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34. Jahrgang InternetAusgabe 2000
Jahrbuch 2000
Thema: 1967
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Japan & IBRD
Japan Inc
Hedge Funds

Japan Inc.


Japan Inc. in the Debt Trap

Its Economic Security is also a US Policy Dilemma

By F. William Engdahl (April 2000 - previously published under the pen-name Paul W. Rasche)

Present US-Japan relations are at their lowest ebb since the end of the War. Since 1990, Japan has been in an economic quagmire which even more sophisticated American policymakers fail fully to comprehend. Often US Treasury officials will rant and rail that, »Japan must do this« or »Japan must do that,« to help world economic growth. Japanese governments, unlike previously, fail to respond. The failure of the Japanese government during the recent Asia crisis to take measures prescribed by then-Deputy Secretary Summers, led to even deeper rancor and distrust on both sides. As well, an independent, if poorly thought-out Japanese proposal for an Asia Monetary Fund, was rejected out-of-hand, by an over-stressed Treasury Secretary, at the same time.

The apparent inability of Japan to revive its economy has led many in Washington policy circles to disregard Japan and look elsewhere for more cooperative government allies. This trend of strategic neglect, is a dangerous one, which, if not remedied soon, could find the United States in a few short years in a strategic disadvantage of mammoth dimensions. That disadvantage would come, not from a remilitarized hostile Japan. Rather, more likely, from a remilitarized and reorganized Euroland, using Japan's difficulties to strategically weaken the global positive potentials of the United States. A significant part of recent cooling of relations between Tokyo and Washington, in our view, comes as much from a failure on the American side to fully grasp the dimension of Japan's present crisis. The full dimensions of that crisis are hair-raising. There is not and cannot be, under present conditions, any self-sustaining Japanese economic recovery. Japan Inc. is being kept alive on artificial life-support of endless Government fiscal injections, which, in turn, have created the largest debt-to-GDP of any major industrial nation.

»An interplay of crises«

Japan is at an economic and social dead-end. The Japan which emerged after the War, under the central administrative guidance of the Ministry of Finance and MITI, was an adaptation of a highly centralized economic model where the »Iron Triangle« of industry, politicians and permanent bureaucracy interlocked efforts around a central consensus of market growth. That model was well suited to an era of mass production of basic industrial products in the world. The Cold War requirements of Western economic growth were largely supportive of the Japanese economic model. The United States, under the priority of a strong, vibrant Japanese economic model during the 1960's and 1970's, allowed Japanese exports to make major inroads into US auto and other markets, even at the cost of many American jobs in the short run.

Coincident with the collapse of the Soviet model in the early 1990's, interestingly enough, also the Japan Inc. model collapsed. For Japan to emerge out of that collapse, which has persisted and in many respects worsened over a period of ten years of deep depression and deflation, will require the most extraordinary Japanese effort, as well as external support, of a qualitatively different character from the earlier, paternalistic, Cold War interventions of often-short-sighted American Administrations.

Genuine self-sustaining recovery cannot be achieved on the basis of anything undertaken so far. At this point, Japan is trapped in the interplay of successive crises. The crisis of the banking system was the justification for creating the crisis of the public debt. The crisis of the public debt, in turn, is laying the basis for a coming crisis of the ageing, a social crisis. This crisis is being exacerbated by the crisis of the Keiretsu system, a system which much predates the MacArthur post-1945 occupation period. Under pressures to create world class competitive industry once more, Japan's corporate sector is faced with the prospect of eliminating entire major sections of their employees, a process already creating social unrest throughout the population. The urgently needed downsizing has been fiercely resisted by most companies to date, for social and deep cultural reasons, as well as, perversely enough, misconcieved economic reasons.

The crisis of the Keiretsu, of the entire large, cross-shareholding owned corporate sector in Japan, is tied to the crisis in the underlying basis of the Japanese consensus model. The basis of the present consensus model, a model perfected in times of wartime economic centralism, crumbled in the beginning of 1990, together with the Bubble Economy of bloated real estate and stock prices.

And Japan at present has no basis to build a new consensus, one which would allow her economy to blossom, for needed new jobs and entire new industries to be created, and population growth to take place. The New Economy, however defined, remains for Japan an object of speculation, little more than a game to lure foreign capital into the ailing Japanese economy to compensate for an enfeebled banking and credit system.

