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BANKING
BUNKUM
Part 4c: More on the Japanese
experience
By
Henry C K Liu
Part 1: Monetary theology
Part 2: The European experience
Part 3a: The US experience
Part 3b: More on the US
experience
Part 3c: Still more on the US
experience
Part 3d: The lessons of the US
experience
Part 4a: The Asian experience
Part 4b: The Japanese experience
Monetary
policy and banking policy in Japan were key factors for
that country's post-World War II economic growth. The
Japanese economy grew at an annual average of 4 percent
from 1974 to 1990, with steady but low inflation.
Recessions were infrequent and brief.
The enabling
dynamics behind this was the Cold War geopolitical
guarantee to Japan of protected access to a large US
market. Still, that smooth economic performance was not
independent of Japanese monetary policy, in particular
the steady growth of money, bank deposits and credit,
keeping economic growth strong through steady export
expansion, keeping inflation in check, and moderating
the boom-bust business cycle. This monetary policy was
made possible by the existence of a national banking
regime to support national goals.
The Japanese
economy began to stagnate in the early 1990s because its
national goal of export became dysfunctional after the
Cold War. The introduction of central banking in 1998
reduced Japanese banks to financial basketcases in a
liberalized financial market, instead of the healthy
service institutions in support of a national policy of
export under a national banking regime. Under central
banking and a liberalized global financial market with
floating exchange rates and full convertibility, the
price to be paid for having trade surpluses manifests
itself in a rising yen. This in turn causes domestic
general deflation in Japan.
Japanese policy of keeping the yen's
exchange value lower than that dictated by market
pressure has now become an attempt to eliminate domestic
deflation. But a below-market yen leads to a larger
trade surplus in dollars, causing a net shrinkage in the
yen money supply, thus shrinking the yen asset economy,
leaving it with overcapacity and making yen assets less
valuable. What Japan is doing is investing in the dollar
economy while disinvesting in the yen economy through
its trade surplus. This is the real cause of deflation
in Japan.
To restore strong economic growth in
Japan, deflation needs to be stopped. Under a central
banking regime, the most straightforward way to stop
domestic deflation is to force the yen to depreciate in
foreign-exchange value. But this would go against market
forces generated by Japan's trade surplus. Yet if Japan
keeps the exchange value of the yen low merely to
sustain its export prowess, it will continue to feed
domestic deflation. This is because the rate of
shrinkage of the yen economy from a huge trade surplus
denominated in foreign currencies, mostly dollars, is
greater than the rise in yen money supply released by a
reluctant central bank.
Domestic deflation can be stopped if
there are more yen chasing after the same amount of yen
assets. But more yen in circulation will lower the
exchange value of the yen. A low yen in turn will
increase Japan's trade surplus, which, because it is
denominated in foreign currencies, mostly dollars, is a
mechanism that transforms yen input into dollar output,
reducing the yen money supply. This reduction of yen
money supply increases the amount of under- or
non-performing yen assets, reducing their market value.
Thus
Japan's trade surplus contributes to increase in the US
dollar money supply. Normally this would push down the
value of the dollar. But dollar hegemony forces the
Japanese and other trade-surplus nations, such as China,
to finance their trade surplus with a capital account
deficit in favor of the dollar economy. This expands
investment in the dollar economy and pushes up the price
of dollar assets and pushes down the price of yen and
other non-dollar assets. Thus dollar hegemony keeps both
the exchange value of the dollar and the price of dollar
assets high, while other non-dollar economies must
choose between a weak currency and domestic deflation.
China is insulated because the yuan is not fully
convertible. When the US Treasury allows the dollar to
fall against the yen, it is in fact condemning Japan to
more domestic deflation through yen appreciation, if all
else remains unchanged. By allowing the dollar to fall,
the United States is in fact exporting deflation.
To stop
domestic deflation, Japan not only needs to inject more
yen into the yen economy but it must also keep the yen
in the yen economy by reducing its trade surplus without
shrinking its economy. This is because the trade surplus
coupled with a capital account deficit is leaking yen
into dollars faster than the Bank of Japan (BOJ), the
central bank, can inject more yen into the yen money
supply because of the so-called liquidity trap. Thus
Japan needs to shift its historical national role by
changing its investment policy from one of promoting
ever-increasing export for trade surplus in dollars that
are of little use to the Japanese yen economy. Japan
needs to adopt a new national goal of developing and
expanding the global economy, particularly the Asian
economy, from which the relatively overdeveloped
Japanese yen economy will derive sustainable expansion
in tandem.
This is true with all the Group of
Seven (G7) economies: they can only grow by making sure
that the rest of the world grows at a faster pace. There
was a period during the Cold War when the more advanced
US economy grew at a slower pace than those of its
Western allies, much to the benefit of the whole Western
bloc. The future of the world economy depends on more
economic equality, not by shrinking the size of the G7
economies, but by expanding the economies outside of the
G7 at a faster pace. It is doubtful whether this shift
toward equality can be achieved through neo-liberal
globalized trade. This is because trade without global
full employment does not yield comparative advantage to
the poorer trading partner. Say's Law, which asserts
that supply creates its own demand, is only true under
conditions of full employment. Comparative advantage in
free trade is Say's Law internationalized, true only
under conditions of global full employment and shrinking
disparity of wages.
Dollar hegemony makes trade surplus
denominated in dollars a mechanism to drain wealth from
the trade surplus economy to the dollar economy.
Development needs to replace trade as the dominant
driving force of the world economy. In the long run,
Japan will benefit from an Asian common currency not
dominated by yen hegemony. And the world will benefit
from a global currency not dictated by dollar hegemony
or by any other single national currency.
Deflation
wreaks havoc with business balance sheets: it
discourages investment; it leads consumers and
corporations to postpone spending. With the consumer
price index falling at about 1 percent per year, and the
broader gross domestic product (GDP) deflator falling at
about 2 percent per year, deflation has become
persistent in Japan in recent years as the country
continues to enjoy a substantial trade surplus.
Aside from a
temporary increase in 1997 when the consumption tax was
raised, prices have been falling in Japan for the past
decade. Deflation is damaging to the operation of the
banking system, and this is one of the key links between
monetary policy and banking policy in a central banking
regime. With deflation, interest rates are forced to
become very low - close to zero. Yet near-zero interest
rates only postpone, not eliminate, the need for banks
to deal with problem loans, because, notwithstanding
Milton Friedman's famous pronouncement that inflation is
everywhere and anywhere a monetary phenomenon,
deflation, the reverse of inflation, is not everywhere
and anywhere just a monetary phenomenon. Deflation is a
problem that cannot be cured by monetary measures alone,
as Japan has found out and as the United States is about
to. Global deflation can only be cured by reforming the
international finance architecture to allow trade to be
replaced by development as the engine for growth.
