The market is the judge in the market-driven economy. For instance, the stock market tells — through prices formed by the collective will of investors — where the real economy stands. Although this fact is self-evident, it is often forgotten or misunderstood. The current slump in the Tokyo stock market, at a time when the economy is finally picking up, provides food for thought.
The market — investors collectively — has plenty of information about the economy. To be sure, the market often overreacts, temporarily pushing prices to unrealistic levels. But, by and large, it behaves realistically, precisely because it is well-informed. Its general condition, for better or worse, is in itself a message that needs to be taken seriously.
When the bubble economy collapsed a decade ago, many Japanese, including policymakers, could not understand why the boom went bust so quickly. With hindsight, they were complacent, oblivious to the approaching crisis. We must not repeat the mistake of being unable to see the forest for the trees.
The Bank of Japan’s recent decision to lift its zero-interest-rate policy is a case in point. The Tokyo stock market reacted with a yawn; there were no selloffs. Political leaders and corporate managers had opposed the decision on the grounds that it could nip the recovery in the bud and send stock prices into free fall. They have been proved wrong.
The decision marked a small step toward ending the anomaly in overnight interbank lending rates, not an outright change of monetary policy. It was largely a symbolic step, not the sort of change that would shake up the stock market. Yet many, including politicians, did something close to crying wolf instead of offering cool-headed analyses.
The Nikkei stock index climbed to the 20,000 level in mid-April for the first time in about three years, but hit the skids in subsequent months. Now it hovers around 16,000. Market participants say there are a number of reasons for the slump.
The first is the slow pace of structural reform in nonmanufacturing industries, such as distribution, real estate, construction and financial services. So far, the market has not given high marks for restructuring and mergers in these sectors, largely because investors in general believe such reform efforts are not going far enough. Moreover, zero interest rates, which have eased the corporate debt burden, are seen to have slowed the pace of reform.
Second, the ultra-easy money policy created a minibubble in stock prices. With deposit interest rates close to zero, vast amounts of savings poured into the stock market, particularly into stocks related to information technology. Cell-phone sellers and even startups with no stakes in the Internet business went public. Their initial public offerings fetched astonishingly high prices. But the “IT bubble” popped around February.
Another but no less important factor is the fact that foreign investors, particularly those in the United States, have held a net selling position in the Tokyo market since April. U.S. investors have also turned up the selling pressure in European markets. It is believed that funds gained from selling Japanese and European shares are going into import payments or stock purchases in New York.
The long-running U.S. economic boom has inflated import demand, creating massive deficits in the trade and payments accounts. At the same time, domestic prosperity has produced an enormous surplus in the federal budget, prompting the government to stop issuing new bonds. As a result, the foreign money flows that used to finance bond purchases have also stopped.
U.S. corporations, meanwhile, continue to raise huge amounts of money for investment, riding on the stock-market boom at home. The total market capitalization of the New York exchange is estimated at double the U.S. gross domestic product — a situation similar to that which existed in Japan 10 years ago, just before the bubble economy collapsed.
That U.S. corporations are selling their overseas holdings means that cash flows supporting U.S. imports and stock prices are beginning to dwindle. That makes it likely that the joy ride on Wall Street will come to a grinding halt.
The question is whether Japan’s economy will have the strength to withstand shocks to the Tokyo market. A U.S. economic slowdown is bound to hit Japan’s export-dependent manufacturing industries. And a slowdown in the export sector will likely affect Japan’s efforts for sustainable economic recovery. That is part of the reason why reform in the nonmanufacturing sector must be expedited so as to absorb the impact of a U.S. slump. This is probably the most important message from the stock market.
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