket index falls to 1,178, the 16 biggest
banks’ net equity losses could balloon to ¥3.8 trillion, warns Yukiko
Ohara of Dresdner Kleinwort Benson, an international investment
bank.
A more imminent danger is that some banks might not be able to
close their books for the year at the end of this month. Until next
month’s market-value accounting changes, they must mark down
any shares which fall below 50% of the price at which they were
purchased or last revalued, a process which could push a few into
insolvency. Such fears have already battered banks’ shares,
notably those of Daiwa Bank and Chuo Mitsui Trust, both of which
have particularly dreadful-looking stock and loan portfolios.
Pre-press requirements
Against this sort of headwind, it is hard to see how the Bank of
Japan’s latest policy can turn the banks and the economy round.
It will help that the bank has committed itself to keeping interest
rates at zero until prices start to rise again. That will reassure
people that it is not going to repeat its mistake of last August,
when it raised rates despite evidence of lingering deflation.
But free money will not make much of a difference to an economy
that was already limping along with interest rates at a mere
0.15%. Rock-bottom rates do not work in Japan, and have not
done so for several years. They do not encourage banks to take
more risks and to make new loans, because the banks are broken.
On the other hand, they do not encourage borrowers to take new
loans, because they have borrowed too much already.
Printing money in huge quantities might work, as it should push the
yen dramatically lower. It might also encourage people to believe
that prices will start to rise again. But printing huge amounts of
money is not what the central bank has promised to do. It fears
trouble in Japan’s government-bond market, which must finance a
deficit of close to 10% of GDP and national debts of ¥666 trillion, a
whopping 120% of GDP (see chart 3).
So far, the market has
digested all this debt with
barely a burp: ten-year
bonds yield only a fraction
over 1%. But the Bank of
Japan worries that the sight
of the central bank printing
money to finance the
government’s deficit (which
is exactly what it would be
doing if it bought large
amounts of government
bonds) might unnerve
investors. If bond yields
then rose, investors might
really take fright, dumping
bonds and the yen. The
bank might then be forced
to print yet more money in
order to cover the
government’s larger interest
bill, pushing rates up further
and entering a vicious
circle. The risk might be
small. But the possible
consequences are dire.
The second reason that the bank continues to resist the
temptations of the printing press is that it first hopes to extract a
sincere effort from the LDP to clean up the banking mess. Masaru
Hayami, the central bank’s brow-beaten governor, is all too aware
of the popularity of printing money among the LDP’s old guard. In
Mr Hayami’s view, conservative politicians like Shizuka Kamei, Mr
Mori’s policy chief, have seized on the idea as a pain-free
alternative to cleaning out the debts. The banks and their
borrowers would simply have their debts inflated away. Managers
would then have no need to sort out their businesses, or sack
their staff (or themselves), or take any other unpleasant
decisions. But this would do nothing, argues the bank, for the
economy’s long-term health. That requires painful restructuring
and, as the bank pointedly put it this week, “decisive
actions...under a strong leadership of the government of Japan.”
The bank is unlikely to have its wish granted any time soon. Mr
Mori’s administration is probably good for at least another month,
while the budget goes through parliament and the LDP squabbles
over a successor. During this time, however, policymaking is likely
to prove challenging. Mr Mori’s opponents in the party will not
want to grant the prime minister any chance to make political
capital out of the economic crisis, and so prolong his stay of
execution. This is the main reason why Mr Mori’s countermeasures
for the stockmarket, which are supposed to include generous tax
breaks for investors, have so far got nowhere.
The outlook beyond Mr Mori
is hardly any brighter.
Because the LDP cannot
agree on his replacement, it
now seems likely that
whoever takes over will get
the job only until
September, when the LDP
will hold yet another party
leadership election. Worse,
the cabinet reshuffle that
will come with a change of
leadership may well scupper
Mr Yanagisawa’s tough new
plans for the banks, as he
himself faces the chop unless he waters them down. “Mr
Yanagisawa is too radical,” says one LDP insider. “He does not
represent the party consensus.” Should he go, his departure would
mark the seventh change at the top of Japan’s financial regulator,
perhaps the most important post in the cabinet, in little more than
a year.
Even if, by some miracle, Mr Yanagisawa’s plan does survive in
some form, the next prime minister’s priorities are likely to lie
elsewhere. The LDP must prepare for upper-house elections in
July, at which it looks like taking a beating. If it loses the majority
it now enjoys with its two coalition partners, the New
Conservative Party and the Buddhist-backed New Komei Party, the
opposition will be able to block the passage of all bills except the
budget and international legislation. The result would be
stalemate.
The LDP might not even get that far. It has its work cut out simply
holding the coalition together until the summer’s elections. The
Buddhists, who are meant to be promoting clean government, are
especially upset about Mr Mori, whose cabinets have been notably
prone to scandal. This week’s stockmarket rally has given the
politicians some precious time. All the signs are, however, that
they will fail to use it wisely.