Posted on 09/14/2002 3:14:50 PM PDT by Jordi
It may not be an original comment, particularly after the World Cup, but the mood swing encountered by anyone visiting Japan direct from Korea could not be more extreme. In Seoul there is a self-confident energy, while in Tokyo there is an air of increasingly desperate resignation - and by all accounts, the capital is a far happier place than the provinces.
There was a time when the slow-motion deflation that Japan has endured for the past 12 years, encountered a host of policy proposals from well-meaning and/or publicity-seeking policy wonks, be they domestic or gaijin. Those days are long gone, since the body politic is so clearly incapable of taking decisive action for reasons that have more to do with culture and mass psychology than with economics. For this reason, it has long been clear that change will only come when there is a crisis and, unfortunately, the timing of that crisis cannot be forecast. One point that can be made very confidently is that the crisis lies in the future, not in the past, despite all the mini crises of the past 12 years. This is a point on which all thinking Japanese agree, and is one reason they remain so cautious about spending. Retail sales declined by 5.3% YoY in July.
In Tokyo today there is almost a numbed quality, which comes from such a prolonged period of malign drift. This was best reflected last week when the Nikkei 225 average drifted intra-day below 9,000 for the first time in 19 years. This was a historic event, yet there was barely a murmur from politicians or pundits, and the money markets were calm in terms of the lack of credit-stress symptoms. I could interpret this as the calm before the storm and a sure indicator that the Nikkei will ultimately head even lower; a signal which is also being transmitted by the rally on the Japanese government bond (JGB) market in recent months. (The 10-year JGB benchmark yield has declined 48bps from a recent peak of 1.56% - reached in late February - to 1.05%. Yet 9,000 is an extremely low number. Anyone who had suggested 12 years ago, that this index would fall to such a level would have been written off as a lunatic.
The stock market's dismal performance is a reminder of the ravaging effect that prolonged outright price deflation has on nominal earnings and therefore on nominal share prices. A further reminder of this came last week with the publication of a Ministry of Finance survey, which revealed that sales of non-manufacturing companies are declining at a scary rate of 11% YoY in 2Q02. For such reasons, investors should dismiss the talk in Tokyo this week of a new government package to support share prices. The last effort appears to be an attempt to get the Bank of Japan to buy exchange-traded funds, but the central bank is unlikely to oblige, though it may increase its monthly purchase of JGBs.
This latest attempt to raise the market seems to have been prompted less by a sense of urgency about the Nikkei than by the fact that Prime Minister Koizumi is due to meet President Bush this week, and wants to show he is doing something about the economy. Washington will not be convinced, but equally, it will probably not hector the Japanese leader. If clever Harvard-professor types in the previous administration like Larry Summers could not persuade the Japanese to get serious about dealing with their long-festering problems,there are severe doubts that Bush has any pretensions on this score. Anyway, Koizumi is obviously desperately anxious to divert attention from the economy and will want to talk about his pending historic trip to North Korea.
Still Koizumi will not be able to ignore the financial issues forever. Koizumi seems, by all accounts, to have very little understanding of the financial and economic issues, most particularly the perilous state of the banking system. The Japanese prime minister's rhetoric has been about reform, but so far the only real reform intent has been attempted fiscal constraint - a policy that, in isolation, is wholly inappropriate given the overall deflationary context. Japan has now suffered outright price deflation for the past 49 months, while bank lending has been declining for the past 71 months. Even after deducting loan write-offs, bank lending still fell by 2.4% YoY in August.
Deposit Insurance
The final nail in the coffin for Koizumi's economic-reform agenda has been the recent apparent decision to postpone indefinitely the imposition of a 10m yen cap on demand deposits, which was due to be implemented next April at the start of the new financial year. This is the most important financial policy development in Japan this year and its consequences are wholly negative. As previously noted here, deposit-insurance reform offered the best chance of introducing much-needed market discipline for Japanese banks. This was already clear from the dramatic fund flows from time deposits to demand deposits, which occurred when a 10m yen cap was imposed on time deposits at the end of March. Demand deposits have increased by 34tr yen in the past five months, while time deposits declined by 29tr yen over the same period. A move to cap demand deposits would have really put pressure on those banks that depositors trust least. It is also the case that the giant postal savings system, with total deposits of 238tr yen (=about 2tr$) , does not provide an alternative for cash-rich companies or wealthy individuals. A sum of 10m (=about 90k$) yen is the limit for any individual to invest in the post office, while companies cannot have postal-savings deposits.
The fears, or market signals, inspired by pending deposit-insurance reform were also apparent from the rapid rise in monetary base growth earlier in the year. Some depositors clearly opted to take their money out of the banking system altogether and hold physical cash. This is illustrated by the fact that bank notes account for a growing share of the monetary base relative to what monetarists like to call "high-powered money", namely commercial-bank reserves held at the central bank. Bank notes accounted for 77% of the monetary base in August, compared with 73% in April; while the bank reserves' share declined from 20% to 16% over the same period. As a consequence, the surge in the monetary base has not been a signal of monetary stimulation but rather a signal of stress in the financial system. Still the rise of bank notes in circulation is likely to slow in the short term if Koizumi follows through, as seems likely, on his plan to fudge, fatally, his own policy of deposit-insurance reform. The fudge referred to here is a plan to maintain a full deposit-insurance guarantee, regardless of the amount deposited, on a newly defined type of current account called a "settlement account".
Defying textbook economics
So Japan, in its typically perverse fashion, continues to discredit the monetarist and Keynesian orthodoxies that can be found in economic textbooks. This year's 27% monetary base growth has not been expansionary, just as more than 10 years of fiscal stimulus has not really been expansionary. For those of the Austrian persuasion, the position is more clear cut: the situation cannot improve until there is clear evidence that the downward adjustment in capital spending and credit has fully run its course. This is not yet the case with many corporate deadbeats still on life support and so undermining any hopes of a more rational allocation of capital. Meanwhile the banks and life insurance companies, increasingly bereft of real equity capital, are digging themselves into bigger and bigger holes, which must ultimately end up as a giant contingent liability of the taxpayer. Recognition of the sheer size of that financial burden will mark the timing of the crisis. The consequence is likely to be a bond sell-off and a yen collapse, as the central bank is finally forced to monetise, without inhibition, government debt.
The problem for investors is, as stated, that there is absolutely no way of knowing the timing of that crisis though it is an obvious risk that Japanese banks and life insurers remain the largest owners of Japanese equities. One point is clear from the past 12 years, which is that the Japanese establishment should be expected to drag out the saga for as long as possible. This means that the yen may move significantly higher and the JGB bond yield even lower before the final trauma hits. The one factor that could bring the timing of the crisis nearer is gaiatsu, which is the Japanese term for external shock. This can be a powerful motivating factor in this culture, since it can provide an excuse to do something, which would otherwise be considered impossibly difficult. The obvious external shock for the Japanese is a real US hard landing on the back of further steep falls on Wall Street.
The problem is that while such an external crisis will trigger a policy response, it may not be of a pro-market variety. This year's highly-publicised debacles on Wall Street are certainly giving plenty of ammunition to the natural prejudices harboured by many Japanese politicians and bureaucrats on the defects of free markets. This mood swing may also likely make it an increasingly difficult environment for foreigners trying to buy distressed assets in Tokyo. This has been a favourite pastime, with varying degrees of success, in recent years. There is then a distinct lack of good news on Japan.
But he has great hair!
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