With
near-zero interest rates, borrowers find it easier to
meet their interest payments to banks, allowing loans to
remain performing even if the borrowing firms are
structurally unprofitable. And deflation makes it harder
for borrowers to repay loan principal. High interest
rate in an inflationary environment can be a negative
real interest rate after inflation adjustment, in which
case banks are actually paying their borrowers.
Conversely, a zero interest rate can be a high real rate
in a deflationary environment. Under a national banking
regime, banks are performing their duty as long as they
support the national purpose. In Japan's case, the
banks' role was to support export. Even if the banks did
not make a profit or their corporate borrowers could not
meet debt service temporarily with current cash flow,
the banks were serving the national purpose as long as
the borrowing corporations were gaining market share in
the global market.
Postwar Japan was prepared to export
the national wealth created by its people in exchange
for gold or gold-backed dollars. This mercantilist
national purpose for a war-torn economy worked until
1971 when the United States took its dollar off the gold
standard. Yet it took another three decades before the
full impact of exporting for a foreign fiat currency
took its toll on the Japanese economy. This adverse
impact was finally brought home by the globalization of
financial markets after the end of the Cold War, and
exacerbated by the Tokyo Big Bang on April 1, 1998, and
the adoption of the Central Bank Law on the same day.
The end of the Cold War robbed Japan of its geopolitical
guarantee for exclusive access to a huge market in the
United States. The Tokyo Big Bang subjected the Japanese
financial system to international market pressures and
the Japan Central Bank Law forced the Japanese banks to
be profit centers rather than service institutions.
With a
central banking regime in a neo-liberal globalized
market economy, firms and banks are separated from any
national purpose, except as affected by domestic tax
policies or by national security restrictions. Banks and
firms exist mainly to make profit for their shareholders
of any nationality. It has become possible for the
global banking system to prosper at the expense of
national economies, including the home economies of
transnational banks.
Monetarists argue that loan default
decisions will surface at a more timely stage if
interest rates, both nominal and real, stay steady and
appropriately low for sustainable expansion of the
economy and its money supply, which generally requires
an inflation rate between 1 and 3 percent. As a result
of delays in confronting de facto default due to near
zero interest rates, business failure, liquidation, and
loss of jobs when they finally occur can be much more
severe than if the finance restructuring were made
earlier. Near-zero interest rates dull the sensitivity
of interest payments as a barometer of business
robustness.
In March 2001, the BOJ, then a
three-year-old central bank, made an important change in
monetary policy. It announced that it would provide
ample liquidity until the inflation rate was equal to or
greater than zero; that is, until deflation is ended.
That policy is in essence one of inflation targeting.
The BOJ
conducts monetary policy and its business operations
under the Central Bank Law of April 1, 1998, which was
established on the principles of "independence" and
"transparency". The BOJ implements monetary policy by
adjusting the supply of funds in line with demand for
them in the money market through market operations.
Since February 1999, the then barely one-year-old
central bank has kept the uncollateralized overnight
call rate, the operating target, at virtually zero
percent. This is known as the zero-interest-rate policy.
This means that the BOJ will inject funds into the money
market without limit whenever necessary. In fact, the
BOJ has been supplying funds in such large volume that
excess funds continue to remain in the banks, but the
funds have not found their way into the market.
The BOJ, at
its Monetary Policy Meetings (MPMs), decides the
guidelines for market operations that cover the
inter-meeting period of about half a month or a month
ahead. Market participants, on the other hand, often
engage in funds transactions that become due in three or
six months. This requires them to forecast movements in
the overnight call rate during the period between the
next MPM and the maturity date of their transactions.
Consequently, when the outlook for interest rates is
uncertain, market forces will set interest rates on term
instruments, such as three- or six-month instruments,
substantially higher than the prevailing overnight rate.
To avoid
such an outcome, the BOJ has announced its intention of
maintaining the zero-interest policy "until deflationary
concern has been dispelled", suggesting possible
continuation of the policy beyond subsequent MPMs. This
announcement aims at ensuring that the effects of the
zero-interest-rate policy permeate the economy. As a
result, money-market rates, including those on
three-to-six-month instruments, have stayed around zero
percent.
This is an application of Nobel
economist (1995) Robert E Lucas's theory of "rational
expectations". The theory postulates that expectations
about the future can influence the economic decisions
independently made by individuals, households and
companies. Using mathematical models, Lucas showed
statistically that the average individual would
anticipate - and thus could easily neutralize - the
impact of a government's economic policy. Rational
expectation theory was embraced by president Ronald
Reagan's White House during his first term, but the
theory worked against Reagan's "voodoo economics"
instead of with it.
When the BOJ first adopted the
zero-interest-rate policy in February 1999, the economy
and the financial markets interacted in a downward
spiral. Sluggish economic activity had made market
participants increasingly worried about the stability of
the financial system. Had extreme pessimism spread in
the financial markets, Japan's economy could have
plunged into a catastrophic crisis. This situation could
create an abrupt freeze on economic activities, such as
business investment and household spending.
The
zero-interest-rate policy in effect stopped the toxic
interaction between economic activity and the financial
markets by removing concerns among market participants
that they might face difficulties in funding due to a
liquidity shortage in the market. In the meantime, the
Financial Function Early Strengthening Law and other
legislation enacted in the autumn of 1998 attempted to
provide a framework for the stabilization of the
financial system. In March 1999, about a month after the
adoption of the zero-interest-rate policy, major banks
were recapitalized by injection of public funds. But the
"convoy system" of bank mergers shelters the weakest
banks at the expense of the strong. Moreover, fiscal
spending was increased significantly to stimulate
economic activity. But the yen money supply did not
expand because of a recurring trade surplus denominated
in dollars. The zero-interest-rate policy masked the
symptoms, but it did not address the disease.
Japan's
economy has shown no signs of a self-sustained recovery
in private demand despite the zero-interest-rate policy.
Under these circumstances, the timing of a policy change
and the meaning of "until deflationary concern has been
dispelled", which is generally regarded as the criterion
for terminating the current policy, have again become
the focus of attention.
The BOJ describes the condition
"until deflationary concern has been dispelled" as
meaning "until a self-sustained recovery of the economy
driven by private demand can be forecast with a certain
degree of probability". A fall in prices of goods is not
necessarily deflation, for it may be the effect of a
rise in productivity from the same cost base. When
computer prices fall from productivity gains, it is not
deflation. Generally, deflation is defined as a spiral
of declining prices, particularly in asset prices in
addition to prices of goods, accompanied by contraction
in economic activity. An overall decline in the level of
prices brings about a fall in corporate profits and
wages, and this fall leads in turn to a contraction in
economic activity, resulting in another price decline.
This indicates that the economic momentum behind price
developments is an important criterion in identifying
the risk of prices declining further.
