Commentary: Japan: This Time, It Could Get Nasty

For much of the past decade, the cycle has been the same: Predictions that Japan's lumbering economy has finally turned the corner slam into a brick wall after a few quarters. Rather than reach for bold solutions, Tokyo's mandarins assemble a massive fiscal-stimulus package to keep corporations and banks afloat. Meanwhile, producers of everything from cars to consumer electronics set their sights on healthy overseas markets and crank up the export machine. That keeps employment up and fills coffers enough to keep the yen from tanking.

But this time, the old formula won't work. And that could make for a brutal 2001. With its 18-month recovery already fizzling, Japan must now confront an unexpectedly sharp slowdown in the U.S. and Europe. Companies such as Kawasaki Steel, Mitsubishi Motor, and Sumitomo-Osaka Cement are scaling back production. What's more, the government, stuck with the industrialized world's largest fiscal deficit after pumping $1.1 trillion into the economy since 1992, will be hard-pressed to pick up the slack.

WELL OFF. Without the usual sources of relief, Japan's dysfunctional economy could plunge into crisis. Foreign investors have been pulling out of Japanese equities. The yen has plunged to a 16-month low. The Nikkei? It just finished its worst year of a dismal decade and remains 65% off the all-time high set in 1990.

Optimists still cling to forecasts of Japanese growth of 1% to 1.5% for 2001. But that's well off the 2% expansion predicted last fall, when rising consumer spending and a still-buoyant technology sector buttressed confidence. A rash of new data have dashed those hopes. They show rising unemployment and slowing output and investment. Bears say that when revised data come out for 2000's fourth quarter, they will show Japan is already in recession. "It's hard to see what's going to get better for the economy," says Bank of America currency strategist Marshall Gittler.

The biggest worry is the sputtering U.S. economy. Throughout the 1990s, Japanese producers have counted on America's insatiable appetite for cars, computer chips, and machinery. The burgeoning euro zone and East Asia also absorbed exports. That drove strong local manufacturing investment.

But Japanese shipments to the U.S. have fallen each month since the summer. Monthly car exports, for example, slipped by 7.9%, to 152,000, in November. Hardest hit were Nissan, Mitsubishi, and Mazda. Auto makers won't get much help at home, either. "I don't sense much vitality in the Japanese economy," says Honda Motor Co. President and CEO Hiroyuki Yoshino. Japan's steel industry, in fact, is bracing for a 6.6% fall in output in the fiscal year starting Apr. 1.

Such production cuts will ripple through the economy. The government says capital spending will fall by 2.1% in fiscal 2001--after jumping 9.4% last year. Workers are already feeling the impact, which explains why consumer spending has slowed.

What Tokyo usually does in this situation is unveil another colossal government-spending program. But now the government can't afford such largesse. After Tokyo floats $860 billion in bonds this year, the national debt should reach $5.8 trillion, or 141% of GDP. If Tokyo borrows more, it could suffer a credit downgrade, higher long-term interest rates, and a sinking yen. The Bank of Japan won't help, either. Rates are already only 0.25%. And the BOJ remains against greatly expanding the money supply, which could spark inflation. Says HSBC Securities' Kazuhiko Ogata: "Fiscal and monetary policy have reached their limits." One-fifth of the current $738 billion budget is already pledged to debt service. So public-works spending is to remain flat at $82 billion.

On top of this, thunderclouds still hover over a financial system already soaked in 2000 by the bankruptcies of Sogo Department Stores and Chiyoda Mutual Life Insurance Co. The critical list still includes corporate giants like Kobe Steel and Mitsubishi Construction.

That spells more bad news for Japan's banks, which are sitting on some $300 billion in nonperforming loans. Several could go under. And new lending, which has fallen for 44 straight months, will remain scarce.

The only way out, agree most analysts, is for Japan to close banks, write off all bad debt, and force wholesale industrial restructuring. Of course, that's the same advice financial policymakers have ignored for years. And Prime Minister Yoshiro Mori is too politically weak to try anything radical. It may be a new millennium, but Tokyo is guided by the same politicians with their quick-fix solutions and lack of vision. But this time, the old remedies may not be able to halt a real crisis.

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