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Since Kenichi wrote this, Japan's GDP decreased only 0.7% in 1999, but it increased 7.6% in 200, another 9.2% in 2001, and is headed for a 1.9% increase in 2000.
Subject: Kenichi Ohmae: Why Japan is Heading for a Major Crash AFR Saturday, June 20, 1998 Why Japan is heading for a major crash By Kenichi Ohmae In 1619, the Spanish Empire's defacto financial centre, Genoa, was at the brink of collapse. A key indicator of financial distress was the decline in the official yield rate to 1.125 per cent. Move now to the first week of June 1998, and Japan's official bond yield has plummeted to a low of 1.115 per cent ... smashing the worldwide historical low held for 379 years. The golden questions are how� and when� do we expect Japan's recovery, and what will be the effects on the rest of the world? Do we turn to her leaders for answers? Leaders who have little understanding for her underlying financial distress are of little assistance. The joint US and Japanese intervention to rescue the yen during the week is nothing more than a morphine shot; a temporary pain relief but no cure. Before tackling these issues, however, it is necessary to establish a common frame of reference. That is, Japan's position in an interlinked global economy. In the global economy there is no free lunch. American prosperity is self- earned, so they say. In actual fact, however, without funds from the rest of the world seeking refuge in Wall Street's gigantic bucket, the Dow Jones may not even reach 8,000, let alone sustain it. Fortunately in the US, super- liquidity has been confined to the stockmarket � unlike Japan in the 1980s when liquidity spilled into expensive golf club memberships, Van Gogh paintings, and above all, overpriced Tokyo real estate. With this in mind, the G8 has demanded the Japanese economy be "fixed" ... and fixed quickly at that. Without proper understanding of Japan's fundamental problems, however, there will be further decline and, in fact, a sustained crash of the Japanese market. This could easily bring a swift decline to the euphoric European and US markets. Unfortunately everyone, including the Japanese Government, is proposing a "quick fix" to the deep-rooted problems of Japan's economy. History has demonstrated that every time such a "fix" is implemented, problems are hidden away ... only to grow bigger in the shade. The "quick fix" I refer to encompasses the measures of "economic stimulus" or fiscal policy. In the past five years, and to no avail, Japan has spent more than $US600bn in public works above and beyond the annual budgets. The recent $US30tr packages set to bail out failing financial institutions and write off bad debts are, in my opinion, nothing but a series of morphine shots to relieve a patient of short-term pain. The US Government has asked Japan to stimulate its economy with an aggressive budget of increased public works and simultaneous permanent tax cuts. The former calls for a big government, and the latter, a small government. If such a remedy were proposed for the US, it would not survive public scrutiny for a moment. According to a wide spectrum of US Government officials (ranging from the President and Secretary of Finance to the Ambassador to Japan), this prescription is in the best interest of Japan. And I agree. Although their reasoning copies that of Wall Street analysts and the so-called new rich. That is, they do not want Japan, or Asia for that matter, to drag Wall Street down. These expectations are way too high. Japan's economic problems cannot be confined to its geographic borders in an interlinked global economy. As such, it cannot be expected that the US economy be shielded and continue to prosper, particularly � when we are referring to the two largest economies in the world. In my view there are five issues, all independent, (at least initially) that lead to the same conclusion ... the crash of the Japanese market. This is not the first time I have raised this viewpoint. For instance, I predicted that in 1992 a market correction would bring the net-present-value of Tokyo properties to one-fifth of their peak, reached in December 1989. The real market experienced the bottom of the market in 1995 but the Government and financial institutions tried to conceal it. They froze the market by changing accounting rules to avoid huge downward revaluations. They neglected to understand that such reactive behaviour was nothing new to the global economy. Actually, it was very similar to events in Houston, Los Angeles, New York and London where excess supply of commercial buildings swiftly led to depressed rents. Neither Japanese business nor the Government, however, admitted that the same historical and economic certainty was occurring in Japan ... a certainty soon to become the cornerstone of Japan's financial problems. The "wishful thinking" mentality is perfectly understandable. I mean, the value of Tokyo in the late '80s was estimated at more than that of the entire US. For the market to fall 80 per cent in just half a decade is more than anybody can adjust to. It is arguable that Japan's bubble was far beyond reality and as such required an adjustment. But in the mid-1980s, Japan's prosperity appeared even sweeter as the Tokyo stockmarket achieved an 80-times PE ratio. That ratio, according to the analysts (who are now in hiding), was justifiable due to the appreciation of the stocks and properties hidden in the books of the mighty Japanese corporations. Today's reality is that the Nikkei is at 37 per cent, and Tokyo's properties at less that 20 per cent of their peak value. The books of account, however, have not been adjusted. This continued state of denial and implementation of superficial economic revival techniques now means that any serious effort to correct the books will cause the market to crash. Allow me to describe five possible scenarios: 1. Accounting firms get serious and perform due diligence Most prestigious accounting firms exist by name only in Japan. They by no means practise professionally. They issue a "clean statement" at the request of their client or otherwise at gunpoint to the Ministry of Finance. Most bankrupted financial institutions had up to 10 times the "audited" bad and non-performing debts. The first indication of accounting mismanagement came as a surprise in January 1997, and was later known as the "Kyotaru shokku".