While
interest-rate policy can be a stimulant or a depressant
in an inflationary environment, a zero-interest-rate
policy can have unintended adverse effects in a
deflationary environment. Since the cost of money is
near zero, there is no compelling reason for banks to
lend money, except for earning fees to refinance loans
made earlier at higher interest rates. This creates
problems for banks down the road by reducing future
interest income for the same loan amount. The narrow
spread in interest will also force banks to raise credit
thresholds, shrinking the pool of qualified borrowers.
It can also cause a distortion in income distribution in
the household sector by denying interest income it would
have otherwise earned by savers. It can create problems
for pension funds and insurance companies.
Structural
reform can be delayed by too much easing of the
necessary cash-flow pain. Market participants' risk
perception can be dulled. Institutional investors, such
as life-insurance companies and pension funds, can then
face difficulty in finding good investment opportunities
to pay for long-term commitments made at high interest
rates. In the United States, where loan securitization
is widespread, banks are tempted to push risky loans by
passing on the long-term risk to non-bank investors
through debt securitization.
The BOJ's zero-interest policy
combined with general asset deflation has caught the
Japanese insurance companies in a vise. Both new loan
rates and asset values are insufficient to carry
previous long-term yields promised to customers. Japan
does not have a debtor-friendly bankruptcy law, as the
United States has. At any rate, insurance companies,
like banks, cannot file for bankruptcy in the US. They
are governed by an insurance commission, which normally
has a reinsurance fund to take care of insolvency. The
fund is nowhere near sufficient to handle systemic
collapse. The same happened to the US Federal Deposit
Insurance Corp (FDIC) in the 1980s. The insurance sector
in the United States will face serious problems as the
Federal Reserve further lowers the Fed Funds Rate (FFR).
Several segments of the insurance sector, such as health
insurance and casualty insurance, have already collapsed
for other reasons.
In the era of industrial capitalism,
a low interest rate was a stimulant. But in this era of
finance capitalism, lowering rates creates complex
problems, especially when most big borrowers routinely
hedge their interest-rate exposures. For them, even when
short-term rates drop or rise abruptly, the cost remains
the same for the duration of the loan term, the only
difference being that they pay a different party.
Central
banks are still applying industrial-capitalism monetary
economics to the new finance capitalism. That is the
main cause of the multi-wave financial crash that began
in 1982 in Mexico and developed with full force of
contagion in 1997 in Asia. In fact, in more than two
years since the zero-interest policy announcement, the
BOJ has significantly expanded money as measured by the
monetary base, which is bank reserves plus currency in
circulation. The monetary base is up 34 percent since
the Bank of Japan began its new policy. However, broader
measures of liquidity that are more closely associated
with general price increases have not grown nearly as
rapidly for reasons stated above. The growth rate of
broad money, which includes individual and business
deposits at banks, has hardly increased at all.
Moreover, bank lending has not increased because of a
liquidity trap. As the Japanese trade surplus adds to
Japan's dollar reserves, yen deposits and loans remain
stagnant. Even after adjusting for loan writeoffs, bank
lending was down 2.6 percent in 2002 and consumer prices
continue to fall.
The reason the increase in the
growth rate of the monetary base has not resulted in
higher growth of loans and deposits at banks, or a rise
in prices, is not, as some economists suggest, that the
increase in the monetary base has not been sustained for
long enough. Nor are more increases needed in reserve
balances banks hold at the BOJ, a key component of the
monetary base. The traditional anti-inflation bias of
the central banking regime has deprived policymakers of
any historical guide in overcoming persistent deflation.
The
current round of global deflation is caused by weak
demand resulting from the effects of dollar hegemony as
sustained by a global central banking regime regulated
by the Bank of International Settlements (BIS). The
neo-liberal globalization of trade and finance prevents
all non-dollar economies from effectively increasing
their local currency money supply for domestic
development. To avoid speculative attacks on their
currencies, all increases in local-currency money supply
must be channeled to fuel export for trade surplus in
dollars. This shrinks the exporting economies' own money
supply while adding to the dollar money supply to fuel
the dollar economy at the expense of non-dollar
economies. Consumers in non-dollar economies are robbed
of purchasing power because low wages are necessary to
compete in the global export market to accumulate trade
surpluses in foreign currencies, mostly US dollars. At
the same time, state credit cannot be used to finance
domestic development to raise income, for fear of
inducing speculative attacks on the local currencies.
Neo-liberal economists argue that the main reason the
increase in the monetary base has not yet worked in
Japan is non-performing loans (NPLs) in the banking
sector. They point out that funds lent by commercial
banks and spent by borrowers create deposits at other
banks that can then be lent to other borrowers.
According to neo-classical monetary economics, this is
the way an increase in the monetary base (high-power
money) leads to an increase in the amount of broad money
and higher prices, through the money-creation power of
banks. But banks that are burdened by NPLs do not seek
out new, profitable loan opportunities, even when they
have excess reserves. Neo-liberal economists argue that
a change in banking policy that effectively deals with
the NPL problem will lead to more banks and more
businesses seeking out new opportunities and creating
new loans. They make this argument all over Asia - in
fact, all over the world.
For Japan, they argue that solving
the NPL problem would significantly increase the ability
of the BOJ to increase broad money, increase bank
lending, and raise the price level. This is like arguing
that after you leave the gas running in the kitchen
stove without first lighting it, an explosion will
result when you finally light it. Therefore you must now
turn off the gas and open all the windows and there is
no alternative to suffering uncooked food for a while
until the air is clear. But neo-liberals are careful not
to tell you that it was they who first suggested that
you blow out the pilot light of national banking. If the
pilot light of national banking had remained lit, the
economic kitchen of Japan would still be producing
delicious hot food. Turning the gas on without a lit
pilot light will cause an explosion again, no matter how
many times you open the window to clear the air
temporarily.
A recent BOJ report highlights the
nature of the NPL problem, in effect arguing that NPLs
are not simply the legacy of the old bubble days, but
reflect continuing problems in the banking sector. There
is truth to that observation, but the BOJ report fails
to note that the NPL problem is a bastard child of
central banking. The BOJ argues that the NPL problem
must be addressed quickly. And there is also truth to
that view. Problem loans do exert a heavy toll on banks.
Heavily burdened banks lose the ability to focus on new
lending to new business opportunities. A banking system
that is weighed down by bad loans cannot fulfill its
role of gauging risk and return and channeling savings
to the most profitable investments. Banking problems
also exert a heavy toll on the economy. Borrowers who
are not servicing NPLs are frequently owners of assets -
property, buildings, capital equipment - that are not
being used productively or profitably in a free market.
All this
is valid, but only in a central banking regime. Under a
national banking regime, these problems remain, but they
take on a very different character. Under national
banking, rather than private bank profits deciding what
should be financed, the national purpose decides what is
financially profitable. Furthermore, the claim that
cleaning out NPLs in the Japanese banking system under a
central banking regime will revive the Japanese economy
has not been empirically verified. It is only part of
the snake-oil cure promoted by the Washington Consensus
to perpetuate US dollar hegemony.
