That Sinking Feeling In Japan

With Japanese real estate prices falling, Toru Takano recently snagged a great bargain: For $330,000--a third of what it would have cost during the booming 1980s--Takano, 33, and his wife, Kaori, 30, bought a three-room house in the Tokyo suburb of Tokorozawa, a 60-minute commute from his job as a salesman at a maker of electronic parts. But is Takano celebrating his good fortune? Anything but.

As the yen spirals and competition from cheaper offshore manufacturers intensifies, Takano's company is being forced to slash prices to keep from losing sales altogether, and he sees no relief in sight. "I don't think the economy is going to get much better," he says.

Takano isn't the only one fretting. Just eight months ago, the Tokyo stock market was rebounding, and it appeared that Japan had emerged from its longest slump since the end of World War II. Then came the Kobe earthquake, followed by the financial shock of the runaway yen (chart, page 54). Now, hopes for an economic upswing appear to be running out despite $546 billion in emergency government spending since 1992.

It's not just land and stocks that are falling. From machine tools to beer, goods prices across the economy are declining. Profits are plummeting. Even the cost of a golf-club membership is way down. Joining the exclusive Koganei Country Club runs about 100 million yen ($1.2 million)--less than a quarter as much as in 1989, the height of the bubble economy.

The key question now is whether powerful bureaucrats at the Ministry of Finance and the Bank of Japan really want to pump more money into the economy to halt deflation. To be sure, bureaucrats bear some of the blame for yen shock, or endaka, by balking at pushing through wide-ranging programs to deregulate and open the Japanese economy. But given this reluctance, as well as their distaste for spending huge new amounts on pump-priming, it may be that a strong yen and declining prices will be the bureaucrats' only choice to trigger the kind of radical corporate restructuring Japan needs.

Deflation is forcing Japanese manufacturing and the inefficient distribution system to streamline, a goal most bureaucrats endorse even though it could exacerbate unemployment. Deflation will make homes more affordable and capital spending cheaper. It will also help bring domestic prices more in line with those in other countries--an important plus as the current price gap becomes a potent political issue. Perhaps this explains why decision-makers don't seem rattled by the Darwinian shakeout in corporate Japan that deflation is causing. "The strong yen is certainly strong medicine," says economist William Sterling of Merrill Lynch & Co. But after the excesses of the 1980s, he adds, perhaps "what Japan really needs is a good crisis" to shock it back onto the path of long-term, stable growth.

In a system that was always rigged to favor producers over consumers, Japanese industrial giants were rarely threatened by such shocks. They would simply deploy cash garnered from high prices at home to keep prices low and expand their reach abroad. That's one big reason the cost of living in Japan is roughly twice that of the U.S.

But now that high domestic prices and profits are waning, companies are driving down costs by consolidating at home, fleeing offshore, and shrinking bloated product lines. As a result of these brutal pressures, private economists believe Japan will be lucky to see the gross domestic product grow even a half of a percentage point in 1995--the nation's fourth straight year of stagnation.

DICEY OUTLOOK. After GDP actually shrank at a 3.4% annual rate in the fiscal fourth quarter that ended Mar. 31, even the Bank of Japan, which earlier had been sanguine about the economic outlook, was forced to suggest that the recovery looked dicey. That came as bad news to Ministry of Finance officials, who need more revenues to pay for stimulus programs and to finance the needs of a graying populace. It's also worrying Asian allies that are currently thriving on rising sales to Japan.

Indeed, fears are rising that Japan's appetite for foreign goods will diminish just as the U.S. economy is beginning to cool and Europe's recovery reaches its peak. That could spell tougher times for the global economy. World growth is already expected to slow to 2.4% next year, after reaching 2.7% in 1995, estimates Deutsche Bank Research. But a steep Japanese slump could worsen the global slowdown.

Economist Jennifer Feldkamp Decker of DRI/McGraw-Hill thinks that in the absence of bold action to deregulate the economy, open the country to more imports, cut its $127 billion trade surplus, and revitalize growth, Japan could face an even higher yen and more stagnation. In that case, she estimates the economy could expand as little as 1.3% annually for the next five years. Adds one high-ranking Western official: "The last thing the world needs is one of the major economies looking like it's going into deflation."

Yet deflation is what's happening. There's even a special term for it: kakaku hakai, or "price destruction." You certainly see that in computers. Once unchallenged at home, the Japanese industry's clout is being undercut by cheap imports. In Tokyo's sprawling electronics bazaar at Akihabara, Compaq and Apple PCs can be had for 20% to 40% less than comparable Japanese brands. And with U.S. rivals grabbing 30% of Japan's $9 billion market last year, NEC Corp. was forced to slash prices by 20% on one line of PCs.

