COMMENTARY
Real reform in Japan may create economic shocks felt worldwide
By Akio Mikuni and R. Taggart Murphy
TOKYO — It is an old routine: a sudden show of resolve in Tokyo to do whatever it takes to fix whatever problem worries the United States — complete with "reformist" ministers and bold policy pronouncements.
In time, the policy and minister are forgotten, and Japan returns to business and politics as usual.
In this case, Heizo Takenaka, Japan's economics minister and chief financial regulator, was set late last month to announce a bold plan to restructure Japan's banking system, which has more than $400 billion in bad debt. With the support and approval of the United States, Takenaka acknowledged that the banks will be unable to recover on their own, and that fixing them will result in the failure of scores of companies.
But at home Takenaka's reform proposals received withering criticism even from members of his own party, and his support from Prime Minister Junichiro Koizumi may not last. Moreover, it is not entirely clear that the Bush administration realizes the consequences of Takenaka's solution.
None of this is to say that Takenaka is not sincere, or that Japan's financial system doesn't face a huge crisis. But the problem has been widely misunderstood.
"Bad loans" only mean something in an environment where a borrower's ability to generate cash flow to service debt is the criterion of whether a loan is good or bad. That was not always true in Japan. Most loans were secured by land and rolled over perpetually. The criterion for loanswas not profitability but bureaucrats' ability to drive up real estate prices.
Japan's banks once lent far more money than they had in deposits.
Then, in the 1980s, government officials directed banks to lend well in excess of real economic requirements. Much of that lending fueled a surge in land prices that saw the theoretical value of Tokyo's Imperial Palace grounds exceed that of the whole of California.
Bizarre as it may appear, Japanese banking was driven by a certain logic: financing an industrial plant that would secure Japan's economic autonomy while also ensuring its political stability.
Four decades after war had left Japan in ruins, the country developed the world's most formidable industrial machine. And a constant flow of subsidies to politically powerful groups — farmers, owners of small shops, construction firms — has bought political peace.
In recent decades, however, the system has changed. Credit now goes increasingly to protect politically well-connected companies rather than to the kinds of firms that built the fabled economic miracle. That and out-of-control land prices brought economic growth in Japan to a halt a decade ago.
One of the results is more than $400 billion in unrecoverable loans. But solving this problem is not simply a matter of closing certain banks, recapitalizing others and letting some companies fail.
For starters, any questioning of the banks' integrity could lead to economic disaster domestically. If the banks are seen as corrupt, individual depositors could pull their money out of them.
Japan's household savings overwhelmingly take the form of bank deposits that carry government guarantees. The Japanese government, already heavily in debt itself, can ill afford to honor these guarantees during a wave of failures brought on by a run on the banks.
Closing the banks could also cause a political crisis. The flow of cash — from household to bank to well-connected borrower employing retired bureaucrats and voters for the ruling Liberal Democratic Party — fuels the engine of Japan's political economy. Turning off this flow is tantamount to revolution.
An upheaval in Japanese finance, bringing with it a complete restructuring, is not impossible. But such a restructuring would produce shocks that would reverberate around the world.
Japan as a nation holds nearly $3 trillion in dollar-denominated assets, many of them supported by the very deposits that would be withdrawn in a reorganization of Japanese banking. Those dollars have played an indispensable role in permitting the United States to swell its trade deficits far beyond the levels of most nations.
If banks were forced to call in loans to pay off depositors, and if those loans financed their customers' dollar holdings, real money and purchasing power would leave the United States as Japanese companies and banks converted dollars into yen, further dampening the U.S. economy.
That is what usually happens to countries that run excessive trade deficits — foreigners lose confidence in their currencies, interest rates rise, the economy goes into recession and, as people can't afford to buy so many imports, the trade deficit begins to close.
The United States has escaped this fate largely because of the very problems with Japanese finance that Takenaka promises to attack.
Akio Mikuni and R. Taggart Murphy are authors of "Japan's Policy Trap: Dollars Deflation and the Crisis of Japanese Finance."
