No Cheer in Japan over America's Woes

Tokyo is too busy sweating about what'll happen to it if U.S. corporate scandals keep weighing down the greenback

By Brian Bremner

U.S.-style capitalism has a major-league image problem in the rest of the world at the moment. In many corners, it's the target of sneering laughter. Americans may not like it, but imagine if you had spent years listening to sermons on corporate governance from the Clinton and Bush Administrations. They and the U.S. business press hyped free-market capitalism as the very Platonic ideal of economic management.

Interestingly enough, though, you don't see as much gloating among the Japanese as you would think. And it's not because they're being polite. Executives and Bank of Japan (BOJ) officials worry about the blowback to their economy should the U.S. get into some sort of serious economic jam. They're particularly worried about a sudden crash of the dollar, which has weakened about 10% against the yen and the euro since the end of the 2001.

President George Bush doesn't want to see the dollar tumble or the already declining foreign-capital flows into the U.S. stock and bond markets turn into a wholesale pullout. That would surely whack the Standard & Poor's 500-stock index and put upward pressure on long-term interest rates at a time when consumers have spent two years wincing at the losses in their 401(k) accounts and kissing off any thoughts about early retirement.


  Bush's pledge to clean the stables of Corporate America in his Wall Street address on July 9 wasn't just for domestic consumption. Every fresh outrage -- take your pick, WorldCom, Tyco, Qwest, Enron, Computer Associates -- gives global investors another incentive to cut their losses before the next disclosure. And that puts downward pressure on the dollar, which is the last thing Japan wants to see.

Japan's Finance Ministry and the BOJ have already been regularly intervening in the currency markets to halt the dollar's slide -- to little avail. Currency traders' anti-greenback sentiment is just too strong, and demand for dollar assets is too weak. The yen has risen in value, from 135 to the dollar to about 118. Should it really overshoot to, say, 100 or so, Japan can probably kiss its nascent recovery goodbye.

In the January-to-March quarter, Japan sprinted out of recession and grew at an annualized 5.7%. Roughly half of the gain came from export growth to the U.S., China, and elsewhere. That export wave also contributed to a pretty big recovery in industrial production. Late last year and during much of the first quarter, the yen was relatively weak, trading in a range of 125 to 130 or so. No more.


  It may well be that the great corporate crime wave of 2002 will prove short-lived. Sure, a tsunami of earnings restatements will likely occur in the months ahead as everyone catches on to the idea that the days of creative earnings management are over. Eventually, confidence will be restored, and the U.S. will recover its image as a global financial center governed by financial probity, the ultimate haven. Let's hope so.

Yet even under the most bullish scenario, the terrorism wildcard remains. A guy I know at the BOJ wondered over lunch what the world would be like if there were no havens, or at least if the U.S. could no longer play such a role. Instead of corporate scandals dragging down investor confidence, the fear is that America is heading into a turbulent period of civilian killings and bombings, something on the scale of September 11 or perhaps worse.

Japan is the world's biggest net creditor, meaning it has huge claims on the rest of the world, particularly the U.S. This includes a huge amount of dollar claims -- stocks, Treasury bonds, truck plants in Indiana, and resort complexes on Maui -- all sorts of stuff. If terrorists were able to regularly deliver multibillion-dollar shocks to American cities and infrastructure, the greenback would get pounded, and so would a lot of Japanese wealth.


  During much of the 1990s, a robust U.S. economy, the importer of last resort, bailed out Japan and exporting economies all over Asia. But now the outlook is uncertain. America's monster current-account deficit and swelling budget deficit mean it's heavily reliant on foreign capital. A lot of things -- corporate scandals or terrorism -- could be the tipping point for a dollar crash.

That scenario would be a double blow for Japan. Its big institutional investors, such as life insurers with big U.S. bond portfolios, would endure huge losses, and the export sector now carrying the economy would also take a beating. Such are the financial and trade ties that bind the world's two biggest economies.

Bremner, Tokyo bureau chief for BusinessWeek, offers his views every week in Eye on Japan, only for BusinessWeek Online

Edited by Beth Belton