It is true
that unresolved NPLs freeze non-performing assets in
place and prevent them from moving to more profitable
activities. But it is also true that under central
banking, some profitable activities may well be
detrimental to the economy as a whole. The US economy is
full of examples of this truism. The result is a robust
financial sector and a sick real economy.
Under
conditions of excess capacity, failure to deal with NPLs
locks in excess capacity, worsening deflationary
pressures. But solving the NPL problem in the wrong way,
through massive layoffs, for example, will only add to
deflationary pressure. The solution requires more than
simply reducing or writing off debt. Over-indebted
borrowers are almost always overextended businesses,
having expanded into activities with little economic
benefit. In the case of Japan, the overextended business
is export of manufactured products for money that is
useless in Japan.
Addressing the problems of the
distressed borrowers requires substantial restructuring
in order to identify a profitable business core, and in
some cases liquidation of the borrower is the only
alternative. The Japanese economy has been historically
structured toward export. It would be unthinkable to
liquidate the entire export sector. However, it is quite
possible to make the export sector earn yen instead of
dollars. A yen trade surplus would contribute to curing
deflation in Japan. But it will still not solve Japan's
economic malaise.
The Japanese export engine has
become unprofitable not only because world trade is
shrinking. The solution to the NPL problem lies not in
liquidating the export sector, but in redirecting it
toward yen-earning developmental institutions. The catch
is that this redirection from trade to development
cannot be accomplished by relying on neo-liberal market
fundamentalism operating in a central banking regime.
The
market favors trade over development because the market
treats development cost as an externality. When someone
other than the recipient of a benefit bears the costs
for its production, for example education and
environmental protection, the costs of the benefit are
external to its enjoyment. Economists call these
external costs negative "externalities". These
externalities amount to a market failure to distribute
costs and benefits fairly and efficiently within the
economy. Globalization is basically a game of negative
externalities. Inhuman wages and working conditions,
together with neglected environmental protection and
cleanup, are other negative externalities that protect
corporate profit. It is by ignoring the need for
development and by externalizing its cost that the
market can deliver profitability to corporate
shareholders. Development can only be done with a
revival of national banking in support of a new national
purpose.
For the 44 trillion yen in loans to
corporations classified by Japanese banks as bankrupt or
in danger of bankruptcy, the harsh choices are clear.
But a more corrosive problem arises with loans that are
technically performing but are owed by companies that
are barely able to keep afloat, have little prospect for
long-term survival, and have no possibility of ever
paying back the loan. These firms may be able to scrape
together their required interest payments in Japan's
low-interest-rate environment. How many of the roughly
100 trillion yen in loans that "need attention" fall
into this category and are likely to become
non-performing loans is at the heart of the dispute
about the size of Japan's bad-loan problem. This
highlights the futility of a central-bank interest-rate
policy as a tool to deal with deflation.
Dealing with
these walking-dead firms before they spiral into
bankruptcy, and while there is still value and
employment that can be salvaged, is a critical issue.
But the answer is not retrenchment through layoffs. The
answer lies in turning these distressed firms from
export dinosaurs to development dynamos domestically,
regionally and globally. Instead of exporting cars and
video games, Japan can export education, health care,
environmental technology, management know-how,
engineering and design, etc, systems to generate wealth
rather than products to absorb wealth from overseas.
Yet the
delay in addressing the NPL problem has not spared Japan
the pain of unemployment. Thus the NPL problem is merely
a symptom, not a cause, of the economic malaise Japan
has placed on itself by continuing to pursue export for
dollars as a national purpose.
For economic
growth to increase in any country it is necessary not
only for productivity growth to increase; it must also
accompany productivity growth with consumption growth.
Productivity is the amount of goods and services that
workers can produce in a fixed period of time, such as a
day or year. Productivity growth is driven by the
ability to move productive resources - labor and capital
equipment - from low-productivity activities to
high-productivity activities. Consumption growth in a
modern economy cannot rely merely on quantitative
increase. It must take the form of qualitative
improvement. A higher level of living standard includes
a rising level of culture, morals, aspirations and
sensitivities.
The Japanese economy combines
industries where productivity is the highest in the
world with industries that lag behind their counterparts
in other countries. This is unavoidable for most
economies because culture demands more than efficiency.
The trouble is that in Japan the high productivity is
heavily concentrated in the export sector, while the
lagging productivity is concentrated in the domestic
sector. And as mentioned repeatedly before, export earns
US dollars. And dollars cannot be spent in the Japanese
yen economy. So Japan is dollar-rich but yen-poor. The
more Japan prints yen to finance export, the more
dollars it will supply to the dollar economy to make it
stronger and richer, and the yen economy poorer.
Economists
have pointed out that in no other major country are the
differences between leading and lagging sectors as
large, or the potential productivity gains so great from
closing the gaps. Food processing is an industry that
employs 11 percent of Japan's manufacturing workforce.
Analysts have estimated that if productivity in Japanese
food processing were raised to the level of France, a
country with equal attention to quality, freshness, and
presentation, then productivity in the Japanese economy
as a whole would rise by 1.64 percent. Yet this would
only exacerbate deflation in Japan by making processed
food cheaper.
The Japanese government is
developing measures to deal with the NPL problem.
Financial Services Agency (FSA) Minister Heizo Takenaka
has outlined principles that will guide its approach to
banking policy. The first is assuring that banks
accurately classify their loans and that they hold
sufficient provisions against losses. The second is
assuring that banks are adequately capitalized. And the
third is improving the corporate governance of banks, to
assure that they operate both effectively and
profitably.
Yet these goals are music only to
the ears of neo-liberal monetarists. They do not address
the real problems facing the Japanese economy. The real
problems are caused by a crisis in national purpose.
Without addressing the issue of national purpose,
cleaning up the banks would merely be dealing with the
symptoms. In fact, Japanese banks can again be healthy
institutions if a national banking regime is revived to
serve a new, viable national purpose. Otherwise, forcing
the distressed banks to clean up their NPLs under a
central banking regime governed by BIS regulations would
risk destroying the entire Japanese economy.
Japan has
already used public funds to try to strengthen its
banking system, and more will be required. Yet public
funds are not a viable solution for a wrong-headed
national purpose. Effective banking reform can be aided
by the use of public funds. But using public funds
without condition is a recipe for moral hazard and
damaging delay.
A healthy, vibrant Japan is a Japan
that can take its proper place on the world stage - a
critical factor in the security of the region and the
world. Yet a prosperous region and a world without
poverty will enhance the security of Japan more than any
military alliance or rearmament program. Japan can
contribute toward a more secure world by focusing on
economic development by exporting wealth-creating
technology rather than wealth-absorbing products.