� Japan's largest sushi chain operator, Kyotaru, filed the Japanese equivalent of Chapter 11, because its accountant refused to continue to fudge the books. Concealed bad debts had risen to $US1bn in diversified businesses unrelated to their core business. The big Japanese accounting firms are all affiliated with the globally recognised firms. That is, Tohmatsu with Deloitte Touche, Asahi with Arthur Andersen, and Century with KPMG. So, it is not that the world is not aware of Japan's accounting practices. More to the point, in this profession, when everyone is engaged in malpractice, why stand up and be the first saint? So, if the books are truly opened and the balance sheet adjusted to reflect market reality, the shokku,� or the crash, will spill over the sushi counter and most certainly be felt throughout the world. 2. The Letter of Awareness is ignored Japan was shocked when a prestigious and profitable company, Daido Concrete, filed for bankruptcy and withdrew from the Tokyo Stock Exchange on February 28. The CEO, Hisatada Ishikawa, revealed by press conference that the company had net debts of $US19.5bn, because it has given several banks shido nenshos� (letters of awareness). The nenshos� were nothing but a series of unofficial letters, stating that the company was aware that its Asian subsidiaries were borrowing money from them. It is not an official letter of guarantee, nor is it an agreement to collateralise its own assets. The paper has no legal significance. Most banks, during the bubble years, begged businesses to borrow more money, even when they did not need it. As such, borrowers were reluctant to surrender collateral. For consolation, the banks, in an easy-going manner, created nenshos,� which simply state: "Yes, we are aware of our subsidiaries borrowing from you". In the case of Daido, the nenshos� amounted to some $US150m that its Indonesian and Hong Kong subsidiaries had borrowed from local branches of the Japanese banks. Daido shokku� is a significant case because currently the total sum of amounts committed by nenshos is unknown � unable to be estimated by the accountants or top management. Some well-informed insiders say that the total amount of this type of lending could be in excess of $US1tr. Recently, Japanese banks "secretly" ordered their branches to sum up the total amount of nensho� lending. A branch manager known to me shrugged his shoulders and commented that it is impossible to size them up because more than half of the loans to "prestigious" companies do not have corresponding written documentation. The seriousness of this situation has worsened, however. As the banks are not legally protected for these loans, they claim defence by forming a "wolf pack" to deal with trouble from their clients with nensho� loans. For example, Daido refused to satisfy loan repayments on behalf of its overseas subsidiaries. Daido preferred the subsidiaries to go bankrupt than to repay debts on its behalf. As a result, and when Daido's short-term borrowings fell due for renewal in Japan, all� the banks ganged up in unison, and refused to revolve their lending. This practice is similar to that seen in the movie The Godfather �. That is, the poor company could not survive without obeying the unwritten law of the wolves. Note that nensho� loans are in addition to the already revealed $US1tr in bad and non-performing loans, and the problem may or may not explode. The equally big exposure of the Japanese banks will certainly add fuel to the fire once the current feeble containment, or the wolf pack efforts, begins to erode. 3. Interest rates rise Japan is one of the few countries that performs better with rising interest rates. This is due to the significant level of consumer savings. Japan is now, however, experiencing historically low interest rates for the sake of saving over-extended corporations. The 10-year government bond yield about 1.14 per cent and as previously noted is now comparable with the one observed in Genoa in the early 17th century. The popular Postal Savings now offers 0.35 per cent interest for a one-year deposit, which is considered attractive compared with the banks' term deposit of 0.30 per cent. The market theoretically sets interest rates. This is not, however, the case in Japan. At present, the Bank of Japan cannot raise rates for fear of an avalanche of failures of heavily geared companies, mostly in property-related markets. This situation is akin to the terminal care of coma. The health of a patient in a coma is not restored by a doctor's prescription. Life is merely prolonged. What happens if the oxygen supply stops? Just as Japan's national savings has prolonged the life of over-geared corporates, the savings supply will eventually be cut off as massive levels of capital flee to higher yielding shores. In the first month after the deregulation of the foreign currency exchange laws on April 1, as much as $US20bn fled Japan for higher-yielding offshore instruments. Japan still has $US12tr in personal savings. So, one might say the oxygen is still flowing. Ultimately, the Government would like to use excess savings to solve Japan's internal problems. To do so, and to discourage savings from gushing out, it must raise official interest rates. As the rate goes up to, say, 5 per cent, the inevitable crash will erupt as massive corporate bankruptcies occur well before consumer spending based on higher interest payment rises. 4. The yen continues to decline The yen has weakened against the US dollar by more than 50 per cent in the past two years. In addition to the spread in interest rates between the US and Japan of about 4 percentage points, if one adds the appreciation of US financial instruments, the return becomes increasingly attractive. Right now, nothing seems hopeful enough to stop the decline of the yen. Japan's result now becomes a "triple low": low interest rates, low value currency, and low stock prices. The drive to place savings in more attractive overseas markets comes primarily from high net-worth individuals and liquid corporations, and hence is different from reasoning stated in item three. The result, however, is the same because, to stop it, the BoJ will have to raise official interest rates. 