This is painfully evident in the recent restructuring of the Nikkei 225 stock market index. This first major revision of the index, knocked out fully 30 companies, in order to make room for »the advance of the Information Technology sector, and its effects on the industrial structure,« to quote the reason given by Nikkei. The move is an attempt to make the Nikkei Index appear to be a Japan version of the Nasdaq, that, to continue luring foreign capital at a time when many foreign fund managers are becoming skeptical of how long the recent Japan stock boomlet can last. In the last 3 weeks of March foreign funds were net sellers of Nikkei stocks for the first time in many months. The deep internal barriers to Japan's undergoing a genuine business-to-business-based Internet or New Economy revolution, are considerable, as we note below.

»Banks that don't work«

The core problem of Japan's economy is embedded in the troubled banking system. Repeated efforts, including a personal trip by Fed chairman Greenspan to Tokyo three years ago, have failed to get Japan to deal in any consequent way with what has been reliably estimated is a bad loan overhang of some $2 trillion in the banking system.

A series of high-profile bank mergers to create giant banks have done little to revive a dangerously sclerotic credit mechanism. To the world outside Japan, it may seem that the banks are finally on a road to recovery. The long-awaited passage of emergency bank restructuring legislation in February 1999, ended the period of dramatic and highly-public bank failures such as the Long-Term Credit Bank or Hokkaido-Takushoku Bank which failed the same month as Yamaichi Securities, and plunged the Yen in free-fall.

Yet creation of a $530 billion (Yen 30 trillion) bank restructuring fund, and forced mergers of some of the large banks into four mammoth global bank groups – Dai-Ichi-Kangyo, Fuji Bank and Industrial Bank of Japan (Mizuho Group), or the trans-Keiretsu merger of Sumitomo Bank (Sumitomo Group) and Sakura Bank (Mitsui Group); the Bank of Tokyo-Mitsubishi and Sanwa Bank (Tokyo-Mitsubishi Group); and Sanwa, Tokai, Asahi merger – have not solved anything fundamental.

The reorganized banks have no visible growth strategy, other than holding up the Old Economy status quo. The banking concentration, according to Hakuo Yanagisawa, head of the newly-created Financial Reconstruction Commission, the agency supposed to restructure the banks, is part of a strategy to correct »overbanking: too many banks which are doing the same thing.« The idea is to build four giant »global banks« and four »super-regional banks,« from the former system of 13 commercial banks, seven trust banks, and 75 regional banks. But nothing is being done, nor under the present social structure, can it be done, to deal with the underlying economic rot. The number of banks is not the problem. The debt overhang of the entire economy is the problem.

Moreover, the terms of the bank bailout law, highly unpopular with Japanese voters, include a proviso that banks repay any government money within three years. In addition, the blanket deposit insurance guarantee, first given by the Ministry of Finance to stop depositor panic which was beginning in 1997, is to expire in one year, April 1, 2001. Next April, only $95,000 bank deposit will be insured against bank failure.

This is notable because, behind the dramatic mega-mergers of the top 20 banks, there are hundreds of regional or local smaller banks which are de facto bankrupt. The deposit guarantee ceiling will lead to flight of depositors to the larger »safe« banks, triggering a new wave of bank failures in the regions. Standard & Poors estimates that this next phase will cost the government another perhaps $300 billion to clean up. Little has been said about this for the time being, as the LDP has an nervous eye to elections this year. Postpone, delay painful decisions, hope for a miracle, is the tactic.   

Because of the peculiar traditional strictures of Japanese culture where a debt is to be honored at all costs, banks have undertaken policies at the beginning of the 1990 crisis which only added to the mountain of bad debts carried on their books. As Bank of Japan interest rates fell, the banks extended new loans to clients that were used to keep many defunct firms artificially alive and listed as performing loans, often via disguised off-balance-sheet tricks, known as Tobashi.

This is the infamous Category 2 of bank bad loans. Just as the cultural code honors debts as a quasi-sacred obligation, a corrollary holds that the bank itself determine which of its loans perform or not, not an independent outside regulator. An outsider intruding would be a loss of face to the bank's honor.

A bank's loan portfolio is grouped into 4 categories. Category 1 loans are »normal.« Category 2, »potential risk;« Category 3, »High Risk;« and Category 4, »Uncollectable.« Most of the bad loans are carried by banks as 2, where the writedowns are not mandated, and the myth of performing loans is maintained, often, as said, with injections of new credit by the relevant bank. This process has allowed what in 1990 would have been a manageable bank crisis to balloon into one of potential size so great, that bad loans, if rigorously defined, would total almost 50% of GDP, some $2 trillions, a staggering sum.