In December
2001, the government forecast that Japan's gross
domestic product for fiscal 2002 (April 2002-March 2003)
would post zero growth in real terms. Because of the
slumping economy, investment in plant and equipment was
expected to drop 3.5 percent, while housing investment
was forecast to decline 1.9 percent. Because of the
difficult employment and wage environment, personal
consumption was expected to grow only 0.2 percent. This
weak domestic private-sector demand would push down real
growth by 0.5 percentage point. Public-sector demand,
meanwhile, was forecast to boost real growth by 0.3
point through increased spending on the new national
nursing-care system and other programs. As for external
demand, exports were forecast to increase during the
latter half of fiscal 2002, bolstering the real growth
rate by 0.2 point. Even these bleak forecasts proved to
be over-optimistic. The Cabinet Office had insisted on
forecasting negative growth for fiscal 2002, in line
with the actual state of the economy in fiscal 2001. But
the Ministry of Finance (MOF) and the Ministry of
Economy, Trade, and Industry (METI) were opposed to a
government forecast of negative growth that might be
self-fulfilling. In typical Japanese style, the two
sides agreed on a compromise. The government would
prevent the economy from bottoming out in the first half
of fiscal 2002. It would make use of the second
supplementary budget of fiscal 2001, totaling 4.1
trillion yen, to continue to implement public works,
which usually experience a lull in the first half of the
fiscal year due to administrative procedures.
In the
meantime, exports were optimistically forecast to
improve, especially those bound for the United States,
which was expected to get back on the path of recovery,
notwithstanding that the decline in value in the US
equity market between March 2000 and March 2003 has
exceeded 90 percent of GDP, as compared with 60 percent
during 1929-31.
Since this scenario was a
compromise, however, there was criticism of it even
within the government. One high-ranking official said
presciently, "Since it depends on a recovery of the US
economy, the figure 0.0 percent [growth] is nothing more
than wishful thinking." These forecasts had not even
taken into account the adverse impacts of the then
unforeseen Iraq war and the surprise SARS (severe acute
respiratory syndrome) epidemic.
Private-sector economists predict
that a second consecutive year of negative growth as
inevitable. Behind these predictions lies the judgment
that it is difficult to foresee any pick-up in personal
consumption and investment in plant and equipment, the
two main engines of growth, when the economic situation
will worsen because of structural reforms, mainly
progress in the disposal of NPLs.
Private-sector economists remain
skeptical that business can act as the locomotive
pulling the Japanese economy out of recession because of
continued shrinking profits as a result of falling
prices and severe competition from China and other
low-wage countries. Because of increasing overseas
Japanese production, a weak yen can no longer boost
exports as much as in the past. In the draft budget for
fiscal 2002, public-investment-related expenditures,
which include both the construction and operation of
public facilities, are down 10.7 percent from the
previous year to 9.2525 trillion yen, which will add to
deflation. With the unemployment rate rising, consumer
attitudes toward personal spending will continue to
worsen.
The biggest cause for concern in the
near future is the stability of the financial system,
the backbone of the economy. The financial system has
been facing recurring crises, as evidenced by the
continued drop in the value of bank shares that began in
the fall of 2001, reflecting the drop of the equity
market of which the banks own substantial holdings. The
Japanese economy has fallen into a vicious circle.
Deflation leads to the emergence of new bank NPLs,
worsening the problem, which in turn exacerbates further
deflation. The disposal of NPLs must be expedited, but
banks are clearly threatened by the combined weight of
the economic slump, the collapse of the equity market
and their own falling shares. Recurrent instability in
the financial system would destabilize the financial
capital market beyond a credit crunch. Banks may then be
forced to call in an excessive number of loans, a move
that would be disastrous for the real economy.
Additionally, the government
introduced a so-called "payoff" cap in April 2002 under
which individual bank accounts are guaranteed only up to
10 million yen plus interest in the event of a bank
failure. So dark clouds hang over the economy after
fiscal 2002. The FSA has been pressing local financial
institutions that are short of capital to speed up
efforts to reorganize and consolidate, and it stands
ready to prevent any chaos, such as a run on banks, from
occurring as a result of the introduction of the payoff
system. But in 2001 alone a total of 46 credit banks and
credit cooperatives were forced into bankruptcy. If this
wave spreads to regional banks and second-tier regional
banks, and there are more cases like that of Ishikawa
Bank, which collapsed at the end of 2001, serious
effects are expected. Because regional and second-tier
regional banks occupy a weightier position in local
economies than credit banks, local industries may be
unable carry on. As for a recovery in the US economy, on
which the government's zero-growth forecast was
premised, the correction after the collapse of the
information-technology bubble has been more severe than
expected. Despite the recent rebound of the tech sector,
US recovery when it comes will not be led by high-tech
industries, but by military hardware, heavy construction
and financial services, which will not have a major
effect on Japanese exporting industries.
Ever since
the United States abandoned the Bretton Woods
international monetary agreement in August 1971 and took
its dollar off gold, the global monetary system has been
plagued by a fiat currency at the core. Countries that
have been hit by currency runs suddenly realized that
the promise of market capitalism had been a cruel joke
to rob them of their wealth and dignity through an
unjust international finance architecture. In the
absence of a stable, equitable international monetary
order consistent with open global markets, the US
continues to push for financial globalization. The
unregulated free-to-manipulate approach to
currency-exchange relationships engenders only monetary
nationalism and ultimately fosters a protectionist
backlash in all countries. The currency carnage rages on
with disastrous economic and political consequences
around the entire globe. Economic war, like all wars,
are recognized as undesirable by all, yet it happens
because of an inequitable world economic order.
Japanese
sovereign debt does not face the issue of the Japanese
government not able or willing to pay its obligations.
It is because both Japanese debt and currency are freely
traded in the open, largely unregulated global market
that credit ratings become important. Recurring and
persistent Japanese government budget deficits impact
the price of JGB (Japanese Government Bonds). For the
past three years, ever since the BOJ reduced short-term
rates to zero, Japanese banks, as well as a host of
international speculators, have been borrowing cost-free
funds to invest in 10-year JGBs at about 1.3 percent.
The banks have by the end of fiscal 2002 some 67
trillion yen ($540 billion) in fixed-income securities,
doubling their holdings in February 1999 when the BOJ
first introduced its zero-interest hyper-loose monetary
policy. The banks have sold roughly 10 percent of their
holdings in the first half of fiscal year 2002.
This
interest-rate spread has allowed Japanese banks to earn
profits to cover some of their losses from distressed
loans and equity deflation. Prime Minister Junichiro
Koizumi's cabinet is not expected to be able to keep its
promise to cap new bond issues to finance further
deficits. Banks, already weaken in their capital base by
asset deflation, cannot sustain a sudden collapse of the
bond market. Under BIS guidelines to be introduced in
2005, government debt rated with a single A standing
carries a 20 percent risk rating, meaning that holders
must set aside capital reserves to cover 20 percent of
the assets. The latest rating for JGB has dropped from
AA+ to AA. Although a local regulator can ignore these
BIS guidelines, it would still be a serious blow to
Japan and its banks' international standing, which would
cost Japan a high risk premium in the international debt
market.
