The root cause of Japanese bad debt
By Nathan Lewis
Published: October 14 2002 22:11 | Last Updated: October 14 2002 22:11
news.ft.com
The Japanese government has promised to get tough with the country's banks, which are buckling under the weight of bad loans. Heizo Takenaka, the new financial services minister, has announced a new bad-debt liquidation plan in which the banks would be forced to clean up their balance sheets. Those incapable of doing so would be allowed to fail.
The trouble is that the proposed plan does nothing to address the root cause of Japan's bad-debt problem. It could even make it worse: shareholders recently gave the plan a unanimous vote of no confidence, selling shares and sending the Nikkei index to its lowest level in 19 years. The stock market drop worsens banks' financial position.
The banks' problem mirrors the economy's problem: companies cannot make a profit. When companies run losses, they cannot pay their debts. These bad debts pile up on banks' books. Banks eliminate bad debts year after year, but companies have been defaulting even faster, leaving the country's financial institutions with more bad debts than before. Since 1992, Japanese banks have taken Y81,540bn ($660bn) of bad-debt losses and have eliminated more than Y71,000bn of bad-debt liabilities from their books. In that time, the amount of bad debt remaining has increased from Y12,775bn to Y42,028bn. This has created the illusion that banks are doing nothing. Even if banks' books were wiped clean of bad debts tomorrow, new bad debts would continue to pile up at a rate of Y7,000bn-Y10,000bn a year at the current rate of economic deterioration. Banks still have about Y380,000bn of loans that have not gone bad - yet.
There is no solution to the bad-debt problem without a solution to Japan's basic economic problems: monetary deflation, economic contraction and falling asset values. Monetary deflation is caused wholly by the Bank of Japan, which has allowed the yen to rise steadily in value since 1985. The bank should increase the monetary base with the stated goal of lowering the yen's value to a point where it is neither deflationary nor inflationary. A 10 per cent fall in the yen's value would be an appropriate start. If the BoJ depressed the yen excessively, it would create inflation, which could be avoided by contracting the money supply. In spite of arguments to the contrary, the BoJ has complete control over the money supply and, by extension, the value of the yen.
Ending monetary deflation would help the Japanese economy tremendously. But to end the recession, the government should do everything it can to create an environment of rising asset prices. This means eliminating the capital gains tax on equities, first imposed in 1989 and due to rise in January 2003; eliminating capital gains taxes for companies, as Germany did this year; and eliminating capital gains taxes on property.
At the same time, property transaction taxes, which were imposed years ago to "suppress speculation", should be scrapped. Property holding taxes, which have gone up about 10 times since the late 1980s, should also be reduced. Double taxation of dividends should be remedied and absurd inheritance tax rates should be slashed. A growing number of ruling-party politicians, including Taro Aso, head of the Policy Research Council, have been making similar arguments. The Yomiuri Shimbun, Japan's largest newspaper, now recommends almost exactly this prescription.
These taxes actually create very little revenue. Added together, capital gains and transaction taxes generate less than Y3,000bn in annual revenue. Compare that with the Y25,000bn a year that the government spends on public works. A new "supplementary budget", which in the past has been frittered away on wasteful programmes, should be devoted to permanent tax reductions of the sort outlined above. A policy of tax cuts and spending cuts is exactly what turned around the British economy in the 1980s and the Irish economy in the 1990s.
If property prices doubled, returning to about their 1994 levels, much of the banks' bad-debt problem would disappear. If the Nikkei rose to 15,000 - from its current level of about 8,500 - banks would be recapitalised automatically.
The Japanese should be familiar with this technique: they used it to pull themselves out of the economic disaster of the late 1940s. In 1953, capital gains taxes on equities were eliminated. In 1955, interest income was made tax-free and dividends were taxed at 10 per cent. In 1950, the 55 per cent income tax bracket started at income of Y500,000. In 1957, the threshold had been raised to Y10m, and other brackets were similarly raised. The hyperinflationary yen was pegged to gold in 1949. The result was a white-hot stock market and one of the greatest feats of wealth creation of the past century. Tax revenues rocketed.
All this could happen once more, but only if the correct solution is applied. In such an environment, the bad-debt problem would quickly dissipate, leaving only bad memories.
The writer is an economist at Polyconomics, which provides research for institutional investors |