It's much the same story for more mundane consumer items. Sumitomo Corp. is importing living- and dining-room sets from such U.S. companies as Thomasville Furniture and Hickory Hill Furniture and selling them through Japan's biggest furniture retailer, Otsuka Kagu. This year, Sumitomo expects to import $18 million worth, 20% more than in 1994. On top of that, the company is bringing in $60 million worth of cut-rate sports equipment, glassware, and leather goods. And some independent distributors have started buying Kirin beer made in Hong Kong and shipping it back to Japan. The imported stuff undercuts domestically brewed Kirin by one-third.

Deflation has acquired such momentum that Salomon Brothers Inc. economist Robert A. Feldman expects consumer prices will fall 0.5% annually over the next two years. That would be something Japan hasn't seen since the years following World War II. In fact, price destruction represents "a structural change that will continue through the end of the century," says Sanwa Research Institute economist Keisuke Iwasaki. Although lower prices are good for consumers, such a lengthy drop in prices could spawn a vicious cycle of lower domestic consumer spending, a higher yen, and even greater pressure on prices, profits, and the battered financial system, Western economists warn.

UNCONCERNED. Despite such gloomy forecasts, the coalition government of Prime Minister Tomiichi Murayama has so far mounted a relatively modest response. On Apr. 14, the government unveiled its latest emergency spending package. Urging companies to buy back stock to support share prices and giving special attention to helping smaller companies hit by endaka, the plan may come up with $12 billion in aid.

Most economists have scorned the proposal as inadequate. And while market watchers say that some Bank of Japan researchers fear deflation will spin out of control, hammer down land prices even further, and wreak havoc with ailing banks, the prevailing view is still that deflation is not yet a big concern. That's one reason why the central bank waited months before cutting its discount rate by 75 basis points, to 1%, on the day Murayama announced his economic program. Some critics believe this cautious policy is only heightening deflationary pressures. To keep interest rates from falling below its target, for example, the bank has been siphoning massive amounts of liquidity from the Japanese banking system. With money growth barely budging, real long-term interest rates now may be a punishingly high 5%--significantly above those in the U.S.

The Bank of Japan seems blithely unconcerned about what its strategy is doing to financial markets. For example, the slumping Nikkei stock average--off 56% from its 1989 peak--is pummeling banks' and insurers' portfolios. On Apr. 24 alone, 11 Japanese commercial banks disclosed they face $7.4 billion in write-offs because the value of their stock holdings has fallen below what's stated on their books. With commercial property prices down more than 50% since 1991, Japanese companies last year sold an astounding 23.7 million square feet of property to raise cash. The amount of land sold was up 19.3% from 1993, according to real estate data service Tokyo Shoko Research. The sales netted only $7.7 billion, down 9.7% from the year before.

While financiers are selling assets, manufacturers are hunkering down for survival. Take Mazda Motor Corp., which derives 60% of its sales from exports. Stung by the strong yen and languid U.S. car and minivan sales, it announced on Apr. 26 that it would slash output at its Japanese plants by 22% this quarter and take new steps to reduce costs. Even more sweeping reductions are hitting metals producers. Mitsubishi Materials Corp., hard hit by cheap zinc imports, plans to close a smelter in Akita Prefecture that has been losing $1.2 million a year. Sumitomo Metal Industries Ltd., meanwhile, is accelerating job cuts at several steel plants to save $700 million a year. Both companies will assign idled workers to other companies.

TAKING THE PLUNGE. Such actions are a clear sign that the Japanese are allowing change to creep into their system. How far and how fast it will go is the key question. Critics argue that Japan must undertake sweeping and immediate steps to open its trading system, deregulate systematically--or face a deep crisis. But so far, the government is resisting sudden moves and seems to be acceding to the power of yen-bred deflation to gradually reshape Japan.

In the absence of wide-ranging macroeconomic-policy moves or huge deregulation schemes, regulators will rely on Japanese corporations and financial institutions to fortify themselves against deflation and yen shock as quickly as they can. For now, Japan is deciding to put up with yen strength. While that leaves the country staring at the likelihood of a continued high yen, falling prices, and even recession, it's a risk policymakers seem willing to take. If that means slower growth for the rest of the world, so be it.

How Deflation Affects Japan


-- NEC has slashed prices on its PC-9800 series by up to 26%, to defend its 50% share of the personal-computer market against U.S. rivals such as Compaq, Apple, and Dell.

-- Chain stores are selling furniture imported from American retailers--and downsized for Japanese households--at a big discount over domestic brands.

-- Beer distributors stock Kirin beer produced in Hong Kong and other countries. The reexported beer costs about $46 a case, vs. $61 for most Japanese brews.


-- Many retailers are selling color TVs, VCRs, and stereos for 10% to 30% below their "suggested manufacturer's price"--and swallowing the difference.

-- The rampaging yen and falling land prices are forcing companies to sell off land holdings at bargain prices to shore up their earnings and balance sheets.

-- Falling share prices are forcing Japanese brokerages and banks to take big write-offs on their portfolios, crimping their ability to pay off bad debts.

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