Had Japan had a Western or Anglo-Saxon cultural matrix, in which corporate failure were not a question of loss of face, it had been possible to clean up the troubled banking system once the scale of the real estate collapse and its impact on the banks was clear, in 1991 or so.

At that point, as Greenspan and others urgently recommended, the Japanese authorities could have created a Resolution Trust Corporation entity, taken in state hands the defaulted real estate and construction loans of the banking system, »bad loans,« and restructured the banks minus their bad loan problem, into functioning, far smaller more efficient entities. Sweden did a similar and quite successful version through creation of a State Corporation, Securum, into which all the defaulted real estate assets of the troubled banks were brought, the so-called »Good Bank«/»Bad Bank« model. After some 2-3 years, as Sweden's economy revived, the State slowly sold the real estate into a growing market, ending up after 5 years with net profit! The banks, minus the burden of bad real estate loans, were smaller but able to lend again, and the economy grew as a result, adding to state tax revenue growth.

The opposite has transpired in Japan, apparently, as noted, for deep cultural reasons regarding the nature of debt. The Bank of Japan has artificially held interest rates at alltime lows in the last years partly to ease the cost to banks of maintaining the fiction of Category 2 loans being still good, as banks and Finance Ministry and Government all pray and hope the economy will grow again to let them come back to health with minimum pain. Those hopes were smashhed with the European hedge fund attacks on Asia beginning May 1997.
A second reason for the Bank of Japan zero interest rate policy since 1998, has been to minimize as much as possible the burden of interest payments in the General Budget for the soaring Public Debt. Largely to compensate for a huge industrial economy lacking a working credit system via the banks, the Government has been forced to step in as the credit-giver, to try to jump start the economy via series of Fiscal Stimulus packages, mainly public works.

»The Public Debt Bomb«

Several weeks ago, Moody's Investors Service announced that it is placing the rating of the Government of Japan's yen debt »under review« for possible downgrade. The reason, they noted, was »structural problems in Japan's economy that have resulted in a level of public sector debt that will soon be the highest, relative to GDP, among the advanced industrial economies.« Japan's gross public debt is already $5.5 trillions, 130% of GDP, well beyond the 60% levels in Germany and even more than that of Italy. By next year, even under best assumptions of the Finance Ministry, debt will rise to 140% of GDP.

This may only be part of the full debt picture. According to Akio Ogawa of the Tokyo Chuo University, the Ministry of Finance is hiding another $1 trillion of public debts above and beyond this $5.5 trillions in a special account used to make loans to state corporations.

Since the Meiji period, 1878 to be specific, Japan's government has run two separate budgets. The above public debt of 140% GDP is only from the accumulated deficits of the General Accounts Budget, which runs about 17% of GDP per year. The second budget, called the Fiscal Investment and Loans Program or FILP, is run by the Ministry of Finance's Trust Fund Bureau. It raises funds via the government's Postal Savings Bank (KAMPO), via employee national pension funds, via postal life insurance, and by issuing government-guaranteed bonds.

At beginning of 1999, total of Postal Savings deposits and National Pension Funds deposits deposited with the Trust Fund Bureau of MoF totalled over 420 trillion Yen ($4 trillions). This FILP is the heart of the enormous power system centered in the Ministry of Finance bureaucracy since the War. It is used to lend money to various public corporations or Government Sponsored Enterprises like the Housing Loan Corporation, the small business Peoples' Finance Corporation, Public Highway Corporation, etc.

The MoF gives no regular figures for the consolidated public sector surplus or deficit. At the beginning of this year, an estimate of the total debts of FILP was some 60% of GDP, or about $2.4 trillion. Many of these loans are made to economically unviable borrowers, as part of the arcane system of maintaining a stable political consensus, largely via LDP patronage rewards and support for local construction companies. FILP is the main source for supporting Japan's inordinately high number of construction firms, more than double that of any other industrial nation as share of GDP.

While MoF gives no data on the quality of these public »off-budget« FILP loans, a ballpark conservative estimate would be that at least 20% are worthless or de facto in default of repayment, which would be an added bad loan cost to taxpayer and the public budget of 12% of GDP or  $450 billion.

Moody's Japan debt warning stated that, given the scale of Japan's fiscal debt imbalances, the huge problems of the state pension system, health care and contingent claims of the banking system on state credit, any attempt by the Government, to correct the huge fiscal deficit and to bring the debt growth under control, would destroy what fragile economic growth there exists.