5. Liquidity crisis begins The so-called "Japan premium" for Japanese banks to borrow in the interbank market has fluctuated between 20 and 150 basis points. Since banks operate with only about 25-basis point margin, the Japanese banks have been forced out of the international market. The Fed and the BoJ are concerned, to say the least. If Japanese banks are hit by a liquidity crisis, they may have to sell US government bonds. These bonds have been held since the '80s when they were used to finance the US Budget deficit. The situation became very serious in November 1997 when Sanyo Securities and Hokkaido Takushoku Bank went belly-up, and the world financial community became concerned about other possible casualties. Due to the excessive liquidity the BoJ subsequently provided and with the help of Fed, the extent of concern seems to have calmed ... at least temporarily. The Japanese banks, however � particularly the traditionally better performing ones � have been hit hard. Hit not only by all of the problems described above, but in addition to the Asian liquidity crisis. Clearly their strength to survive is to be tested from all angles. Independent of these problems at hand, the Government unleashed the cruel tiger of the Big Bang into the domestic market. This is the same Government still trying to rescue the banks. Obviously there is confusion, or at least an anomaly of economic policy. Is it the Japanese Government's priority that competitive banks prevail and the weak exit, or are they prioritising to save the entire fleet of banks? The MoF has promised an end to bankruptcies of the major financial institutions. Yet the "Big Bang" is supposed to mean the survival of the fittest. This is clearly a contradiction of economic and political priorities. In reality, it does not matter. When they fall, they will all fall together. That is the nature of traditional Japanese financial practices. That is, Japanese banks form syndicates to finance large projects. As such, no bank will be absolutely safe should one of its members fail. So, contrary to commercial principles, the banks act in harmony, but when it comes to matters internal to themselves they threaten each other so that no member can bail out without recourse to other members of the syndicate. Again this behaviour is like that of the wolf pack. Wolves gang together to seek prey, but in absolute hunger they will suddenly attack the pack's weakest member. So far, they have eaten one by one from the bottom of the ranks. The situation has worsened now. The Japanese economy is classified as deflationary as unemployment reaches a high of 4.1 per cent, and consumer spending and confidence levels decline at alarming levels. As for policy options? They have been exhausted because the MoF has implemented too many phoney ones already. For instance, a frantic $US220bn credit line morphine injection ensured a few bottom performers just made it over the line by the end of the last fiscal year (March 1998). So, when the next round of liquidity crises hits, it is likely that the pack itself will be tried for collective survival. The once glorious MoF and BoJ, having been at the centre of public criticism and having produced several staff for indictment, have no power, let alone credibility, to steer Japan along the slippery road ahead. All these scenarios lead to the same conclusion. Japan is going to slide further ... and perhaps even crash. There are, however, many reasons to believe panic can be avoided. This is provided the Government can be honest enough to explain the real situation � not only to the Japanese people but to the rest of the world, as this is a matter of global concern and consequences. First, the Government has more than $US4tr worth of assets and properties on Japan's balance sheet. This already exceeds the amount required to extinguish the financial problems of Japan, and may even be sufficient to cover all of Asia's troubled debts. Furthermore, Japan's consumers have $US12tr in personal savings in addition to $US28tr worth of assets. Unlike its Asian neighbours, Japan does not owe money. Japan's problem is entirely internal. It is a simple case of internal mismanagement. Despite the prevailing negative sentiment, Japan still retains a very strong consumer sector, powerful industries with ample exporting capabilities, and above all, diligent people. Trouble skyrocketed primarily because its government tried to hide facts and attempt to rescue the wrong industries at the taxpayers' expense. Essentially it is a relatively simple matter. Japan requires a political vision strong enough to allow bad banks and corporations to exit, and smart enough to open the economy to the globally competitive ones. In the process of Japan's normalisation, the American and other markets will fall a little. But ... the recovery will be fast if� the enormous mount of wealth, currently hijacked by the MoF to rescue the wrong people, is used for the benefit of all. The solution is quite obvious: improve the quality of life at the lowest cost of living, by allowing the goods and services to come from anywhere in the world. So, instead of demanding that Japan spend more on public works and artificial creation of jobs for special interest groups, the US Government should work with the Japanese voters to secure long-term benefits for both countries. This means, at least for a short while, it has to warn its own passengers to fasten their seatbelts and prepare for turbulence. Given a good pilot, the choppy ride is going to be over in a few years. � Kenichi Ohmae is managing director of Ohmae and Associates, and has written many books on the globalisation of the economy, including� The Borderless World (Harper Collins). |
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Modified Tuesday, August 26, 2008 Copyright @ 2007 by Fathers' Manifesto & Christian Party |
