a blurb from Stratfor on Japan's financial system
STRATFOR.COM Global Intelligence Update
2 February 2000
Japan Borrows From Banks To Float Economy
Summary
Japanese Prime Minister Keizo Obuchi said Jan. 28 that his country
would forgo fiscal reforms until the economy stabilizes. On the
same day, the Japanese government announced it would begin
borrowing money directly from Japanese banks to cover budget
shortfalls. By refusing to implement deep, painful and necessary
reforms - and instead borrowing from domestic banks to fund
additional unworkable government "stimulus packages"- Japan has
sentenced itself to a descending spiral of economic malaise.
Analysis
Japanese Prime Minister Keizo Obuchi stated in a Jan. 28 speech to
the Diet, Japan's legislative assembly, that "fiscal reform is
important," but that the country "cannot commit the mistake of
undertaking it while the economy is not firm and before it is on
the path of full-fledged recovery." His remarks came within hours
of the Japanese government's announcement that it would begin
borrowing money directly from its crippled banking system in order
to meet its financial obligations to local governments.
Government policies have locked the Japanese economy in a downward
spiral. In order to promote growth, Japan creates supplemental
budgets funded by borrowed money. When the government money runs
out, the economy again slips into the doldrums, thus necessitating
new projects funded by new loans. This deepening addiction to
borrowed money has caused catastrophic damage. Japan's inefficient
economic structures promote social welfare at the cost of stymied
growth.
Japan already holds the record as the world's most indebted
government. Its newest budget deficit, at 38.4 percent, will only
compound this. At this pace, Japan's debt will top 150 percent of
its GDP within three years. Japan's budget and economic structures
are not sustainable, and by refusing to adopt direly needed
reforms, Japan's economy will only decay further.
Put simply, Japan is attempting to borrow-and-spend itself to
recovery, but without constructing an environment that encourages
private sector development. Every action the Japanese government
takes along these lines to bolster its economy only extends the
damage.
Japan's latest plan seeks to achieve three goals: give business to
Japan's banks; decrease the value of the yen; and gain additional
income for the government without issuing new bonds.
First, Japan's recession has idled many of the nation's banks; few
companies are willing to take on additional financial risks until
the economy recovers. The new plan would give the banks some badly
needed business.
Indeed, Japan's banks are awash with money, but this does not mean
they are healthy. Japan's banking sector is still struggling to rid
itself of at least $2 trillion in bad loans, acquired from two
decades of irresponsible lending practices. Furthermore, Japan has
a bad habit of instituting superficial reforms throughout its
political and economic systems. Its banking industry is no
exception. When many Japanese banks went bust after the Asian
financial crisis, several "reformed" themselves by closing foreign
offices in order to avoid adherence to international financial
norms. Moreover, Japan went so far as to refine the meaning of a
bad loan, loosening the criteria, thereby delaying or preventing
unprofitable enterprises from foreclosing. This, in turn, meant
that on paper the banks appeared to be more financially solvent
than they really were. It's easy to avoid a debt reckoning if you
rewrite the financial laws.
Japan's second goal is to increase the country's money supply. In
borrowing from these same capital-rich banks, the government will
inject additional money into its economy. Japan hopes that this
additional spending will reduce the value of the yen and increase
the international competitiveness of Japanese exporters. Yet, in
the recent past financial markets have shrugged off every attempt
by Japan to reduce the yen's value; there is no reason why a
slightly less direct attempt will be successful. In the unlikely
event that it does work, it will be a fleeting success at best. As
soon as the Japanese lending spree ends, the yen will rise again.
Japan will have spent borrowed money and achieved nothing.
Third, the plan calls for loans instead of bonds - Japan's
preferred method of borrowing money. After nearly a decade of
issuing bonds to fund massive, and irrelevant, infrastructure
projects in an attempt to jumpstart the economy, Japan has
saturated its bond market. Japan's plan allows the Japanese
government to obtain additional funds without harming the bond
market.
This actually magnifies Japan's debt problem. One of Japan's
advantages over its neighbors during the Asian financial crisis was
that Japanese debt was long-term at low interest - it in and of
itself did not trigger a crisis in the way that Korea's short-term
development debt did. Japan's new plan destroys much of that
advantage by racking up short-term high-interest loans for regular,
recurring expenses. This is tantamount to charging your rent on a
high interest credit card that you cannot pay in full. If Japanese
debt rises as Japan's Finance Minister Kiichi Miyazawa predicts, it
will top $6.15 trillion this year. When Japanese interest rates
rise, as they must eventually, the cost of servicing this mountain
of debt will be massive. Japan will have secured an additional
source of income, but condemned itself to paying interest payments
indefinitely.
Powers outside of Japan have noticed these problems. Fitch IBCA and
Moody's Investors Service - international credit rating agencies -
have both reduced Japan's credit rating and are considering
lowering it further due to excessive debt. This raises the cost of
borrowing for Japanese businesses. The G7 and the OECD have also
tried and failed to get Japan to take more appropriate action.
Japan's Asian neighbors are also aware that the region's economic
colossus has feet of clay. Japan's Miyazawa funds, designed to
stimulate the purchase of Japanese exports in Japan's neighbors,
have found few takers in recent months. Japan has also seen most of
its Pacific Rim trading partners eschew new trade links with Tokyo
in favor of lashing themselves to a seemingly unending U.S.
economic boom. This is unsurprising considering Japan's
unwillingness to dismantle its outdated protectionist policies and
its inability to stimulate consumer demand. This "Fortress Japan"
mentality atop a mangled financial infrastructure will ensure a
continued exodus of economic - and therefore political - power from
the world's second largest economy.
By publicly abandoning financial reforms, Japan is sending a
dangerous message. Japan continues to borrow in order to fund
temporary stimulus packages. These stimulus packages create an
economy dependant on continual government investment, which can
only be paid for with more borrowing. Having exhausted the bond
market, Japan has now resorted to higher-interest loans to
perpetuate this vicious circle and make the Japanese economy even
more indebted, and more out of synch with the rest of the world.
Japan's day of reckoning is not far off.
(c) 2000 WNI, Inc. stratfor.com
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