The debate over economic reform in Japan, especially the alleged need to force banks to dispose of bad loans, resembles the story about the hospital patient on life support because of a serious blood-circulation problem. One result of that problem is badly swollen feet. But the doctors can only focus on the swollen feet, which they amputate. They also want to terminate life support, claiming it did nothing to cure the feet.
Crazy? Of course. Yet this is how many of Japan’s top economists and commentators seem to think. The immediate cause of Japan’s current economic sickness should be obvious, namely the drastic fall in asset values, mainly shares and real estate, after the collapse of the bubble economy in the early ’90s. The long-term cause is a circulation problem — the chronic weakness of consumer demand compounded by a lack of investor confidence following the bubble’s collapse.
One result of all this is the swollen volume of bad loans held by banks. The government provides life support in the form of expanded public spending. However, the “doctors” who dominate the economic debate here insist that the main problem is simply those bad loans. Amputate them and all other problems will be solved, regardless of the fact that throwing the collateral for those loans on an already depressed market will cause a further fall in asset values, even more chain-reaction bankruptcies and an even greater loss of confidence. The patient will get worse rather than better.
The doctors want to get rid of the life support, too, on the grounds that it has been functioning for almost a decade and the economy is still sick.
Meanwhile — and as Richard Koo of Nomura Securities tried vainly to point out to some of the more vocal and dogmatic of the doctors in a recent TV debate — expanded public spending is more crucial now than ever, since spending by the corporate sector, which in the past made up some of the deficit in consumer demand, is also being cut in order to repay bank loans.
Many are worried by the high level of official debt — some 660 trillion yen. But given the low interest rates and the high volume of savings in Japan, there is still scope for more deficit spending by the government, hopefully of the confidence-building kind. Repayment of borrowed money can wait till economic recovery, as we saw in the United States.
But something must also be done about the collapse in asset values — the key both to the bad-loan problem and the loss of investor confidence. Some cry waste of public money whenever official intervention to prop up share prices is suggested. But Hong Kong government purchases of collapsed shares not only sparked recovery from the 1997 Asian financial crisis; the profits have financed much of the former colony’s budget ever since.
With real estate, we see the confidence problem in full force. Returns relative to current values are already very high — close to 10 percent, against interest rates of around 3 percent. But for Japan’s emotional investors — the people who during bubble times were willing to pay 10 percent interest on loans for property returning only 3 percent — even this incentive is not enough.
All the talk about bad loans has convinced them that prices will fall even further in the future. And to the extent that they do wait, their prophecies become self-fulfilling.
Some note how rapid intervention by the U.S. authorities to get rid of bad loans during the savings-and-loan crisis of the late ’80s created a bottom to real-estate prices from which the economy could later rebound. But Japan’s problems are much deeper than they were in the U.S., and the risks much greater, as anyone who checks the already crowded lists of court-ordered fire sales of bankrupt real estate will realize. Unlike in the U.S., real-estate values were allowed to underpin so much of the Japanese economy that any sharp fall creates a vicious downward spiral effect forcing further drops in land values and even more loans to turn bad.
The bankers and some in the government have long realized this dilemma, which is why from the start they have done what they could to postpone foreclosing on doubtful loans, to prevent the spiral from getting under way while waiting for an economic recovery that would automatically eliminate much of the bank debt problem. A rising tide can float a lot of stranded boats. And, but for the 1996-7 disaster, when a promising recovery was stopped dead in its tracks by the “doctors” convincing the politicians foolishly to cut public spending and to raise the confidence-killing consumption tax, it is quite likely they would have been proved right.
Today, however, the unrepentant architects of that disaster still criticize the bankers for their delay and seek a return to the very policies that caused that earlier disaster. They like to talk about the need to create some “pain” (“itami”) in the economy, as if the patient were simply malingering and a few quick amputations would soon get him back on his feet.
These people should be sent back to medical school.
Back in the 1930s, the U.S. needed almost a decade to realize that massive infusions of public spending, rather than fiscal and financial stringency forcing more firms into bankruptcy, was needed to overcome the Great Depression. But in those days the science of economics was just beginning. The mistakes in Japan’s economic policies today lack even that excuse.
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