There is open political pressure for
the BOJ to adopt a reflation target. Ironically, the
bank lobby is most among the most vocal in this pressure
group. Japanese banks have been selling their JGB
holdings as a risk management move. There is also
political pressure to depreciate the yen to the 150-160
range from its benchmark of 120 to the dollar. Yet a
148-yen dollar would trigger regionwide competitive
currency depreciation, including China's yuan, which is
considered undervalued in relation to that country's
current account surplus.
With Japan caught in a liquidity
trap, zero interest has had the effect of pushing on a
credit string domestically. But profits are being made
by those who borrow cost-free yen to invest in US
treasuries, Japanese deflated real estate and distress
debts. The purchase of US treasuries caused a temporary
reverse-yield curve in US debts in the late 1990s,
making long-term rates lower than the short-term Fed
Funds rate target set by the Federal Reserve. This
amounts to a black hole of unlimited drain on the future
of the Japanese economy. With potential yen
depreciation, this problem is further exaggerated,
motivating market participants to borrow yen to invest
in instrument-denominated in dollars. Overseas investors
had built up arbitrage positions between bonds and yen
swaps on the assumption that swap rates would not fall
below JGB yields. But 10-year swap yields were about 1.3
percent (as of November 27, 2002), 9.5 basis points
below the 10-year cash JGB yield. This prompted
liquidation of JGBs against swaps, leading briefly to
serious contagion to other markets. This type of
mini-crisis is now commonplace and hardly attracting
notice in the financial press. One of these days, it
will add up to a major crash.
The fact is
that Japan, and really the whole world, cannot solve its
financial problems without facing up to the reality that
no free market or regulated markets exist now for
foreign exchange, credits or even equity anywhere.
Arbitrary, secretive and whimsical intervention on a
massive scale hangs as an ever-present threat over the
global system of financial exchange. Individual
self-preservation moves and short-term profit incentive
will bring the system crashing down some Tuesday
morning. This is what Alan Greenspan, chairman of the US
Federal Reserve, means by the need of central banks to
provide "catastrophic insurance".
The BOJ
stunned the market on September 19, 2002, by announcing
that it would buy shares directly from Japanese banks.
On October 11, it announced that it would buy 2 trillion
yen ($16.5 billion) of bank shareholdings to make them
less vulnerable to stock-market swings. The BOJ also
urged the government to use public funds to accelerate
the disposal of banks' NPLs. The share-buying plan would
last up to the end of September 2003 and would cover
more than 10 banks. Masaru Hayami, BOJ's then retiring
governor, said: "If liquidity problems emerge from
declines in stock prices, the BOJ is ready and has the
means to provide additional funds."
The move
signaled a more coordinated approach between the BOJ and
the government, which had for some time been at
loggerheads over tackling Japan's weak economy,
deflationary environment and bank NPLs. But the BOJ
decided to keep its monetary policy unchanged, despite a
call from Masajuro Shiokawa, the finance minister, for
further easing. The Nikkei dropped almost 20 percent
within months after September 19. The benchmark Nikkei
225 average had difficulty closing above the key 8,500
mark. It hit new 19-year lows almost every day for the
week ending on October 11, on uncertainty regarding the
government's plans to clean up NPLs. Analysts say that
if the Nikkei falls to 7,000-7,500, bank
capital-adequacy ratios could fall below the BIS
requirement of 8 percent. The 2003 first-half low was
7,607.
Japan's banks are estimated to have
40 trillion yen ($322 billion) in equity holdings,
making them vulnerable to market swings. At the same
time, an export slowdown is threatening to derail
recovery in the world's second-largest economy, largely
because of a decline in US consumer demand for Japanese
products such as cars and electronic goods.
Japanese
government data show that the country's jobless rate in
October 2002 rose to 5.5 percent, its highest level of
the postwar era and a figure last seen in December 2001.
Reform
is seldom an engine of growth. It is also never a timely
cure for emergencies. Instead of concentrating on making
the economy roll, government bureaucrats devote most of
their energy thinking up ever more ingenious ways of
pandering to official directives while at the same time
ensuring that their own official turf is not reorganized
out of existence. This tends to stop the economy in its
tracks. Japan's banking crises greatly reduced the
impact of any macroeconomics policy to stimulate demand.
Regardless of measures to stimulate domestic demand in
the economy, Japan is structurally condemned to no
growth for the foreseeable future, unless its national
purpose shifts.
Even if Tokyo does all that
Washington wants it to - spurring demand with monetary
and fiscal policy, cleaning up the banking system and
vigorously pursuing systemic reform - its estimated
contribution to stability in the global economy is
overstated. US export to Japan is a mere 1 percent of US
GDP, to all Asia 2.4 percent. Rising European economies
are filling in the Asian gap in world demand.
The Japanese
insurance companies offered below-market yield during
the boom in return for safety to customers. The
insurance companies then put their assets in real
estate, fueling the bubble, not only as lenders but as
investors to capture capital gain. The long period of
deflation that followed the bursting of the financial
bubble in 1990 has caught Japan's life insurance in a
double bind. On the one hand asset values are falling,
while on the other hand high returns to policyholders
are still being offered in an effort to stave off a
collapse of new policy subscriptions. A vicious circle
of insolvency then arises when liquidity needs oblige
these funds to liquidate depreciated assets.
Bankruptcies have multiplied. These institutions are at
the heart of Japan's economic system but have now become
a source of uncertainty, leading to deflationary
pressures.
The bankruptcy of Nissan Mutual Life
in May 1997 pushed the most protected sector of Japan's
financial system into open crisis: of the 18
life-insurance funds that have developed historically in
Japan, six have gone into liquidation. In expectation of
further bankruptcies, the Financial Services Authority
got the Japanese Diet (parliament) to revise
substantially the Insurance Code and the Framework Law
organizing the restructuring of the financial system. Of
the various modifications adopted, the most notable
involves state commitment to providing public funds for
supporting the restructuring of the sector. This type of
decision can only be justified economically if the
social cost of bankruptcy is considerably greater than
the direct costs borne by shareholders and creditors,
and hence shows clearly the importance Japanese
authorities have given to these financial institutions
in the economic stability of the country.
The
deterioration of the financial health of Japanese
life-insurance institutions is the direct consequence of
their aggressive commercial policy implemented during
the speculative bubble, and pursued for a further five
years during the subsequent deflation. Between 1985 and
1986, the 50 percent appreciation of the yen led to
colossal portfolio losses in foreign-currency holdings.
