A very interesting article on Japan and the US. Well worth reading.
Japan: America, Japan, and Potholes
Robert Alan Feldman (from Washington DC)
Key Points
US policy toward Japan is now being driven by a combination of (1) fear of a Japanese meltdown, (2) hope that the voter message to the LDP is heard, and (3) worry that the new leadership my not be strong enough to implement necessary reforms. The most likely result is that the US administration and Congress will keep applying pressure on the Japanese government, although the tone of the pressure will attempt to be constructive. Pressure will focus on financial and structure reform, implemented under the cover of a further expansion of fiscal support. The new Japanese administration will face a number of potholes very quickly, including the choice of a credible Cabinet, forging a working majority in the Upper House, dealing with the difficulties of the SumiTrust-LTCB merger, creating credible rules and powers for the new Financial Supervisory Agency, putting meat on the bones of the bridge bank plan, and convincing the US that the efforts are credible.
Details
The prevailing attitude among US policymakers toward Japan now is one of fear. In both the Administration and on Capitol Hill, there is a strong fear that Japanese economic and financial problems will prove contagious. Congress and the Administration are both worried that worsening of Japanese economic weakness will infect financial markets, drive the yen weaker, worsen protectionist sentiment, and push Asia into yet another downstep. These fears have generated a genuine desire to help Japan out of its economic and financial hole, not out of altruism but out of self-preservation. In short, the US views helping Japan to be a positive sum game.
There is also a widespread hope among US policymakers that a message of the desire for more aggressive reform from the Japanese electorate to the LDP will be heard. There is, however, doubt, on two counts. First, policymakers worry that the Japanese voter may have voted in favor of more state capitalism than less, in light of the fact that left-leaning parties gained most seats in the Upper House election. Even if the message from the voters was merely protest against inept policy by the LDP, there are doubts that the LDP heard properly, due to the business-as-usual methods by which the new PM selection has started. (Postponement of the LDP party president election from July 21 to July 24 is viewed as a positive sign, however.) In short, there is hope that the right message was heard, but proof will be required.
After fears and hopes, there is worry that the new leadership may not be able to implement policies that are more aggressive. In DC, the frontrunning candidate for PM, Foreign Minister Keizo Obuchi, does not have a clear constituency of supporters, even though the State Department believes that its relationship with him during the most recent Hashimoto Cabinet has been constructive. His impression on the DC press was not favorable, and thus as PM he will face an uphill battle for credibility. In this sense, should Obuchi become prime minister, Washington will be looking for a Cabinet of heavyweights as a sign that policy action is likely. Should Kajiyama become prime minister, his bluntness and willingness to give orders on financial reform will be appreciated, but there remain doubts about his command of the broad range of policy issues that confront the country or the relationships among them.
In light of the fears, hopes, and worries, Washington is not likely to ease pressure on Japan. On the contrary, there appears to be a clear consensus that targeted, specific, and frank advice at this point would be constructive, even if it steps on some Japanese toes. The most likely change will be the tone of the suggestions from annoyance to concern. The metaphor will be that of The Deep Hole. The US is eager to help Japan out of The Deep Hole into which it has fallen, but there are two conditions.
The first condition is that Japan must stop digging. This first condition requires major financial sector reforms on the lines of the six hurdles that I discussed in the Global Economic Forum of June 26, or the five points mentioned by William Seidman (former FDIC Chairman and now an advisor to the Japanese Deposit Insurance Corp), such as credible accounting and a czar to oversee coordination of the many financial reform actors.
The second condition requires that Japan not pull the US into the same hole. Potential contagion points (such as the yen/dollar rate, trade developments, and rules on financial market reform) must be isolated and treated before contagion starts.
For investors, all of this adds up to a set of potholes that the new Japanese administration must avoid if markets are to remain calm. The first is the choice of the new Cabinet, which must have the desire, brains, sincerity, and power to implement reforms rapidly. Second is the relation of the new Cabinet to potential allies in the Upper House. Without a good working relationship with either (1) the Komeito or (2) the Liberals along with a number of independents, the LDP will not be able to pass reform legislation, and thus would be forced into a general election soon. Third, the issue of the proposed merger between Sumitomo Trust and LTCB must be handled in a way that creates a viable precedent for the future. Fourth, the powers and responsibilities of the new Financial Supervision Agency must be clarified and made credible. Fifth, the bridge bank scheme must be made more specific in both scale and scope, while provisions for dealing with institutions that fall outside of the bridge bank scheme must also be specified with conditionality strict enough to satisfy investors. Sixth, support of the United States must be secured, in order to enhance market confidence.
It is imprudent to expect all of the potholes to be fully avoided. However, the very density of potholes may in fact contribute to a better solution. The market consequences of falling into any of the potholes would be serious enough to encourage a great deal of focus on all of them.
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