hi Heinz,
in looking at the bank crisis in Japan, i believe we need to consider their trade policy and what it means for the US. what is the trade policy? for 100 years, it has been to build industrial capacity exceeding domestic needs, in order to support a structural current account surplus. originally the goal was to acquire foreign exchange sufficient for Japan to finance its own industries, but subsequently they realized that a rising yen (a result of the trade imbalance) would reduce the competitiveness of Japanese exports.
therefore, Japan adopted the historically unique position (for a country running such a large structural surplus) of accepting the fiat currency of a debtor nation (the United States) in lieu of gold or its own currency. (even before Nixon closed the gold window, which was done largely due to pressure from the increasingly undervalued yen, it was never the Japanese who complained of an overvalued dollar. it was a fiesty French economic minister, as i recall, who bemoaned America's "deficit without tears.") the problem was, Japan could not recycle these dollar payments into yen without driving up the yen. in order to maintain the strength of the dollar, therefore, Japan has elected over the years to acquire a burgeoning portfolio of foreign assets, such that it now has the largest net external asset position of any country in history.
unfortunately, every asset must be funded by a liability. in Japan's case, funding these external assets required the MoF and BoJ to create yen liabilities within Japan. the approach adopted in the 1970s, and again in the 1980s, was to create a real estate asset bubble. a real estate bubble creates capital gains which are not part of real economic activity. these gains, captured as profits (by constituents supporting the LDP, namely farmers and executives of construction firms), were placed, alongside wage-earner savings resulting from real economic activity, as stable deposits in the Japanese banking system to fund the overseas assets.
unfortunately, all bubbles must burst, and leave a debt overhang in their wake. in the 1970s, Japan was fortunate in that oil shock-related inflation allowed bad debts to be inflated away. Japan made the mistake of thinking this would happen again in the 1980s.
the policies instituted by the MoF and BoJ during this period relied on some unique aspects of Japanese finance. firstly, Japanese banks, as opposed to equity markets, were the key sources of funds for Japanese industries. they were intent on not relinquishing this status, and maintained considerable leverage with industrial "partners". to achieve the goal of increasing systemwide credit (and liabilities to fund burgeoning foreign assets), the MoF and BoJ used banks as a funnel via industrial cos to create a land bubble.
a second key aspect was that bank loans, while formally written up as short-term agreements, were informally understood to be "evergreen"--i.e., the principal need not be paid back as long as the loan was serviced. furthermore, underwriting was not based on a co's cash flow to service their loan, but rather the co's collateral. collateral in this case consisted of the co's real estate assets in Japan.
what happened was cos were "force-fed" loans by their "main banks", and they used these loans to buy real estate. this caused real estate to rise, and each incremental price increase on a given transaction raised the collateral available to all landholders. this led to a Ponzi scheme which is well known to buyers of US Internet stocks in the late 90s.
MoF officials probably knew the bubble would end, but figured they could inflate their way out of it. unfortunately, Japan's cumulative current account surplus had grown so large (now totalling some 200 trillion yen), and domestic capacity so excessive compared to domestic demand, that deflationary pressures could not be overcome.
as a result, the bad debts from the 1980s RE and stock bubbles remain on the books at face value, and have merely grown in real terms due to deflation. since many transactions were done at ludicrous land values, there was no way landowners could service their loans out of cash flow. these loans are now insolvent, the borrowers having gone bankrupt in many cases or persisting merely as zombies, and rest on bank books.
if bank assets were marked to market value, they would be shown to be less than liabilities, which would cause a run on banks.
theoretically, one solution Japan has to this problem is to repatriate its external assets. a capital infusion of several trillion dollars could certainly help bank finances. unfortunately, this would drive up the yen and cause the dollar to tank. as a result, Japan would be thrown into a severe recession as their excess industrial capacity would be put out of commission.
land prices would be driven down to the point where cos could produce cash flow to cover payments while being internationally competitive. as it stands, they are competitive not thanks to cash flow, but due to their dependence on banks.
but this whole jerry-rigged system is now coming apart at their seams, to the point where banks and group cos are being forced to liquidate their cross shareholdings. this is one more nail in the coffin of Japanese banks' capital adequacy as per BIS rules. (the banks' satisfying the capital ratios requires them to count cross shareholdings, which are in fact nothing but treasury stock and thus phantom capital.)
it seems likely that the government will continue its erratic behavior to try to maintain the status quo. (for the past decade, in the wake of a popped land bubble, that has meant unprecedented deficit spending, which lines the pockets of LDP insiders and construction firms.)
the situation has been coming to a head in recent years. this is obvious from the plunge of the Nikkei, which as you point out, has continued to outperform on the downside whenever the limbo bar is lowered. perhaps the deflationary and competitive pressure from China and other Asian rivals is accelerating this trend.
eventually the whole spiral will unravel and the consequences are extremely grave for the United States. Japanese will have to start liquidating foreign assets. i can only imagine that the US dollar will be obliterated (no more "deficit without tears"), and perhaps set off a global depression. |
