Speaking of junk bonds, how about JGBs?
Ten Years After the Kobe Quake: Japan's Economic Tremors
January 18, 2005 2212 GMT
By Peter Zeihan
At 5:46 a.m. on Jan. 17, 1995, a massive earthquake struck Kobe, Japan, devastating the city and killing more than 6,400 people. But Kobe was more than a physical and humanitarian disaster; it also laid bare the inconsistencies of the Japanese economic model and heralded much bigger earthquakes to come.
After the post-World War II U.S. occupation ended, the Japanese struck upon an economic model that would stick with them to the present day. Economic growth and profit were certainly considerations, but they were not the guiding light for Japan's early post-war years.
The key concern was to rebuild the citizenry's faith in the government and Japanese culture by ensuring everyone had a stake in the new system, and that placed employment at the center of economic planning. The Japanese figured the best way to ensure that everyone had a job was to ensure that Japanese firms got as large and as important and held as much market share as possible. Bigger -- since it meant higher employment rates -- was by definition better.
To facilitate the formation and growth of the massive conglomerates -- the famed Japanese keiretsu -- the government needed to ensure the firms had immediate access to absolutely everything they could possibly need. But aside from forming a top-notch educational system, the government had very little control over anything that a company might need. Commodity prices and availability were all determined by international markets, as was demand for Japanese goods. Japan learned those twin facts all too well in World War II.
This led Japan to take control of the one thing it could: money. Japan squared the circle by forming a new financial system from the ashes of its defeat, which -- at government direction -- ensured that select firms were consistently granted access to all the cheap loans they could use. In order to prevent the hemorrhaging of capital abroad, Tokyo had to at least partially divorce the Japanese economy from the global one. Against the background of the Cold War, the United States found this a price it was willing to pay.
The mix of American interest in Japanese success and Tokyo's command of credit set the stage for not only survival, but also for rapid growth.
Oil prices too high? More cheap loans to buy oil. Development costs too high? More cheap loans to cover research and development and training. Products flopped? More cheap loans to move on. Insufficient demand? More cheap loans to make customer financing possible. Too much debt? Get a cheap loan to pay off your cheap loans.
The key tenets became market share and employment, with cost management and profitability quietly fading into the background. By the 1980s, Japanese firms were expertly manipulating their debts with a skill that would dazzle any credit-card shuffling American college student.
But such developments cannot happen in a vacuum. The boards of directors at Japanese banks knew full well they were offering more and more credit to their clients. Over time this led to ever-closer relationships between debtor and creditor until banks found themselves supplying the bulk of their loans to the same industrial conglomerates. This made the banks desperate to make their clients successful -- it simply would not do to have their primary clients declare bankruptcy. So the loans flowed on, increasing the banks' exposure with every passing year.
Loaning money at minimal interest rates might have kept the client firms alive, but it no longer made them thrive. When Japan was an impoverished archipelago bent on reconstruction, maybe, but once it began contending internationally the only way in which Japanese firms could consistently compete was on price and financing. That sparked huge inefficiencies throughout the Japanese export sector, which was and remains the most "dynamic" portion of the Japanese economy.
The minimal cost loans also did nothing for the banks' bottom line. Ever try making money when you charge zero percent interest -- or less? The "solution" was for the banks to "diversify" their holdings and income by purchasing stocks. In order to reinforce their loan sheets, most banks chose to invest in their clients. On occasion the Japanese conglomerates simply dispensed with the fiction that the banks were independent and purchased them outright. (Some did not even have that fiction to shed.)
With all this cheap money sloshing around in the system it was only a matter of time before some type of asset that existed in an absolutely limited amount -- in this case, land -- began to rise in price to stratospheric levels. If one has access to an unlimited supply of cash, one can purchase nearly anything. If multiple players have similar access, the bidding wars can get amazingly steep. By 1989, plots of land in downtown Tokyo were valued more highly than entire American states.
Needless to say, this was a bubble.
Needless to say, it popped. Loudly.