In order to maintain the overall returns on assets,
institutions were subsequently tempted to compensate for
losses by participating in Japan's rising stock-market
euphoria. To increase the scope of their investments,
and hence raise profits, the funds sought to attract
more savings, through aggressive marketing. Returns of
6-7 percent, if not 10 percent, to clients were thus
offered constantly. Given the long-term nature of such
savings, only continued rises in asset prices could
support such payments.
But the bursting of the bubble in
1990, followed by the long period of financial
deflation, put the life-insurance institutions in the
position of having asset returns that have fallen below
interest payment commitments to policyholders. Their own
reserves have been insufficient to absorb this shock. On
the one hand, reserves were reduced to a minimum during
the bubble as regulations on the use of capital gains
and constraints on reserves were relaxed. On the other
hand, market values have depreciated considerably since
the euphoria has ended. Under these circumstances, the
life-insurance funds had to reduce their guaranteed
returns on new policies as soon as possible, for their
financial position to be restored. But this revision did
not take place until 1995, when the guaranteed rate went
from 4.5 percent to 3.5 percent, the latter still being
excessive given Japan's deflationary context. Thus,
these institutions continued to sell policies likely to
generate losses up until the second half of the decade.
The
importance of these financial institutions led the MOF,
as well as the institutions themselves, to conceal the
weaknesses of the sector while waiting for a recovery.
As long as policies were not canceled or did not mature,
the opaque accounting system allowed losses to be hidden
from public view. But, as the deflation took hold, such
losses rose. Despite the level of returns offered,
market saturation and economic recession led to a fall
in new policies. This in turn led to a persistent cut in
the current resources available to the insurers.
Reimbursing contracts reaching maturity by liquidating
corresponding assets would lead to the forced revelation
of losses. To prevent such a liquidation of assets, the
insurers must therefore ensure that current resources
are higher than those in use: hence they are forced to
bid up returns to attract new investors. This has led to
the development of Ponzi-style finance. Savings are
attracted at a high cost and are meant to be invested,
but in reality are used to mop up losses on existing
policies. Financial charges rise as high-yield policies
reach maturity.
From 1996 onward, the losses
associated with the returns gap were declared. The fall
in stock market values and the leveling-off of interest
rates led to a collapse in investment incomes and latent
capital gains. This double bind on the profit-and-loss
account led to the failure in May 1997 of Nissan Mutual
Life, whose disastrous management triggered a slump in
household confidence. The fall of new subscriptions has
been aggravated by an explosion of policy cancellations;
in short, there has been a run on the funds, though less
violent than in a real banking crisis. The weak
macroeconomic and financial situation of the late 1990s
thus led to a self-fulfilling deterioration of solvency.
To satisfy their rising liquidity constraints, the life
insurers, which found it increasingly difficult to
borrow, were led to liquidate depreciated assets in
ever-increasing volumes.
Since 1997, each new bankruptcy
announcement has reduced the credibility of the sector
as a whole and intensified the crisis. While all the
institutions are not in the same situation, low
accountancy standards tarnish all actors and reduce the
solvency of the sector as a whole, thus becoming a
self-fulfilling prophecy. Official pronouncements by the
authorities, as well as from the profession itself, have
been that latent capital gains in life-insurance
portfolios should make it possible to mop up losses, a
position that was previously applied to banks until
their recapitalization in 1999. This argument is still
faulty. On the one hand, latent capital gains (net of
latent capital losses) have in essence been exhausted.
On the other hand, cleaning up balance sheets by
liquidating assets in the middle of a crisis actually
nourishes the downward pressure on asset prices, reduces
the solvency of asset owners and worsens the need for
liquidity. This aggravates a vicious circle of financial
deflation, from which life-insurance companies cannot
escape by themselves. At the heart of the Japanese
economy, these institutions have now become an important
factor in worsening uncertainty and sustaining
deflationary macroeconomic pressures.
As with the
banks, Japanese life-insurance companies are "not just
another financial services institution". They have a
systemic influence on the economy, which is directed
through three major channels: 1) household savings; 2)
long-term financing; and 3) financial markets.
Pensions in
Japan are mainly financed by capitalization. Within this
system, the life-insurance institutions manage the major
share of individual, long-term savings, as well as a
substantial share of the savings collected by pension
funds. Overall, the financial holdings of the 18 mutual
funds are drawn from 96 percent of households and
account for more than one-quarter of their savings.
Confidence by savers in these institutions is vital to
the stability of behavior and the long-term equilibrium
of the economy. Conversely, doubts concerning the
solvency of mutual life-insurance funds are leading to a
general feeling of insecurity about the future,
encouraging cautious behavior and a fall in consumption,
which in turn is feeding deflationary pressures. The
last two bankruptcies have affected 3.5 million savers,
and may cause them to lose part of their long-term
savings.
As an integral part of Japan's large
financial and industrial groups (the keiretsu), mutual life-insurance
funds play a structural role in the organization of
finance and industry. They are dormant shareholders and
providers of stable finance. During the 1970s and 1980s,
their long-term liabilities along with the continued
growth of their markets ensured that they did not suffer
from liquidity constraints. They were protected from
competition through a cartel structure, and from
shareholder pressure by their status as mutuals. Thus,
they are bound little by the obligations of short-term
profitability, by transparency rules or the need to
build up equity resources. Above all, they are protected
from hostile takeover, which makes them very stable core
players in the financial cross-holdings of Japan's large
groups, and in particular in their cross-holdings with
banks.
When the life-insurance institutions
weakened, the solidity of the whole financial system
came under threat. As stable funds became rarer, the
expectation horizon of numerous economic agents
shortened. Debt reduction and the buildup of equity have
become priorities over investment projects, while the
downgrading of the latter stifles economic growth and
future profits. Since the first bankruptcy in the sector
in 1997, the solidarity and links between life insurers
and their partners have been called into question,
clouding the outlook for painless restructuring of the
keiretsu and the whole of
Japan's market sector.
Last, the most powerful and visible
channel for propagating tensions is that of the
financial markets. The concurrence of significant
financial weight, high concentration and homogenous
behavior in terms of portfolio investments gives the
mutual life institutions particular power. Under these
circumstances, the worsening of their financial
situation is likely to provoke highly sensitive market
movements that could weigh down on the liquidity and
solvency of all investors, especially the banks.
Since the
collapse of Nissan Mutual Life revealed the absence of a
framework for managing bankruptcies in the sector,
significant progress has been made with respect to
guaranteeing saving-insurance contracts, accounting
rules and prudential policy. However, problems still
persist, necessitating substantial progress. The life
sector's Policies Protection Fund was set up in 1995,
and reformed in March 2000. Henceforth, it has become an
essential tool for restructuring the industry. Its
present capital stands at 460 billion yen, but is set to
rise by a further 100 billion yen contributed by the
industry itself by this year, plus 400 billion yen in
the form of government loans. The fund may also borrow
in the markets, with the state underwriting such
borrowing. The fund will thus guarantee life-insurance
policies through to this year, in the case of
bankruptcy.
