Japan: This Time, It Could Get Nasty

As Japan's economy tanks again, the old fixes won't work

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.

This time, however, it looks like the old formula won't work, and that could make for a brutal 2001. With its tepid 18-month recovery already showing clear signs of going completely cold, Japan Inc. 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 Japanese government, stuck with the industrialized world's largest fiscal deficit after pumping $1.1 trillion into the economy in the form of public-works proj- ects and tax breaks since 1992, will be hard-pressed to pick up the slack.

IN RECESSION. Without the usual sources of relief, Japan's dysfunctional economy could plunge into crisis. Sensing the crunch to come, foreign investors have begun pulling out of Japanese equities. And the yen, which has remained steady since the Asian crisis, has weakened precipitously in the past few days, reaching 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 are still clinging to a forecast of Japanese growth of 1% to 1.5% for 2001. But that's a far cry from the 2% expansion predicted last fall, when rising consumer spending and still-buoyant technology investment in the West buttressed confidence that the economy was improving. Those hopes have been dashed by a raft of recent data indicating that unemployment is rising, output and capital investment are slowing, and unsold inventory is accumulating. Indeed, bears say that when revised data are released for 2000's fourth-quarter, they will show that 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 cause of alarm is the sputtering U.S. economy. Throughout the 1990s, as Tokyo came up with one wasteful stimulus scheme after another, Japanese producers have been able to count on America's insatiable appetite for cars, computer chips, machinery, and building materials. The burgeoning euro zone and neighboring markets in East Asia also absorbed Japanese exports, which account for 10% of gross domestic product. And rising exports continued to drive strong local investment by Japanese manufacturers.

But with America's consumers growing weary, signs of a slowdown are already showing. 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 Japa-nese 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 April 1.

Production cuts will ripple through the economy. The government now forecasts that 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 Japa-nese consumer spending--which accounts for two-thirds of the economy--has slipped and unemployment has inched back up toward a record 4.9%. Overtime hours, which workers rely on to finance cars, homes, and other big-ticket items, are drying up. Companies are also hiring more part-time staff while cutting back on more expensive full-time workers. "It will be some time before households reap the fruits of any recovery," says Jardine Fleming Securities economist Mikihiro Matsuoka.

The pressure is building. What Tokyo would usually do in this situation is unveil another colossal government-spending program. But the government is exhausting its capacity for such largesse. After Tokyo floats a record $860 billion in bonds this year, the national debt is expected to reach $5.8 trillion, or 141% of GDP. The U.S. debt, by comparison, is 51% of GDP. If Tokyo adds even more debt, it could suffer a credit downgrade, higher long-term interest rates, and a sinking yen. Politicians would also risk the wrath of Japanese voters, who don't want to foot the bill for more pork-barrel spending. The Bank of Japan can't help much, either, since rates are already only 0.25%. And the BOJ remains dead set against dramatically expanding the money supply, which would boost inflation as well as spending. In sum, says HSBC Securities' Kazuhiko Ogata, "fiscal and monetary policy have reached their limits."

Any additional money for public spending will have to be recovered from the current $738 billion budget. But one-fifth of the budget is already pledged to servicing government debt. So even though Liberal Democratic Party elders would love to prime the pump, overall spending will grow by just 1.2%, while public-works spending is to remain flat at $82 billion. Moreover, local governments must match outlays by Tokyo--and many are too broke to finance new projects.

On top of all this, thunderclouds still hover over a financial system already soaked in 2000 by the mega-bankruptcies of Sogo Department Stores and Chiyoda Mutual Life Insurance Co. The number of companies on the critical list keeps growing. Among them are Kobe Steel, Mitsubishi Construction, and retail giant Daiei.

ONLY ONE WAY OUT. That spells more bad news for Japan's banks, which are already sitting on some $300 billion in nonperforming loans. Construction contractors alone have compiled an estimated $92 billion in dud loans, and such giants as Kumagai Gumi, Mitsui Construction, and Fujita are persuading their banks to forgive debts. Due to a $600 billion emergency fund set up by the government in 1998, few analysts expect a full-fledged meltdown. But several banks could go under. And tight balance sheets will again crimp new lending, which has fallen for 44 straight months.

The only way out, agree most analysts, is for Japan to close banks, write off all bad debt, deregulate the economy, force wholesale industrial restructuring, and end wasteful public works. 0f course, that's the same advice financial experts have been offering since Japan's bubble burst in 1990. Tokyo's policymakers have ignored it because the consequences would be a destruction of Japan's tight social contract--and probably the ruling party's system of patronage. With Prime Minister Yoshiro Mori presiding over a wobbly coalition government, radical action is unlikely.

It may be a new millennium, but Tokyo is guided by the same politicians with their quick-fix solutions and lack of vision. With many of those old policy options unavailable, now nobody would be surprised if this time a real crisis develops.

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