No surprise then, Finance Minister Kiichi Miyazawa recently announced that Japan is »unlikely« to enact any significant fiscal reform, i.e. measures to control budget deficit via tax or other changes, until Fiscal Year 2003. Postpone, delay, hope, pray. To return to a Budget balance at this point is well-nigh politically and fiscally impossible. Japan's deficit – the gap between tax and social security revenue receipts versus total public spending including the huge fiscal stimulus programs – is so huge it cannot be closed merely via higher tax, even if the economy were strong enough this time to absorb higher taxes, which it is not. Cutting public spending, given Japan's demographic and debt problems, in turn, will be increasingly difficult as well, if not impossible.

Since the Japanese stock and real estate bubble collapsed in early 1991, the Government has passed no less than nine major fiscal stimulus budgets, ostensibly to revive the contracting economy, to compensate for the crippled private bank credit mechanism. When Finance Minister Miyazawa announced the latest such fiscal stimulus November 1999, that one for some $180 billions, which began to be spent April 1, he proclaimed it was to be »the final one.«

It brought the total of government economic stimulus since 1992 to  more than $1.12 trillion. Without the regular stimulus public spending, Japan's economy would have contracted in growth, over the entire decade.

Yet the spending has not gone to create the basis for a self-sustaining recovery of Japan's debt-bloated private or public sector. By informed Japanese accounts, the money has mostly gone to finance the traditional LDP party patronage machine in rural areas, by funneling public funds to LDP-tied construction companies and other channels. Proof that the stimulus has not led to self-expanding real economic prosperity, Japanese tax revenues between 1992 and 1999 dropped fully 24.6%, from 62 trillion to 47 trillion Yen. 

According to Masahiko Iishizuka, of Japan's Nihon Keizei Shimbun, the country's major business paper, the fiscal spending has instead gone for »nothing but the worst of pork-barrel politics, to represent benefits for the construction industry – not coincidentally, a major backer of the ruling Liberal Democratic Party – throughout the country.« He points to the incredible proliferation of such small construction companies – more than half a million in all, »the ultimate beneficiaries of public spending of this archaic character.« Press accounts abound of bridges being built, in remote areas where no road exists, but where LDP voters do.
The public spending injections create spurts of growth, which, as soon as the fiscal budgets run out, stops. In the last Quarter of 1999 public spending fell by 8.5% as the stimulus fund then was exhausted, and the economy fell back into official recession, with GDP contraction of 1.4%, after a 1% fall in the previous Quarter, leading some economists to compare Japan's economy to a »junkie economy,« dependent on endless injections of public money. 

But Japan is rapidly approaching the physical limits of the present system of debt-financing. For the Japanese Fiscal Year just ended, tax revenues were barely above the level of new public bond issuance needed to cover the deficit, Yen 34 trillion taxes and Yen 31 trillion bonds. Fully 38% of the total Budget had to come from new bond issue. Prospects over the next several years are even worse. In the Fiscal year just ended on March 31, the public deficit--municipal and national--reached an Ecuador-like almost 10% of GDP. Debt service on existing debt, despite the de facto zero interest rate policy of the Bank of Japan, is the largest single Budget item, Yen 22 trillion in FY 99/2000, or 26% of the total Budget outlays.

Japan Inc. is in a classic debt trap, in some ways like Germany in 1921-22

Adding to the Finance Ministry's woes, one source of financing this huge addition to its public debt has been the state's Postal Savings System. In 1990 and again in 1991 it issued ten year savings bonds in huge sums to finance the deficit. Beginning this month, April 2000, some Yen 110 trillion of these Postal Savings bonds mature. With interest rates now at well under 1% for new Postal Bonds, much of those savings are likely to go elsewhere, or even out of Japan entirely, as older Japanese savers desperately search higher gains to finance retirement or even daily living. Even if half the amount is lost to the Finance Ministry's Postal Savings System, it means a devastating loss of funds to absorb the soaring public debt. The option is either to offer far higher interest rate returns in order to sell the new Postal Savings bonds, or hyperinflate the economy, Weimar-style, to get the Government out of the debt trap, at the expense of the entire non-indebted population.

