Now, Japan Needs Domestic Growth

Japan's money pump is pouring liquidity into the global financial system at a prodigious rate. By recycling its huge trade surpluses, Japan is helping to boost stock and bond markets around the world. Interest rates are lower, equities are higher, and everyone benefits, right? Not exactly. Japan has been running a low-yen, high-tax, anticonsumer policy mix for much of its postwar history. That leads to tremendous export-led growth. But it generates giant trade surpluses that must be constantly recycled to keep the yen from soaring further and curbing exports. What Japan--and the global economy--need is not more liquidity but more Japanese growth.

Japan's powerful bureaucrats, especially in the Finance Ministry, don't agree. When the yen shot up against the dollar in 1995, hurting exports, no serious effort was made to cut taxes or deregulate the economy to compensate and stimulate domestic growth. Instead, the Ministry moved to push the yen lower. It won when a deal was brokered between the U.S. Treasury and Tokyo in April, 1995, that led to a 25% depreciation of the yen, from 80 to about 100. (It is currently trading at 110 against the dollar, down 37.5% from its high.)

Had the yen remained at 80 to the dollar, the entire structure of the keiretsu system might have radically changed, opening Japan's closed economy for the first time. Close-knit relationships between big corporations and domestic suppliers were just beginning to unravel. Global prices rather than long-term domestic ties were starting to determine purchase practices. The Ministry's victory allowed the keiretsu system to survive. At 100 to 110 yen to the dollar, Japanese corporations have the profits to keep their system intact even as they evolve and set up closed keiretsu systems around the world.

The sloshing about of huge amounts of cash in the world financial system may provide short-term benefits to some, but it comes at a price. For Japan, it is lower economic growth and the end of employment security. For the world, it means the erosion of the free-trade system over time.

    Before it's here, it's on the Bloomberg Terminal.