By 1991, Japan was in its first post-Cold War recession (it has had three more since). Among myriad problems was the debt issue. The banks were insolvent by any non-Japanese evaluation, and few Japanese firms could compete effectively in the international marketplace without continued cheap loans. So cheap loans they got, and all the problems compounded.
At this point, the government stepped in and attempted to restart the post-bubble economy with a modest stimulus package. As the conventional thinking went, a short burst of stimulus spending would spark economic activity and get things moving again.
Enter the Kobe earthquake. The government's response to the tragedy was the largest reconstruction and infrastructure development program since the post-World War II rebuilding effort. In 1996, Japan racked up an impressive 4 percent growth on the rebuilding effort -- and promptly slipped back into its stupor in 1997.
The problem was that the private sector was in no shape to help out. So indebted were private firms that even after a national emergency they had no spare bandwidth to grow. As soon as the government's stimulus spending -- paid for with borrowed money -- ended, the economy staggered back into recession. Non-Japanese international banks found all this a little spooky and began to tighten up international credit requirements in the hope that the Japanese would shape up. Instead, many Japanese banks recognized that meeting international requirements would destroy them and their clients, and simply sold their overseas assets so they could ignore the new rules. The government responded by spending more to bring growth up again, only to watch helplessly as growth fell the moment they stopped spending.
The new "solution" was supplementary budgets, which were financed entirely on deficit spending, particularly ones that built things: dams, roads, bridges. Of course Japan, already being a highly developed state, did not really need this new infrastructure. By 2003, Japan had had about 20 of such budgets that collectively spent more than $1 trillion on building roads to nowhere and bridges to empty islands. It has become so bad that about 10 percent of Japan's non-farm workforce is now employed by the construction sector.
Make that many people that dependent on government largess and you can probably visualize some of the evolutions within the country's ruling party. Suddenly, there was a large, vocal, voting population that had a vested interest in ensuring that the little problem of deficit spending never got seriously addressed. In short order Japan transformed from the biggest creditor in human history to its biggest debtor, with a national debt equal to 150 percent of its gross domestic product (GDP).
That is the type of factoid that makes people sit up and take notice, and the Japanese consumer certainly did. But instead of rallying up to demand change, the Japanese bunkered down and saved their money. Perception became reality: the result was a falloff in consumer demand, which slashed corporate earnings, and, by extension, that all-important job security. Now Japan has deflation and unemployment problems on a scale to rival its debt crisis.
The question is not so much will Japan ever learn, but will it collapse?
The answer is most certainly yes, and the timeframe is probably closer than most would think. Already Japan's credit rating is down at the level of Botswana, and with budget deficits that would make the Bush administration -- and even the Italians -- blush with embarrassment it will only go down from here. Simply put, this is not something that a country can recover from without a crash. As an example, Argentina was forced into default when its debt load hit about 55 percent of GDP, only about one-third of Japan's.
The upside, if it can be called that, is that some 97 percent of Japan's government debt is owned domestically. There are no international investors knocking on Japan's door asking where their money is. Partially, this is because the market is so flooded with Japanese government debt that no one abroad has much interest in holding it, but mostly it is because Japan has a network of de facto capital controls that force savers -- largely through the country's postal savings system -- to invest in Japanese government bonds.
This characteristic means the ultimate solution to Japan's problem will not be international and economic, but domestic and political. That does not mean it will be pretty. It will still result in the annihilation of every savings and retirement account in the country, but financial spillover to the wider world will be rather limited. Suddenly, the world should be quite thankful that Japan decided to divorce its financial system from the rest of us.
For Japan this is nearly old hat. Japan has not incorporated change into its system as a fact of life. It resists it, rails against it until the pressures become so large that the country shudders …
… and experiences an earthquake.
The last two times Japan quaked were the Meiji Restoration, in which the shoguns were physically eliminated as a class, and the Japanese defeat in World War II.
Another earthquake is coming to Japan, and it will make Kobe look like child's play. |