But the terms under which such
guarantees are met lead to harmful uncertainties. In
effect, the measure stipulates that if bankruptcy
procedures go ahead, then the returns on policies
already sold may be revised, retroactively. This amounts
to the ending of obligatory liabilities for
policyholders. Thus, it is already clear that some
households holding policies with Chiyoda Life will see
their assets depreciate by at least 10 percent. These
measures have a strongly negative impact on private
consumption behavior. They may also worsen the
instability of the insurance sector, by accelerating the
pace of contract cancellation. The debate surrounding a
satisfactory resolution of the crisis thus remains open.
The
governing Liberal Democratic Party (LDP) has put forward
a proposition that would allow mutual life-insurance
institutions to modify the guaranteed rates of return on
existing policies. This proposal is being supported by
the largest institutions. They are less vulnerable to
savings flight than the smaller institutions because of
their renown, and they hope to capitalize on this at the
expense of the rest of the sector. But the proposition
does not provide a way out of the crisis. On the
contrary, it risks provoking a macroeconomic shock and
aggravating the crisis of confidence faced by the whole
life-insurance industry.
The errors of the banking crisis are
being repeated. By liquidating depreciated capital
assets to meet obligations, the life institutions have
weakened themselves day-by-day. These institutions need
to be recapitalized by an injection of public funding,
as finally happened with the banks. A major lesson from
the Japanese crisis is that institutional investors can
raise systemic risk by intervening in the financial
markets. All such investors must therefore be subject to
supervisory rules and strict prudential standards. This
has been common knowledge concerning banks for a long
time. It is a lesson learnt with respect to Long Term
Capital Management (LTCM) hedge fund crisis in the
United States and it is beginning to be learned for
pension funds and for the Japanese life-insurance
industry.
The BOJ policy board said on March
25 that it would buy more stocks from the nation's
lenders and flood the credit markets with yet more yen
in hopes of stabilizing financial markets unnerved by
the fighting in Iraq. The decisions came after the board
met in a one-day extraordinary session, and are the
first policy steps taken under the bank's new governor,
Toshihiko Fukui.
In the weeks since he was nominated
for the post, Fukui has been pressed by lawmakers to
cooperate closely with the government on measures to
revive the economy and rid the banks of NPLs. By calling
the special meeting, the bank's first since it became
independent from the Finance Ministry five years ago,
Fukui signaled his willingness to go along. For five
years, the "independent" central bank worked at cross
purposes against government efforts to halt deflation,
revive the economy and rebuild business and consumer
confidence. Now many economists and analysts in Japan
say it has become clear that the situation will not
improve unless the two act in concert. They raise
questions whether the "independence" of the central bank
is in the national interest. Richard A Werner's
best-selling Princes of the Yen
(En no Shihaisha) documents how the Japanese economy
has been manipulated by its central bank. Based on its
arguments, several well-known LDP politicians in Japan
recently founded a new Central Bank Reform Research
Group, which Werner advises.
Fukui's predecessor, Masaru Hayami,
guarded the bank's independence jealously and often was
dismissive of suggestions from outsiders. The new
governor's modest moves signaled that the central bank
will now be more accommodating. The Bank of Japan
slipped into a shaky position under Hayami. The message
now is that this central bank will be proactive.
Significantly, Fukui assembled his
policy board just five days into his term, and did not
wait for the regular two-day meeting scheduled to begin
April 7. The Japanese fiscal year ended on March 31.
The central
bank's plan to buy an additional 1 trillion yen ($8.3
billion) in equities from the nation's banks comes even
though Japanese stock prices have largely stabilized
after hitting 20-year lows in early March. It expands
the bank's appropriations for stock purchases by 50
percent, to 3 trillion yen. Through March, the bank had
actually spent only 1.032 trillion yen of the 3
trillion.
Japanese regulators have for years
allowed banks to count as capital a portion of their
immense stock portfolios, which often include
substantial stakes in their customers. But the
regulators have recently started insisting that the
banks revalue their portfolios to match market prices at
the end of each fiscal year, making the banks' balance
sheets highly vulnerable when share prices fall. The
central bank has tried to aid the lenders by agreeing to
buy portfolio holdings from them, especially holdings
that could not be sold in an orderly way in the open
market.
The central bank said recently that
it would go on flooding the money markets with cash in
excess of its formal target of 20 trillion yen, and that
it would loosen its restrictions further on making money
available to borrowers. Some analysts said these
measures would do little to blunt the longstanding
criticisms of the central bank and the government, and
that they seemed capable only of piecemeal steps, and
then only under duress. Exhibiting this distrust of the
central bank's efficacy, the Japanese stock market fell
both before and after the BOJ policy announcement. On
May 16, nearly a decade into Japan's banking crisis, the
Resona Group, Japan's fifth-largest banking group, with
$360 billion in assets, announced that it needed an
estimated $17 billion cash infusion to shore up its
capital base. Koizumi offered to put up the cash, giving
the government majority ownership. It was the use of
deferred tax assets to calculate core capital that sank
Resona, and the same accounting device could trigger
other bank bailouts. Deferred tax assets are in essence
future tax refunds banks anticipate collecting once they
clean up bad loans. The government figured that this
accounting technique, which is used also in the United
States, would encourage a financial cleanup. Auditors
have allowed the uncollected refunds to be counted as
part of capital even though they aren't a concrete
asset. On Resona's books, these yet-to-be-earned credits
represented an amazing 77 percent of its core capital.
But the bank's auditor, Shin Nihon, refused to count
more than three years' worth of deferred tax assets as
capital, slashing Resona's capital to 2 percent of its
assets. That pushed it below the 4 percent
capital-adequacy ratio mandated for domestic lenders,
forcing Resona's senior execs to go hat in hand to the
government.
Resona Group appealed to the
government for a giant funding injection to bring itself
back to fiscal health. The call triggered the first ever
meeting of the Financial Crisis Management Committee,
and the money was immediately granted. The 2 trillion
yen government bailout and de facto nationalization of
Resona is a major development in Japan's struggle to
right its economy.
Kozo Yamamoto, a member of the LDP's
Finance Committee who questioned key figures in the
debacle over Resona bank, which received 1.9 trillion
yen ($16.6 billion) of public money, said that if the
criteria used to calculate Resona's capital are applied
to other Japanese banks, "there will be a flurry" of
banks that will need public funds.
BOJ governor
Fukui said the country could suffer a financial crisis
"at any time" unless its near-crippled financial sector
is fixed, with the banks becoming more and more
vulnerable to shocks.
Next: The
Chinese experience
Henry C K Liu is chairman of the
New York-based Liu Investment Group.
(Copyright
2003 Asia Times Online Co, Ltd. All rights reserved.
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