You know it is bad when even the WSJ [see below] doesn't get it. Japan hasn't chosen to help finance the US budget deficit. Japan chose not to have its economy implode. Their domestic economy is dead and being kept above room temperature on life support. That life support system is one way trade to the US. This keeps companies working, people employed, etc. However it gives them piles of dollars. If they trade those dollars for yen or euros or gold, the price of Japanese goods will rise so high that they will not be able to export enough to the US to keep the financial shell game alive. They ran the yen to 80ish to the dollar once and almost put themselves out of business. They are in competition with the rest of East Asia on much of their production and with US domestic production on autos and heavy machinery. Their profit margins are already razor thin to nonexistant. So they didn't choose to keep buying our T Bills. They have no choice except to sell us less. Ain't worldwide deflation grand? Don't we all love financial liberalization? We are doing a real time playtest with trillions changing hands per day. All it has to do is glitch badly once and 1929 will seem like a kiddie show.
A New Confidence in Tokyo
By JESPER KOLL
A new confidence is sweeping through Japan. This is because Japan is back in the No. 1 slot -- as the world's most advanced deflation economy. In the U.S. and Continental Europe, the risks are rising that other advanced industrialized countries will follow in Japan's footsteps.
The most important effect is that many of Tokyo's policy makers are starting to believe, once again, in the supremacy of the Japanese model -- that Japan has attained a stable "deflation equilibrium" and that it remains to be seen whether other G7 countries can manage a transition as stable and smooth as Japan's. Viewed from Tokyo, Europe's rhetoric of denial or America's table-thumping insistence that "deflation will not happen here" is little more than deja vu. Japan has been there, done that.
As a result, Tokyo's confidence in excusing its lack of action is growing. Asked about nonperforming loans and excess employment, a typical response is "Japan has fewer than China." Asked about asset deflation and policy rigidity, the quip is "Better than Germany." Asked about corporate governance, they'll answer "better than America -- our managers may be incompetent but they are not crooks."
Whether Japan has done "too little too late" in terms of easing monetary policy, fiscal support or competition policy is debatable. What concerns me is that the underlying arguments from Europe or America always boil down to an insistence that they cannot possibly fall into a deflation trap because "Japan is different." But viewed from Tokyo, it is precisely because Japan is different that deflation risks in Europe and America are that much higher than in Japan. America's policy makers appear to be fully aware of this -- what else could explain the increasingly aggressive rhetoric from the U.S. Federal Reserve assuring everyone that a "shock and awe" attack will be launched at the slightest sign of deflation?
In contrast, Europe's continued denial of the risk of deflation is more troubling. Indeed, Germany's coming deflation experience is going to make Japan look very good. The key difference between Japan and Germany is Japan's strategic pragmatism and flexibility. At the macro level, Japan is in full control of her own monetary and fiscal policy. In contrast, German monetary and fiscal policy is hostage to European parameters. This means that Germany has no macro safety valve. It has no choice but to pursue structural adjustment. That, of course, is economists' code for cutting wages, laying off workers and reducing pension benefits and other trappings of a bloated welfare state.
Here lies the difference with Japan: In Japan there is a strong national consensus that, yes, the belt needs to be tightened. A case in point: Japan's labor unions have been actively lobbying for wage cuts and longer working hours for the past two years. And Japan's pensioners have accepted cuts in benefits while workers and firms agreed to pay increased contributions. The result will be, of course, a reduced standard of living at first, but it will also help raise the competitive position of Japanese firms. Wages going down and productivity going up -- that's a double benefit that German managers can only dream of.
A second reason Japan is different is that Japan never depreciated its currency. In contrast, the building of deflationary pressures in America has triggered a fundamental change in U.S. monetary policy. The dollar is more or less actively being depreciated. Japan never did this. The yen has remained a strong currency throughout the last decade. Nobody can accuse Tokyo of triggering "competitive devaluation" or "exporting deflation."
However, now that the U.S. is in essence pursuing a dollar depreciation strategy, Japan has been quick to follow suit. Since the start of this year, more than two-thirds of Japan's current account surplus has been recycled via Japan's dollar buying to keep the yen from appreciating. That means the yen is now, in effect, pegged to the dollar. Of course, Americans welcome Japan's funding of the growing budget deficit. And Japanese policy makers are doubly happy -- the extremely aggressive yen-dollar intervention funds both budget deficits, first the U.S. one and second, the Japanese one.
But just as the winners in this scenario are clear, so is the loser -- German manufacturers will get squeezed out as the euro surges. Already, Japanese car and machinery companies are taking market share and profits away from their German competitors, particularly in Asia.
So yes, Japan is different, but the key differences are poised to haunt particularly German manufacturers and politicians. Before long, they will be wishing they were running the Japanese economy or Japanese companies. Right now, the pain being inflicted on Germany is the most tangible outcome of Japan's deflation confidence and policy stance.
The more interesting -- and less tangible -- element of Japan's new confidence is the philosophical one. Make no mistake -- Tokyo's policy elite is growing increasingly confident in the success of the Japanese model. Deflation has been accepted as an inevitable reality poised to persist for another decade. The combination of global technological progress, industrial societies' aging and the emergence of China and India has been studied in detail. The conclusion is that price deflation across all sectors of industrialized economies is poised to persist. This fatalistic view of the world is the mainstream view among many of Japan's policy elite. The net effect is that Japan's top policy priority is to redistribute the benefits and costs of deflation, rather than promote new growth. From the outside, this may look like inaction, but from the inside it has been very hard work, with bureaucrats and politicians working overtime to contain the damage done by deflation.
Viewed from this perspective, the Japanese ruling elite has done an outstanding job. Despite an unprecedented destruction of wealth caused by the collapse in the stock and real estate markets -- almost one generation of wealth accumulation has been wiped-out -- Japan has successfully avoided a great depression. More importantly, Japan has remained free of foreign debt and never once lost the status of being the world's largest net creditor. Last year the current account surplus brought in about $350 million per day.
The bad news is that Japan's fatalistic view of global deflation is poised to be proved wrong. Neither America nor Asia have the political tolerance to impose "deflation contracts" on their people. Whether it is cutbacks in pension and healthcare benefits or reductions in insurance annuity guarantees or looming tax increases -- the cost of merely containing the damage caused by deflation is slowly but surely starting to force a renegotiation down of past contracts. Promised returns cannot be delivered, but the Japanese way is not to try and restructure in order to raise returns, but rather rely on the ability and willingness of the Japanese people to suffer together and accept the new reality of lower returns.
A case in point: Recently a major bank received a major public capital injection, but is neither nationalized nor under any specific obligation to present a business plan that allows for the public funds to be paid back. Optimists may call this successful crisis management. The bad news is that it will probably be nothing but another bad investment of taxpayers' money.
All this leaves Japan in a curious state. Yes, it is the world's most advanced deflation economy. And yes, it has the means and ability to contain the damage and maintain a deflation equilibrium because the ability and willingness of the Japanese people to suffer together remains unsurpassed. And yes, the rest of the industrialized world has problems. However, the current rise in confidence is likely to prove misplaced. It is a romantic excuse for inaction with a strong undercurrent of "Schadenfreude". The failure to actively promote growth in domestic demand and maintain pro-growth contracts will merely increase the eventual cost to the Japanese people. Moreover, it leaves Japan vulnerable to remain nothing but a "free rider" at best -- once global growth starts to accelerate it can only hope for another export-led recovery.
Mr. Koll is the chief economist of Merrill Lynch Japan.
Updated June 2, 2003
posted by scott 10:07 PM