»The Private Debt Bomb«

With a public sector – historically a huge part of Japan's GDP – bloated by untenable levels of debt to GDP, the private sector is in little better shape. For ten years Japanese industry has stagnated under the burden of the bank crisis and domestic price deflation. Japan's once vaunted technological leadership in auto production, machine tools, steel and electronics is today some 5-7 years behind the state-of-the art. Japanese companies have little surplus to invest in needed R&D to reach world class. In terms of the New Economy Internet revolution underway in the US and parts of Europe, Japan is pathetically behind events.

In order to become more competitive, Keindanren, the industry association, has made a drive to rationalize and make more efficient company employment. The era of »guaranteed lifetime employment« is supposed to be over. Indeed official unemployment, well over 4.4%, is already a postwar high.

Yet, were Japan to have a labor productivity density equal to the United States of today, 16 million more jobs would be gone from existing companies, one in four workplaces would disappear. Companies like Sony and Toyota have only done the most tentative steps in reducing the bloated laborforce they have. Most companies, for social reasons, have resisted adamantly cutting jobs, which is still seen as an admission of failure, a loss of face.

Japanese corporations have a huge unpublished debt obligation in terms of yet-unfunded pension obligations. After ten years of depressed growth and years of record low interest rates, and depressed stock market prices, Japanese corporations have been unable to finance their own employee pension obligations. Goldman Sachs estimates that Japanese private corporations now have a deficit in legally obligated pension funding of 80 trillion yen or $770 billions. Funds invested with Japanese insurance companies for pension earnings by corporations, under depressed stock prices and zero interest rates are earning a pathetic 2.5% return.

The problem is getting worse for the private companies by the minute, owing to the most severe demographic crisis of any industrial nation today. Japan's elderly are not the major problem, rather the fact that no young working people are coming in to the economy to offset the retiring. Japan's birth rate is catastrophically low. Why, is subject of another study.

Suffice it to say, Japanese companies are under enormous pressure to shed labor costs, if only in order to be able to finance pension liabilities. An ageing workforce is going to be put increasingly in retirement, yet companies must cut back on their promised pension benefits at the same time. Just before his stroke, Prime Minister Keizo Obuchi managed at end of March, to enact the first tentative pension law reform. Under it, certain governnemt-paid Social Security benefits to company retirees are cut 5% as of April, and retirement age is raised by 2013 to 65 from 60, which is hoped will save the government $103 billion per year in costs. Such small changes are a pittance in relation to the scale of the problem, and only serve to add to social anxiety, already at high levels among the ordinary population. The new law cost the LDP its coalition and probably Obuchi his health.

»Softbank Sucker Games«

The Unites States, whether official Washington or private fund managers and industry people, stand by,  perplexed at the scale of Japan's problems, when they at all comprehend them. By contrast, the financial and political powers behind the Euro, the same financial interests which deliberately staged the May 1997 (see article on Hedge Funds) attacks on vulnerable Asian economies in order to set the stage for launch of the Euro currency, are very conscious of just how vulnerable Japan is.

For most of the past year, it has been European banks and funds which have created the new bubble in Japanese stocks, and the dangerous rise of the Yen. Against the Euro, the Yen has appreciated more than 30% since January 1999, well over twice that of the Euro versus the dollar. In a large scale replay of the Thai set up, it appears Euroland banking interests are carefuly setting Japan up for the final kill. Instead of selling Japan stocks, they are buying. European hedge fund front man for leading Euro financial interests, George Soros, just opened offices in Tokyo.

But these Euro forces are buying in order to create short-term profits, and set up a bubble trap. French President Jacques Chirac, who personally has been more than 20 times to Japan in his career, is very aware of how deep Japan's crisis is. Other Europeans as well. They know fully that such stock market games as the recent bubble in shares of the Internet investment bank, Softbank, are largely being hyped in order for Japan to lure foreign capital in as their domestic banks are incapable of financing a new industry investment. Japanese industry is structurally and culturally unable to create any Japan version of a real New Economy. Were they to try,.it would simply collapse the Keiretsu entirely, and bring the economy into worse crisis.

With the Yen so dangerously high that it hurts export profits, the only sector of profit in the ailing economy, Japan is precisely where the Euroland powers want the second largest industrial economy to be for now. At anytime it suits Euroland financial powers, they can now pull the plug on Japan by forcing the Yen even higher, against the Euro. European exports already are far more competitive against Japanese in the past 15 months in world markets. Euroland is intent on eliminating Japan as a future competitor. It is dangerously close to its goal, helped enormously by the cultural paralysis of the internal Japanese crisis since the collapse of Cold War structures. In this context, a qualitative rethinking of American-Japanese relations is of urgent interest.